Dennis C. Butler, President
of all guest columns written by Dennis C. Butler, CFA
U.S. stocks rose, fell, and rose again during the quarter just ended, amidst much hand-wringing over interest rates and corporate earnings. For those who look to the financial markets for entertainment the real excitement occurred abroad, in Asia, where a few stock markets lost 50% in U.S. dollar terms. Also of interest was the sudden fall from grace of some of the big-name companies -- Coca-Cola, General Electric, etc. -- that only weeks earlier had been favored by investors for their superior "relative strength" (that is, their stock prices had risen faster than those of most other companies). These fickle market participants discovered that the stocks of smaller companies had taken the lead. To our point of view, the most interesting event of the quarter was the precision landing of robot craft on Mars. In stark contrast to the investment business, the Mars landing demonstrated what can be accomplished when one sets an objective and, aside from a few mid-course corrections, sticks to it.
Timing the Market
As investors we believe in keeping things simple. We consider ourselves as part owners of the businesses whose securities we purchase. We make our purchases when the businesses are undervalued in the public marketplace. We ordinarily hold our investments for long periods, sometimes for many years. If we cannot find securities that meet our criteria for purchase, we are willing to wait until appropriate candidates appear, whenever that may be. Other considerations are not germane to what we do. For example, we have no idea when the current bull market will end. Mutual fund cash flow data hold little interest for us. Whether or not the el niño weather pattern will impact world commodity prices is not something we feel competent to judge. Neither is the apparent cyclicality involving large and small capitalization stocks (alluded to above) something we can comment cogently upon. These subjects make for interesting conversation and fill endless columns in newspapers, but to take them seriously in investment decision-making complicates the process unnecessarily.
Despite its simplicity, this investment approach has implications that give rise to a surprising amount of confusion and misinterpretation. Foremost among them is the possibility of holding cash (meaning money funds or short-term fixed-income securities) in an account designated for equity investments. This particular issue came up recently when we spoke to a colleague about the difficulty of finding good investment ideas and casually remarked that we would place a large portion of new money intended for equity investment into treasury securities until something better came along. Our friend replied: "If that is the case, why hold any stocks currently? If cash is preferable to buying stocks at current prices, then why isn't cash also preferable to holding onto the stocks you already own? Furthermore, if this analysis is true...and everything should be sold now because of inflated prices, then isn't that similar to ‘timing the market'?" We were amused at this argument since market-timing is a dubious activity that couldn't be further from our thoughts, not to mention inconsistent with our basic investment principles.
We were not surprised, however. Questions such as these reflect attitudes prevalent in the investment community and the financial press, including a focus on market fluctuations and a fascination with stocks as trading vehicles. As part owners of businesses our views of the stock market are quite different. We are not interested in short term price changes. Under ordinary circumstances we do not intend to sell our positions, and may very well add to them if prices were to drop to a level representing a large enough discount to what we know the businesses to be worth. The idea of catching short-term peaks and troughs in our companies' stock prices -- "buy low and sell high" -- is very difficult to execute and not advisable for serious investors. Our discipline requires us to purchase undervalued securities, not create uniform portfolios for all clients (some consistencies really are foolish). So, new clients may very well hold cash or securities not held by more seasoned clients. Note also that this approach to stock ownership presupposes a very long term perspective and is not suitable for those worried about short term "performance."
The willingness to hold cash is particularly vexing to those for whom short-term performance is critical, namely many in the investment business (although we suspect feelings on this subject are highly correlated with the trend of stock prices). These professional investors are motivated by a different pattern of thinking than that represented by our friend above. Holding cash in a rising market is a drag on results. Since most investment managers are in competition with each other for customers, and the basis for the competition is by and large short-term returns, the amount of cash in a portfolio can be a significant competitive factor -- for better or worse. Consequently, there is enormous economic pressure within the business to maintain a "fully invested" posture at all times, whether or not such commitments make sense purely from an investment standpoint. The official justification for this policy maintains that since effective market-timing is impossible, being fully-invested permits the investor to benefit from the long-term upward trend in stock prices. We suspect, however, that the fear of missing a short-term market move figures prominently in these calculations. The real test of this approach will come when the markets fail to move inexorably upward.
In our case, holding cash reflects neither a strategic move nor a lack of interest in achieving good investment results. What may have the appearance of market timing is in fact the result of a fruitless search for good investment value and an unwillingness to take risks that do not make sense to us. In our view a policy of being fully invested is as silly as one of actively allocating funds among cash and securities depending on one's outlook for each asset class. Both distort the investment process by distracting investors from what should be their primary focus -- investment value -- and adding risk and costs. To the degree that they permit market considerations to intrude upon decision-making, they also tend to rob investors of their independence of judgement. As Roger Lowenstein of The Wall Street Journal said in a recent article: If the investment manager "lets the market substitute its judgement for his, why be in business?" If this is market timing, we plead guilty.
Early last year the press reported the story of a woman who upon her death left twenty million dollars in stocks to a university. A recluse, she had embarked upon her investing career in the mid-1940s with a sum estimated at about twenty thousand dollars. She seldom sold anything and some of her shares had been held for over fifty years. In some respects this very successful investor was lucky since she happened to buy the stocks of companies that enjoyed enormous prosperity during the postwar period. Also, given the time period during which she began to accumulate her portfolio, she probably paid very reasonable prices for some of her largest holdings. Nevertheless, her example provides important lessons for all investors. She was not swayed by passing economic developments or market emotion. She ignored market forecasts and all manner of Wall Street opinion. She held on to her investments through wars both 'hot' and 'cold,' and markets both bullish and bearish. She also robbed the IRS of millions of dollars in taxes and brokers of untold amounts of commissions. We know of no better argument for keeping things simple.
Dennis C. Butler, CFA, is president of Centre Street Cambridge Corporation, investment counsel. He has been a practitioner in the investment field for over 23 years and has been published in Barron's. He holds an MBA from Wharton and a BA in History from Brown University. His quarterly newsletter can be found at www.businessforum.com/cscc.html.
"Current low valuations reward the long-term view", an article by Dennis Butler, appears in the May 7, 2009 issue of the Financial Times (page 28). "Intelligent Individual Investor", an article by Dennis Butler, appears in the December 2, 2008 issue of NYSSA News, a magazine published by the New Yorks Society of Security Analsysts, Inc. "Benjamin Graham in Perspective", an article by Dennis Butler, appears in the Summer 2006 issue of Financial History, a magazine published by the Museum of American Finance in New York City. To correspond with him directly and /or to obtain a reprint of his featured articles, "Gold Coffin?" in Barron's (March 23, 1998, Volume LXXVIII, No. 12, page 62) or "What Speculation?" in Barron's (September 15, 1997, Volume LXXVII, No. 37, page 58), he may be contacted at:
Dennis C. Butler
Centre Street Cambridge Corporation
Post Office Box 390085
Cambridge, Massachusetts 02139
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© Copyright 1997 Dennis C. Butler, All Rights Reserved
Revised: October 14, 1997 TAF
© Copyright 1997 Dennis C. Butler, All Rights Reserved