Portfolio manager’s Letter August 2002
It is now generally accepted that this Bear Market began with the peak of the tech stocks in March 2000. While Losch Management Company’s average managed account is down 7.3% from the first of the year, that compares to a decline of 19.5% for the S&P 500 and 31.9% for the NASDAQ. In addition, Losch Management Company’s record for the entire Bear Market is much better.
From March 31, 2000 to July 31, 2002 the composite return for Losch Management Company’s managed accounts was a plus 27.4%, while the Wilshire total Market index has shown a decline of 39.7% and the NASDAQ is down 70.9%. Normally I would consider it impossible to beat the big indexes by this sort of margin, but these clearly are not ordinary times. While, this performance is probably not a testimony to management genius, it is clearly a documentation of the insanity that prevailed on Wall Street two and a quarter years ago for the bear market. I thought it might be interesting to explore some of the reasons behind these results.
The truth is, it has been fairly easy to beat the market over the course of this bear market, all you had to do, was to be willing to move in the opposite direction of the big money, and listen to Warren and Charlie. Specifically, this record is the result a few simple decisions:
1. First of all by January of 1999 we held no Tech stocks. After attending annual meetings since 1992 it had finally dawned on me that Warren Buffett’s aversion to Tech was not really based on his lack of understanding of Technology, but his belief that it was impossible to make meaningful long term predictions. Besides, by the summer 1999 the valuations were absurd. Mr. Market was paying a huge premium for uncertainty; his chronic bi-polar personality had turned him stupid.
The popular misconception that Warren Buffett would not buy tech because he was a technophobe was a widely held, and I suspect to some extent, cultivated by Mr. Warren Buffett. Like any good negotiator he wants people to underestimate him. In any event he made no public attempt to correct this impression until recently, but several times, at Annual Meetings prior to 1998 he explained this distinction to the shareholders in attendance.
This was a decision (not to hold tech stocks) that was painful in 1999 and early 2000 (lots of calls from clients wanting me to buy various tech stocks) but worked out well in the bear market.
2. As the tech stocks ascended into orbit until the bear market 2002 money was being sucked out of old economy stocks and we were able to buy companies like Berkshire Hathaway, Costco, Sealed Air, Heartland Express, Tidewater, and Fossil at very reasonable prices, and it is those purchases that have provided the positive returns of the last two years.
3. Finally there was the decision to build our position in Berkshire Hathaway over the last year to 35% to 45% of most portfolios. The logic being that a declining market would eventually increase Berkshire Hathawa’s intrinsic value and the hard market in the insurance business would help the bottom line for the next year or two. By the middle of last year most of the small value plays were gone, and until the last month or so Berkshire Hathaway was one o very few American companies I felt comfortable putting money into.
A look back now shows that Losch Management Company’s record could easily have been substantially better if your investment manager had been less encumbered by certain prejudices. A prejudice against paying taxes prevented the liquidation of some low basis Home Depot positions because of the large tax bill the sale would have generated. This was in spite of a PE ratio that was in the high seventies at the end of 1999. The bear market 2002 was responsible for this expensive mistake for long term accounts.
An inclination to hold on to good stocks that worked well in the nineties has cost us money in the last two years. In the nineties if you sold any of your goods stocks it was a mistake because the market never gave you a chance to get back in. Lately the opposite is true, and a decision not to sell even your best stock means that sooner or later you get to watch the gains disappear.
I do not expect the current market environment to change any time soon. The last secular Bull market lasted for 18 years (from 1965 to 1982), so the current roller coaster could easily last another five or ten years. In the nineties it was possible to beat the market by simply buying and holding good companies. But this is a very different market; once the bear market 2002 is over, the market is likely to favor a more traditional value approach. Buy stocks only when there is a significant discount to value and sell the position when the stock approaches full value.
What this is likely to mean is that as we go forward from here, you will see more activity in your accounts than you did during the bear market 2002.