Portfolio manager’s Letter December 2008
Buffett says when it comes to investing in stocks, that you “pay a high price for a cheery consensus”, and most of us have been around long enough to have witnessed the demonstration of this principal on quite a few occasions. Investment risk is never what it seems.
In June 2007 investment risk premiums on all manner of debt instruments were practically at zero, a demonstration that investment professionals throughout the world saw little investment risk in financial markets. This perception was almost universal. It was common to Large Institutions and small individual investors, yet as we look back today it is easy to see that the truth was exactly the opposite. Real investment risk was the highest it had been in a generation or more.
The current investment market has discounted a great deal of disaster. Mr. Market appears convinced that we have gone off the cliff and that a great deflationary chasm lies beneath us. So, today the perception of investment risk by the people listed above is the opposite of what it was in June of 2007, yet chances are they are just as wrong today as they were then, logic and mathematics would suggest that the actual risk inherent in most equity investments today is lower than it was a year and half ago.
After all stock prices have declined 40% to 50% from their highs. So as panic grips the market place we are getting paid a lot more to take on investment risk at a time when the actual risk that we face is lower than it has been for a long time.
I do not know if the $700 billion TARP; and the 2,922% expansion of the FED’s balance sheet is enough to ward off a deflation; but I do have almost absolute faith in the ability of the people in charge of our fiscal and monetary policy to keep printing and spending money until they are sure that they have done enough to ward off the great depression II.
A short six months ago the Market’s main concern was inflation, today Mr. Market it is certain that we are face a deflation, but likely as it is that today’s mind set will keep the politicians pumping until they have rescued us from deflation, it is probably also a given that they will overshoot, and the sooner or later the cure will become the problem by causing the inflation monster to reappear.
When this happens, it is likely that all the money currently rushing away from risk and into U.S. Government debt will start rushing in a different direction (back into equities). And that today’s “risk free return” (US T Bills) will become next year’s “return free risk”.
It appears that Mr. Market, in addition to his previously diagnosed case of by-polar disorder is now showing symptoms of short term memory loss. The old fellow appears to have forgotten the name of the chap in charge of our central bank. The rush by institutions (foreign and domestic) to give money to the U.S. Government in exchange for a promise by that government to pay back less in real money than they receive would seem strange indeed even if the man sitting at the controls of the nation’s money machine were not named “Helicopter Ben”.
“Helicopter Ben” (bless his heart) has been kept quite busy lately in a herculean effort to live up his name. In the past three months the FED has increased the asset side of its Balance Sheet by an amount that is totally without historical perspective.