• Home
  • About
  • Team
  • Contacts
  • Blog

Stability Unstable

  1. Home
  2. Blog
  3. Stability Unstable

Portfolio manager’s Letter June 2007

Stability Unstable

Stability Unstable

I have been studying economic cycles ever since I went to work for Merrill Lynch in 1967. At the time the Dow was approaching 1000 for the first time. The Market had been going up more or less steadily since the end World War II. The depression was a bad memory that existed only in the minds of old men and on the pages of text books. Economic cycles did not concern me because the depression was long gone and everybody knew that it couldn’t happen again. I was spending my time trying to figure out the fastest way to compound my customer’s money, and I had never heard of “Rule Number One”.

Business cycles and bear markets have been with us since birth of the market economy, and will continue as long as there are human beings participating in markets. In the 20th century we had the 1930s, and the 1970s. In the Nineteenth Century there was in 1873, a recession so severe that until the 1930s it was called the “Great Depression”. Then there was the panic of 1893 that drove unemployment to 18% and was thought at the time to be the worst economic crisis to hit the nation’s in its history.

Now we are 33 years out from the bottom of the last secular economic correction. It is easy to assume the economic cycle has been repealed by the Federal Reserve Board, a political agency that prefers soft landings a “Goldilocks Economy” and other fairytales. Certainly, we learned how to deal with depression in the 30s, and how to deal with double digit inflation in the 70s. If you were to say to me that we won’t have another depression 30s or inflation like the 70s. I would probably agree. But if you try to convince me that the economic cycle has been laid to rest you are going to get an argument.

As Hyman Minsky an economist popular in the 1970s postulated “stability unstable” this economic paradox exists, Minsky explained because long periods of stability lure investors, bankers, and businessmen into taking on progressively more risk. While our economic system is good at correcting past mistakes it is even better at inventing new engines of instability.

In 1967 the depression was ancient history, its causes were understood, and everything necessary to prevent a repeat was in place. Economists and security analysts issued forecasts based on what had been going on for the previous 10 years. But as it turned out the 10 years that followed did not look anything at all like what they saw in their rear-view mirrors in the late sixties. In the financial markets nothing that worked in the sixties worked in the seventies.

Unfortunately, it is impossible to predict when the next economic down cycle will begin, but it seems logical that farther out we get from our last learning experience, the more unstable our stability becomes. Risk grows with compliancy, the more comfortable we get, the more risk we accept.

Shanghai Market

The China Shanghai Composite Index it is up 52% so far this year and 300% since the beginning of 2005. The total number of A-share accounts in China is now approaching 90 million, 15 million more than a year ago. On May 20th the Chinese central bank raised their interest rate by .27% the next day the Chinese stock market responded by going up 1%.

The number of new brokerage accounts opened by retail investors in china in the first three weeks of April reached 2.8 million vs. 3.1 million in the twelve months of 2006. 310,000 new accounts were opened on April 18th. Volume on the Shanghai exchange in April was twice what it was in January, and seven times larger than it was in the same period a year ago. Things have gotten so bad there; that now Even Alan Greenspan can see a bubble (perhaps his vision has improved now that he has left his government job).

Rule Number One

In my opinion the most interesting nugget to come out of the Berkshire Hathaway and Wesco Annual Meetings this year was something Charlie said in relation to the interpretation of “Rule Number One.” I had always considered Warren Buffett’s edict to “never loose money” as more of a guideline than the rule. Sure it’s better not to lose money, and so it’s important to be very careful about value when you open a position.

But everybody takes losses, you know, “take your losses, let your profits run” yada yada. I had always considered it good conservative management policy to take a small loss if the position started to go against you, and you couldn’t see exactly where the bottom was going to form.

But, in one of the transcripts I read, I think it was from the Wesco meeting, Charlie was quoted as saying he doesn’t remember Warren Buffett ever taking loss. Wait a minute, Fifty years, and he’s never taken a loss? I thought to myself, that can’t be, Charlie is getting senile, everybody takes losses.

Then I started to think back over the years that I have followed Berkshire Hathaway and tried to identify an equity purchase that ended in loss, and I couldn’t do it. Sure there were losses, USAir for a while, but they ended up smelling like a rose. USG corporation, they bought before the bankruptcy and held it as the stock went to single digits and stayed there for a couple years. But look at it now.

I even went back to my early years of following Berkshire Hathaway, and identified Warren Buffett copycat positions that I’d taken that didn’t work out for me. But with these positions, I bought too late and sold to early. I would buy after Warren Buffett’s purchase had been announced, so I was always buying at a higher price than Berkshire Hathaway had.

If the stock went against me, I would take my small loss, out of fear of having to take a bigger one later. But, I doubt that Berkshire Hathaway ever took a loss on any of the positions they held. We do not have very good information on the stocks Warren Buffett bough in the early eighties. But if Charlie says they were profitable I will take his word for it.

Then I began to think about my own ideas. I have been very careful in valuations. And I haven’t had to take many losses. Most of those losses occurred because, like many value investors, I tend to buy too early. The stocks reach a point were I feel, they are good value, but continue to drift down after I take a position. Then if this goes on for a long time, I get impatient, or I get nervous. I still like the stock, but I think to myself “If I take a small loss now, I can do something else with the money and get back in later, maybe at a lower price.”

The funny thing is it never works out. Maybe the stock does nothing for six months, but I never get back in, and eventually the stock starts to rally. So if I had just had more patience, or if I had more faith in my original purchase, the position would have been profitable.

So is “Rule Number One” really meant to be taken literally? Is it possible to go through life without ever taking loss? If you’re Warren Buffett, clearly the answer is yes. In my case, maybe I can do better in the future. From now on I plan to take “Rule Number One” more seriously. This may mean that I will pass up some marginal opportunities, but maybe this is the whole point.

“Rule Number One” Rules

  • Don’t buy stocks that make you nervous.
  • Be patient
  • Be patient

The key is the first of the above rules. It means that you buy a stock only if you are willing to add to the position if the stock continues to go down. It requires that the stock not only be a good value today, but it also means that you are convinced the company has limited downside risk even in a really bad recession. It means you have been able to identify a deep and durable moat.

Of course, this is going to limit your activity. For example, at today’s prices I can think of very few stocks, other than Berkshire Hathaway (and maybe a few of Warren Buffett’s recent buys) that would not make me very nervous in the event of a serious economic contraction.

Current Market

This year is starting out pretty much like last year, only worse. Last year Berkshire Hathaway rallied at the end of the year, and we ended up beating the S&P 500 marginally. I do not know if the same thing will happen this year, but as market continues to work higher, I will be very happy with a result similar to last year.

Losch Management Company has structured our portfolio’s to out perform in a bear market so staying even with the averages is about the best we can hope for in an up market. Losch Management Company continue to feel this is a high risk market and that our main objective must remain the preservation of capital.

06/01/2007



Leave a Reply Cancel Reply

Your email address will not be published.


Comment


Name

Email

Url


Blog Archive

2020

  • The Stock Market

2019

  • Behavioral Investing

2018

  • Trumped
  • Warren Buffett vs Wall Street
  • Globalism, 1982-2000 Bull Market

2017

  • Volatility Underlying Calm Market
  • What’s new with CB&I?
  • Passive Investing
  • Economic Cycles
  • Current Stock Market 2017 Comment

2016

  • Global Plastics Summit Highlights
  • Value Investing vs Index Investing
  • How to Play an Index Bubble
  • Successful Investors
  • Is the Market Overvalued?
  • Operating Earnings
  • Article by investment manager in Bay Hill Living
  • Building Foundation

2015

  • 3G Culture – Dream Big
  • Myopic Loss Aversion
  • CBI Nuclear Energy
  • St Joe Company
  • What’s in a Word? Plastics.
  • Are Bonds Safer Than Stocks?

2014

  • Chicago Bridge and Iron
  • CAMEX 2014
  • Global Economy October 2014
  • Fluor Corporation
  • Interesting Quotes from Daily Journal Annual Meeting
  • The Daily Journal Annual Meeting
  • Albemarle Corporation
  • Triumph Group
  • The American Energy Revolution
  • Singapore

2013

  • St Joe Company Update
  • Hedge Fund Managers
  • Triumph Group Inc.
  • Bitter Brew
  • An Antifragile Portfolio

2012

  • Leucadia National Corporation
  • This Time it is Different
  • Successful traders psychology
  • St Joe Company
  • Learning from Pain

2011

  • Long Cycles – Part II
  • Long Cycle
  • Nasty Month for Market
  • Make a Buck with Fortescue Metals Group
  • Berkshire Hathaway Look Through Earnings
  • St Joe Company Inc
  • Successful Investment Management
  • A Look Into Latin American Market
  • The Mother of all Quarters
  • 2010 Investment year results

2010

  • Fault Lines
  • US Market 2010
  • Berkshire Hathaway Third Quarter 2010
  • The Stock Market 2010
  • Berkshire Hathaway Second Quarter 2010
  • Berkshire Hathaway Performance
  • Long Term Greedy
  • Goldman Sachs
  • Berkadia and Leucadia
  • USG corporation
  • Berkshire Hathaway 2009 2010
  • Why Capitalism Works

2009

  • The Lords of Finance
  • The $44 Billion Dollar Train Set
  • Berkshire Hathaway 3rd Quarter 2009
  • Career Risk for Investment Manager
  • Berkshire Hathaway financial statements
  • Berkshire Hathaway Preferred Stock
  • Moral Hazard
  • Credit Default Swap
  • The Shadow Banking System
  • Learning Things the Hard Way
  • Our C-System
  • 2008 Investment results

2008

  • Investment Risk
  • Bear Markets
  • Generational Events
  • Orange sheets – Money is doing better
  • Inflation Not The Problem
  • Tipping Point
  • Long Term Capital Management
  • Financial Insurance
  • Western Refining Inc
  • Berkshire Hathaway Year To Date
  • Berkshire Hathaway Cash Flow
  • 2007 investment results

2007

  • Investment results 4th Quarter 2007
  • Greenspan on Inflation
  • Berkshire Hathaway Third Quarter 2007
  • Berkshire Hathaway Operating income 2007
  • Berkshire Hathaway Hedge Fund
  • Leveraged Buyouts
  • Stability Unstable
  • Weak Dollar
  • Berkshire Hathaway Chairman’s Letter
  • Steel Dynamics
  • Breakwater Resources
  • 2006 Investment year results

2006

  • New Investment Stocks
  • Equitas
  • Berkshire Hathaway Third Quarter 2006
  • Hurricane Synergy
  • Berkshire Hathaway Second Quarter 2006
  • Fat Pitch
  • Perfectly Obvious
  • Berkshire Hathaway Growth Rate
  • Berkshire Hathaway First Quarter 2006
  • Berkshire Hathaway Annual Report 2006
  • Inflation Is
  • 2005 Investment year results

2005

  • Exogenous Events
  • The Easy Money
  • Look-Through Earnings
  • High-Risk Mortgages
  • Unintended Consequences
  • Rydex Ursa Fund
  • Warren Buffett Premium
  • Private Equity
  • Latticework Mental Models
  • Buffett’s Lackluster Performance
  • 2004 Investment year results
  • Professor Smith’s Second Bubble

2004

  • Hedging Currency Disaster
  • Risk Assessment
  • Too Many Bears
  • The Chinese Century?
  • Patterned Irrationality
  • Timber
  • Costco’s Cash
  • Physics Envy by Charlie Munger
  • Asset Allocation Berkshire Hathaway
  • The Balance of Payments
  • 2003 Investment year results

2003

  • Hedge Funds
  • The trade deficit is not debt
  • Secular Bear Market
  • Which Index Funds?
  • A Different Drummer
  • Costco’s Float
  • The Power of Float
  • Berkshire Hathaway Annual Meeting 2003
  • Psychology of Human Misjudgment
  • Sitting on the Sidelines
  • Berkshire Hathaway intrinsic value
  • 2002 Investment year results

2002

  • Insurance company Moats
  • Bond Bubble
  • Berkshire Hathaway Cash Flow 2002
  • Behavioral Economics
  • The Bear Market 2002
  • Greenspan Put
  • Second Quarter Cash Flow at Berkshire Hathaway
  • Berkshire Hathaway Annual Meeting 2002
  • Red Wire – Green Wire
  • Stupid FED Tricks
  • The Bottom Line
  • 2001 Investment year results

2001

  • Don’t Fight the FED
  • Buy and Hold? – It all Depends
  • Ben Laden and Berkshire Hathaway
  • The Dinosaurs Dance
  • Costco Moat
  • Bubble Watching
  • Sit on your Ass investing
  • Berkshire Hathaway Annual Meeting 2001
  • Carnival Cruise Lines
  • 450000 Square Ft Furniture Store
  • Lunch Money Indicators – Annual report
  • Other People’s Money

2000

  • Bear Tracks
  • Build It and Money Will Come
  • Efficient Stock Market
  • Style Drift
  • Lunch Money Indicators – Options
  • Identifying Problems
  • Small Retail Stocks
  • Charlie Munger comments
  • Big Al and the Bubble Machine
  • Berkshire Hathaway Cheap
  • Index Funds
  • 16 rules for investment success
Make an appointment or contact us by phone: +1 (689) 246 49 49
© 1999 - 2022 Losch Management Company
Support by Global AGM