First Quarter 2010 Letter to Clients

This past quarter – March 9 to be exact – marked the one-year anniversary of the bottom of the 2007-09 bear market, when the Dow Jones Industrial Average hit a low of 6,547.

From its record high of 14,164 on October 10, 2007, the Dow declined 54%. It was the second-largest decline in the U.S. stock market’s history, eclipsed only by the 1929 market crash.

During the midst of the turmoil, the experts admonished us not to cling to the naïve hope that we would enjoy a “v-shaped” market recovery. Rather, the Great Recession, as they dubbed it, would be more of a protracted, u-shaped kind of thing, with the U.S. economy bumping along the bottom of the economic cycle and holding the stock market there with it. Ultimately we would crawl out of the abyss, they said, but it would take years and years.

It is instructive – predictable, even – that we sit here today, a mere thirteen months later, looking back at a very pronounced V in the market recovery:

The market rally has been nothing short of astounding, confounding the experts at every turn. Through early April the Dow is up more than 75% from its bear-market low and has retaken the 11,000 threshold. It has been the strongest market recovery since a 100% gain coming out of (you guessed it) the 1929 market crash.

We do not presume to sound the “all clear” bell. Perhaps the ultimate shape of this recovery will be a W, but the fact remains that a U it was not. And the real lesson in all of this is that the conventional wisdom of the experts is, in reality, anything but wise. The talking heads are always building their story around what is and projecting that into the future. But that has absolutely nothing to do with what will be.

For a well-diversified investor, the hardest thing to do during times of market turmoil is to do nothing when all those around you are busy doing something. Ironically, though, it was those who did something who did untold damage to their investment portfolio. It has taken only 18 months to regain the ground that was lost during the Panic of 2008 and return us to pre-Lehman levels in the stock market – if you were in the market for the recovery.

We often speak of successful “long term” investing, and it is true that investors have to keep a long-term perspective in order to be successful. But within that context is a deeper reality: A great deal of investment success is dependent on how the investor handles the crisis moments – the “blink moments,” as we call them – that come along periodically in one’s investment life. Moments like the fall of 1999, when many dot-com stocks routinely gained 300% and 400% in just a few months’ time and it seemed as though free money was being made. And moments like the first week of October 2008, when the Dow dropped more than 3,000 points in only six trading sessions.

Staying the course is easy in theory, but rare in practice. As Warren Buffett so aptly put it, “Much success can be attributed to inactivity. Most investors cannot resist the urge to buy and sell.”

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Sadly, it is becoming very clear that the Average American Investor was not, in fact, in the market for the epic rally, as a March 23 story on Bloomberg.com made clear.

The article, entitled “Americans Say They Missed 73% Rise in S&P 500 As Economy Surged,” reported on a Bloomberg poll in which only 3 out of 10 Americans said the value of their investment portfolio had increased in the past year.

Think about that for a moment. The S&P 500 has gained about 75% since its market bottom, and many other asset classes have gained more than that, some into triple digits. And yet, if this article is to be believed, some 70% of our fellow citizens say their investments have gained no ground in the past year.

So…what is the only asset class that has made virtually no money in the past year? Cash, of course – the supposedly “safe” investment during the market meltdown, which proved to actually be the least safe investment of all. Clearly, the great majority of Americans fled the market and are still hiding out in cash while the market delivers once-in-a-lifetime gains.

It is a sad story, but a predictable one. The well-established tendency of individual investors is to buy high and sell low, and it is becoming clear that this pattern repeated itself with a vengeance in the past three years.

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Another intriguing article, this one in The Wall Street Journal, offered an interesting take on why, in the author’s opinion, the huge stock market rally is not the end but rather the beginning of a long run of corporate productivity. Entitled “Dow 11,000 Is Only the Beginning,” the article makes a compelling case that there is more in the global economic landscape to propel the markets forward than back:

U.S. corporate balance sheets are as flush with cash as they've ever been, in the neighborhood of $2 trillion. Conservative and cautious, companies haven't been quick to spend that stash. They haven't been buying back stock (which would be good for the market); they haven't been undertaking aggressive spending (good for other businesses); they haven't boosted dividends; and they haven't been hiring. But those trillions will be spent, on mergers, acquisitions and capital spending. With trillions on the sidelines, there is fuel to move markets higher.

Then there is the global growth story, which is revolving around China but includes Brazil, Canada, Australia and many parts of East Asia. There is also strong positive momentum developing in India, and cash is once again piling up in the sovereign wealth funds of the oil states of the Middle East. That growth is generating cash, which is looking for return. The China Investment Corporation recently released a list of its holdings, which showed that it had begun to invest—albeit very quietly—in U.S. stocks ranging from Apple to Coca-Cola. That is a harbinger.

In short, much of our economic data doesn't matter to the prospects for the market. Corporate profits themselves bear more relation to an increasingly complex and interlinked global system than they do any national economy.

Companies go where the growth is, and with leaner inventories than the world has ever known and sparser work forces, they can make profits even when national economies sputter.

-- Zachary Karabell, “Dow 11,000 Is Only the Beginning,”
Wall Street Journal opinion page, April 7, 2010


Whether or not the author’s bullish prediction proves to be right in the near term, he makes a compelling point about the nature of today’s global economy. Thanks to technology, national borders are no longer barriers for the world’s corporations, and an economic downturn in one country – even one as dominant as the United States – does not spell certain doom for the companies that reside, on paper at least, within its borders.