Second Quarter 2016 Letter to Clients

The United Kingdom’s surprise vote to leave the European Union last month shocked the global financial system and sent stock markets around the world into a steep two-day decline.

The so-called “Brexit” referendum was hard proof of the old adage that “the stock market hates uncertainty.” By the same token, however, the market’s rapid recovery in the weeks since the initial downturn has confirmed another old adage: “stocks climb a wall of worry.”

Predictably, market pundits rushed to out-prophesy each other after the Brexit vote about how fast and far stocks would fall. The real doom-and-gloomers urged investors to shed their equity holdings and seek shelter in “safe” assets like gold and Treasury Bills until the carnage had run its course.

Suffice it to say the market ran a much shorter course than the pundits expected. Investors who followed their advice and sold their equities have watched the market pass them by and, as of this writing, attain record highs.

Where the market heads from here is, of course, anyone’s guess. Volatility will return to stocks in time, as it always does. But the rapid turnaround the market has experienced in recent weeks should underscore to all investors that the very last place anyone should get investment advice is from those claiming to know the near-term direction of the stock market.

This seems a good time to dust off one of our favorite Warren Buffet quotes from a half-century ago, when the Dow was below 1,000:

After the Dow declined from 995 at the peak of February to about 865 in May, I received a few calls from partners suggesting that they thought stocks were going a lot lower. This always raises two questions in my mind: (1) if they knew in February that the Dow was going to 865 in May, why didn’t they let me in on it then and (2) if they didn’t know what was going to happen during the ensuing three months back in February, how do they know in May? There is also a voice or two after any hundred point or so decline suggesting we sell and wait until the future is clearer. Let me again suggest two points: (1) the future has never been clear to me (give us a call when the next few months are obvious to you- or, for that matter the next few hours); and, (2) no one ever seems to call after the market has gone up one hundred points to focus my attention on how unclear everything is, even though the view back in February doesn’t look so clear in retrospect.

-- Excerpt from Warren Buffet’s 1966 Berkshire Hathaway Client Letter

That the Oracle of Omaha’s observation is as appropriate today, at Dow 18,000, as it was fifty years ago at Dow 1,000 speaks to its eternal truth. No one knows what the future holds; it’s only in retrospect that anything about the short-term behavior of the market is clear. And until someone invents a way to go back in time and adjust their investment strategy accordingly, making changes to one’s investment strategy based on unknowable future events will always be a loser’s game.

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We must confess that we sometimes feel like a broken record harping on the media’s role in stoking the fears of investors in times of volatility. Truth be told we sometimes wonder if we beat that drum too hard. And then we read articles like the one we saw on the CNN Money website in the midst of the Brexit market selloff, and we feel compelled to beat the drum even louder.

Consider just the lead paragraph from the offending article:

A record $3 trillion was wiped out from global markets on Friday and Monday. That means more money was vaporized as a result of the Brexit crash than in any previous two-day period ever. (Source:, June 28, 2016; emphasis ours).

Note, in just those two sentences, how many emotionally charged words the writer throws at the reader. “Wiped out.” “Vaporized.” “Crash.” “Ever.” Who wouldn’t read that and get a panicky feeling?

Let us spend a moment, then, parsing all the ways this one paragraph misled investors during the midst of the market downturn:

1. It is our understanding the phrase “wiped out” means “gone forever.” And yet the Dow Jones Industrial Average was back to its pre-Brexit level within 10 trading days. Somehow we must have missed the follow-up article about the market “wiping in” the previously wiped-out $3 trillion.

2. The reason more money was “vaporized” (and of course it wasn’t vaporized at all) in the Brexit selloff than in any previous two-day period “ever” is a function of valuation, not volatility. Global stock market capitalization (the total value of all publicly traded companies on the world’s stock exchanges) is higher than it’s ever been. Therefore, a $3 trillion sell-off at 2016 levels is a far cry from a similar selloff in, say, 2009, when global market capitalization was a third of today’s levels.

3. While there is no technical definition of a stock market “crash,” conventional wisdom holds that a crash occurs when the market experiences a sudden and historically significant downturn and remains down for many months and even years thereafter. Notable examples include 1929, 1987 and 2008.

In this context, the market sell-off in the two days after the Brexit vote was no crash at all. The total percentage decline in the Dow over those two trading days was 4.83%. That decline wouldn’t even make the top 20 worst single-day declines in the Dow’s history.

Note that we are not giving the “all clear” signal as it relates to the Brexit impact on the stock market. We are still very much in the midst of this event and it’s impossible to predict how that event will influence the market in the weeks and months ahead. But it’s worth noting the way that the financial media preys on all of our emotions in times of turmoil to draw eyeballs to their newspaper articles, websites and TV shows.

It may seem counterintuitive, but the truth is the best thing you can do when volatility seizes the stock market is to turn off the news. Your portfolio will thank you for it later.