become, we were concerned enough to have sold two former favored stocks and long- term holdings, Freddie Mac & Fannie Mae (sold in 2003 & 2004) at substantial profits. The following year we noted that while generally speaking, the market looked fairly valued to us, several high-quality blue-chips appeared to be favorably priced. Specifically, we singled out Anheuser Busch (acquired, + 70%), Coca-Cola (+42%) and Johnson & Johnson (+5%). The characteristics these stocks all had in common were reasonable stock prices, very good business franchises and dividend yields approaching or in excess of three percent that were likely to continue growing into the future. Also highlighted that same year was the recent run-up in short-term interest rates and the recommendation to purchase short-dated (2-3 year) treasuries then yielding near five percent.
Almost as important as having the correct “toolbox” with which to analyze securities is having the proper temperament. We wrote about this subject at length in our 2006 client letter. We pointed out that the corrosive impact of emotions on the investment decision making process could not be overstated. That fear and greed and Wall Street’s willingness to eagerly cater to both had a lot to do with the poor performance investors often experienced in their own portfolios. As we were to find out, emotions would play an important role in subsequent years.
Our two most recent pieces of correspondence were written in the middle of the recent financial panic, in October 2008, and last year’s client letter written in February 2009 while stock prices were still declining. While the magnitude of the meltdown surprised almost everyone, we were fortunate enough to have entered the crises with large cash positions in our managed accounts and thus were able to take advantage of the severely depressed prices in the securities markets. Although our account values were obviously impacted by the large declines in prices, we were fairly certain that the entire system wouldn’t collapse and that we were buying securities at levels that would prove to be very rewarding. Many high quality businesses were priced at levels not seen in years. Similarly, high quality bonds, issued by conservatively operated and financed businesses, and in some cases municipalities, were available at double-digit yields. This was not the time to be a seller.
As of this writing, a large rally has indeed occurred. With respect to stocks, the market has rallied sharply off its March 2009 lows. In the fixed-income arena, the rally in the bond markets began several months earlier with large price gains and declining yields taking place in December 2008 and continuing to this day. It’s worth noting that at these inflection points (before large declines or big rallies), no one ever rings a bell telling you to buy or sell because securities are over or under-priced. These decisions are made using judgments. Often, those judgments may differ markedly from the then prevailing conventional wisdom.
By and large we are proud of the judgments we have made over the past decade and the outcome achieved as a result of them. Among his many brilliant observations, the economist John Maynard Keynes once commented “It is better to be approximately correct than precisely wrong”. We feel the same way when it comes to managing money.