Does Progress Depend on Being Unreasonable?
Legendary investor, Benjamin Graham (1894-1976) is widely considered the father of two fundamental investment disciplines: security analysis and value investing. In his 1974 seminar entitled “The Renaissance of Value”, Graham states:
“The title of this seminar … implies that the concept of value had previously been in eclipse in Wall Street. This eclipse may be identified with the virtual disappearance of the once well-established distinction between investment and speculation. In the last decade everyone became an investor – including buyers of stock options and odd-lot short sellers. In my own thinking the concept of value, along with that of margin of safety, has always lain at the heart of true investment, while price expectations have been at the center of speculation.”
The quote and corresponding letter are from the semi-annual report of investment firm Tweedy, Browne Company. Madison views Tweedy, Browne’s semi-annual communication as a must-read given the wealth of knowledge and historical perspective it provides on markets. Below are several tidbits from their most recent semi-annual communication that we find compelling given the parallels between the underperformance of “value stocks” versus “growth stocks” over the better part of the last decade.
“As we mentioned in one of our previous letters, the last time technology stocks were in such ascendency back in early 2000 (the last time we felt as badly as we do today), Barton Biggs, the renowned equity strategist at Morgan Stanley at the time, provided the following admonishment to investors: ‘Don’t despair on value, and for goodness sake don’t fire value managers now and hire growth firms. In fact, the rational brave fiduciary with a contrarian bent should be doing just the opposite.’ He wrote these words just two weeks before the technology bubble burst in late March of 2000, heralding in a period of significant outperformance for the beleaguered value strategy.
If we look back even further in time, there have been other periods that come to mind where value investing underperformed for uncomfortably long periods, including, among others, the period leading up to the dot-com bubble of 2000, and the “nifty fifty” era between 1965 and 1973. We should not lose sight of the fact that both of these challenging periods for value were followed by long periods of outperformance for value. The lumpiness of value’s return stream over time reminds us of Warren Buffett’s comment in Berkshire Hathaway’s 1996 Annual Report regarding the ‘gyrations of Berkshire’s earnings … Charlie and I would rather earn a lumpy 15% over time than a smooth 12%.’
The upside down nature of today’s investment markets has produced confusion and at times bewilderment among many investors. But the markets have also been able to assuage investor concerns with ever increasing valuations on risk assets, bonds and equities alike. Ten years into this market advance, with valuations on quality risk assets at above average levels, and a whole host of macroeconomic concerns on the immediate horizon, a nervousness has crept into markets which has created periodic and, at times, unsettling market volatility.
In an investment seminar held in New York back in September of 1974 (referenced by the quote at the beginning), Ben Graham reflected on a similar period in markets between 1965 and 1973 when according to Graham, ‘value had been in eclipse in Wall Street.’ Some readers may recall that exuberant “nifty fifty” era when investors abandoned price discipline to bid up the prices of so called “one decision” stocks. This included the technology stocks of the day–darlings such as IBM, Xerox, Digital Equipment, Polaroid, Texas Instruments, and a host of other popular companies. Given their seemingly unending growth trajectory, the mantra of the day was that you only needed to buy these securities. Investors followed suit, paying as much as 15 to 90 times earnings or more for the privilege. Many of us remember how that era ended in 1974. After many years of outperformance, the “nifty fifty” stocks collapsed. According to Boris Schlossberg at Bloomberg, ‘By 1975, investors who bought the nifty fifty at their peak in 1972 would have seen more than two-thirds of their wealth evaporate.’
Today, with tech stocks in seeming unending ascendancy, value investing is once again rumored to be dead or dying. As value investors, we take solace in the title of Graham’s 1974 seminar, “The Renaissance of Value.” Graham believed fervently, as do we that the concepts of value and margin of safety have always lain at the heart of true investment, while price expectations have always been at the center of speculation. The collapse of the nifty fifty in late 1973 and 1974 did indeed usher in the mean reversion in stock prices that inspired the title for Graham’s seminar.
Will we look back on this recent period as a condition precedent to value’s next “renaissance,” or will it prove to be a harbinger of a new era? We would caution against new era thinking. In the past, it has proven to be costly.
As George Bernard Shaw once said, ‘The reasonable man adapts himself to the world, the unreasonable one persists in trying to adapt the world to himself. Therefore, all progress depends on the unreasonable man.’ Value investors such as Benjamin Graham were and are unreasonable men, and as we approach our 100th Anniversary of service to investors, we humbly count ourselves among them.”
Important Note: This material is for informational purposes only and is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product. The opinions expressed herein are those of the named advisors at the time written. Actual economic or market events may turn out differently than as presented. © 2019 Madison Wealth Management