By The Sizemore Letter
Michael Jordan was in the prime of his basketball career when I was a teenager. However, my most enduring memory of watching Jordan play was not one of his show-stopping slam dunks or one of his buzzer-beating fadeaway jump shots. Jordan had plenty of those, but the most distinct memory I have of watching this legend play was one of Jordan’s rare mistakes.
In an otherwise uneventful midseason game, Jordan stole the ball from a Detroit Pistons’ forward and raced across the floor, going coast to coast… only to miss an uncontested dunk. Jordan bricked the ball so hard on the back of the rim that it bounced all the way to the half court line.
Yes, even the great Michael Jordan made the occasional mistake.
I tell this story because 2011 has been a brutal year for everyone. However, some of the best traders in the business are having the roughest time of it on a very public stage.
George Soros—regarded by many, including myself, to be the best global macro trader in history—has had an awful year. His Quantum Fund, which has returned 20% per year for its entire multi-decade history, actually lost 6% in the first half of the year, and that doesn’t include the recent spate of volatility. Perhaps not coincidentally, Soros has also decided to retire as a hedge fund manager. He claims that he doesn’t want to comply with the new regulations that are coming into force, but one has to wonder if the Godfather of hedge funds has simply found a market that he no longer understands. He wouldn’t be the first.
John Paulson—the most successful trader in history who made an absolute fortune shorting subprime mortgage securities in 2008—has done worse than Soros this year. Much worse. His flagship Advantage Plus fund was down 31% for the year through August 5, taking losses far in excess of those taken by the S&P 500 or Dow Industrials. Paulson’s horrid performance is all the more remarkable when you consider that 16% of Paulson’s assets are in gold, which is the only asset besides Treasury bonds that has actually done well this year. (The website Guru Focus tracks Paulson’s current holdings here. )
I report Soros and Paulson’s misfortunes not to gloat—after all, even though our investment themes are basically working as expected, several Sizemore Investment Letter positions have taken a brutal beating in 2011 too—but merely to hammer home an important point:
Given sufficient time, the market has a way of humbling us all.
John Paulson’s undoing was to bet heavily on a recovery in the financial sector. Fully 30% of his fund was invested in financials, and another 23% was in energy and materials. His exposure to telecom—my favorite sector at current prices—is next to zero.
I have intentionally avoided the financial sector throughout the post-2009 bull market. This does not reflect any unique insight or inside information on my part. Quite to the contrary, in fact. I avoid financials not because of what I know but because of what I don’t know. I can’t get a proper grasp on the risks facing the sector or of what might be lurking in the shadows on their balance sheets. So, rather than take a gamble on something I don’t understand and can’t quantify, I simply sit this one out. I avoid financials.
I am following the advice of Warren Buffett and investing instead in attractively-priced companies I do understand. And right now, that means a heavy exposure to consumer staples and international telecom, among others. Ironically, Buffett himself has a rather large exposure to the financial sector through his investment in Wells Fargo, at 19% of his publically-traded portfolio, and American Express, at 15% of the portfolio. And this says nothing of his recent bailout of Bank of America, which potentially makes Buffett a 7% owner of the bank should he exercise his warrants. Apparently Buffett, unlike myself, can get comfortable with the sector. (Check out Buffet’s holdings on Guru focus.)
The normal knee-jerk reaction during a volatile time like this is to sell first and ask questions later. This comes from our natural fear of the unknown: What might the market know that we don’t?
If I were to have a large exposure to the financial sector, I wouldn’t be able to answer that question. And as a result, I would lack the confidence to hold them during a market rout like the one we’re experiencing today.
The vast majority of Sizemore Investment Letter recommendations are high-quality, high-dividend-paying companies with a global clientele and only modest amounts of debt. When bought at a reasonable price, your chance of permanent or long-term loss is virtually nil.
The key, of course, is “reasonable price.” While I would consider Intel (NASDAQ:INTC) to be a riskless bet at $20 per share—where it yields 4.4% and trades for less than eight times earnings—investors who paid nearly $80 for the stock when it was a tech darling in 2000 might beg to differ. Those investors might never see a return on that investment in their lifetimes. Investors who are today buying gold at over $1,800 per ounce or Treasuries yielding 2% are not likely to fare any better.
We live in a world that is often “Fooled by Randomness” in the words of Nassim Taleb and which makes the mistake of valuing short-term results — which can be skewed by good or bad luck — over process, which cannot.
There will be some investments that simply don’t work out as expected. There will be that occasional trade that looks like a slam dunk but ends up bouncing off the back of the rim. But don’t let a single bad investment or even a string of bad investments shake your confidence.
Over time, a sound process will generate better returns than luck, as good and bad luck will ultimately cancel each other out. Reasoned analysis will prevail over wild emotions. As Benjamin Graham said, the market acts as a “voting machine” in the short term, subject to human emotions and the madness of crowds, but over the longer time it acts as a “weighing machine.”
Today, investors are scared, and they are “voting” by dumping their stock investments and running to perceived safe havens. Take advantage of this volatility by buying some of those high-quality blue chips you always wanted to own but could never justify the price.
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