The Rational Investor #006: Seth Klarman on Buying During Bear Markets
Happy Saturday to you,
Welcome to the 6th edition of The Rational Investor Newsletter.
I recently came across a great article titled The Value of Not Being Sure which is a collection of excerpts from Seth Klarman’s 2008 annual shareholder letter that was published early in 2009. While dated, it contains a lot of big-picture wisdom that investors can learn from when it comes to investing during frustrating markets as we’ve experienced over the past couple of years. Below I’ve included one such example. The only edit I’ve made aside from emphasizing certain sentences is breaking up the paragraphs to make it an easier read.
Onto the main event…
Here’s Seth Klarman on Buying During Bear Markets (emphasis is mine):
Warren Buffett has said – and others have endlessly repeated – that you can’t tell who is swimming naked until after the tide goes out. This turns out to be only partially true.
The tide has receded, and most portfolios are down. But not all declines are equal. Some investors have lost money and locked in those losses by going to cash. Some have made investments in failed or failing banks, brokers, and homebuilders, or toxic subprime mortgage securities; these losses are largely permanent and irreversible.
But the investment baby has been thrown out with the bathwater, and some who invested wisely aren’t naked, it just seems that way. Buying early on the way down looks a great deal like being wrong, but it isn’t. It turns out you won’t be able to accurately tell who’s been swimming naked until after the tide comes back in.
As Benjamin Graham and David Dodd taught us, financial markets are manic and best thought of as an erratic counterparty with whom to transact, rather than as an arbiter of the accuracy of one’s investment judgments. There are days when the market will overpay for what you own, and other days when it will offer you securities at a great discount from underlying value.
If you look to “Mr. Market” for advice, or if you imbue him with wisdom, you are destined to fail. But if you look to Mr. Market for opportunity, if you attempt to take advantage of the emotional extremes, then you are very likely to succeed over time.
If you see stocks as blips on a ticker tape, you will be led astray. But if you regard stocks as fractional interests in businesses, you will maintain proper perspective. This necessary clarity of thought is particularly important in times of extreme market fluctuations.
It’s obvious that Klarman's perspective was spot on. Just a month later, the market bottomed and it was the patient and persistent investors who were the big winners once again. As is always the case.
For a more recent and personal example, when the market was bottoming in October of last year, I was emphasizing Klarman’s wisdom that buying early was better than waiting too long, encouraging investors to stay the course and to use the bear market as an opportunity to buy.
For evidence, see here, here (this post was literally on the day the market bottomed), here, and here as just a few examples. Scroll through my feed around that time and it’s a combination of encouragement to stay the course and to buy when you can.
To be clear, I didn’t know when it would end (and never claimed to), I just knew that the prices of great companies that people were eagerly buying just ten months earlier were at least 25% off. If the market had continued declining from there, I would have been all the more emphatic that people should be buying rather than running for the hills.
Why? Because history has shown us time and time again that tough times in the market are the best times to invest since lower prices = lower risk for diversified long-term investors.
I didn’t need to know how or when it would all work out to believe that the bear market would come to an end at some point. Per Klarman’s note, we shouldn’t look to Mr. Market for advice, but for opportunity. That was, and always will be, the rational perspective to have during bear markets.
Thanks for reading. I’ll be back again next week with more timeless wisdom from great investors.
Enjoy the weekend!
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