In February 1999, Barron’s published an article written by Seth Klarman titled, “Why Value Investors Are Different”. It’s a very good article. I particularly like his comments on why certain professional investors play along during manias. He uses a fictitious manager, Buff T. Warren, to illustrate several points as it relates to the greater fool theory and groupthink. A couple of my favorite quotes include, “Buff has a lot of company. His stocks are going up not necessarily because they should, but they do,” and “…the markets constant vindication of his judgement only reinforces his conviction and self-image.” Like today, the article was written when the financial markets weren’t making a lot of sense. Investors were overpaying for technology, telecom, and high quality large cap stocks. It was a speculative bubble.
Reading Mr. Klarman’s article brought back a lot of memories of the late 90s. It was my first market cycle as a lead portfolio manager. After working with a five star fund in 1996-1998, I thought I could do no wrong. I was very confident and managing a brand new portfolio at a new firm. It was an exciting time. I was going to take over the investment world! Then the tech bubble hit. I’d never seen anything like it. I went from feeling like an investment genius to an idiot almost overnight.
In 1999 I was one of the few portfolio managers in the country to lose money. Instead of buying technology stocks, I bought out of favor small cap value stocks. The value stocks would go down almost daily while the tech and growth stocks soared. Every night for over a year I went home with my tail between my legs. It was a very difficult period for me. The Nasdaq was up over 80% in 1999 while the portfolio I managed was down 8%!
One morning in 1999 I woke up and itched the back of my head. It felt like a bug had bitten me. I didn’t think much about it until I started losing my hair around the “bug bite”. I went to the dermatologist and he informed me I had alopecia. I asked, “What in the world is alopecia?” He said it’s an immune system disorder in which your immune system attacks your hair follicles. Great! Just what I needed. He asked if I was experiencing stress. Boy, did he wish he didn’t ask me that question. I went on and on about the technology bubble and how everyone was losing their mind. I’m pretty sure the doctor thought I was the one losing my mind! I was lucky he didn’t put me in a straitjacket and send me to a padded room. I really let him have it. He told me I needed to relax or I was going to lose every hair on my body. I said, “Relax?!?! Have you seen the price of eToys? It’s a joke! They’ll never make money!” He gave me a shot in the back of my head to reduce inflammation and hurried me out of his office.
I continued to lose my hair until the tech bubble popped. It all grew back shortly after. I learned a lot during that period. It was my first battle with an asset bubble. I won and had a very good 2000-2002 and full cycle performance. However, it didn’t come easy. Remaining disciplined throughout a market cycle and asset bubble turned out to be a lot harder than I expected. It was especially difficult in 1999, considering it was my first market cycle as lead manager of a new strategy. I felt I had a lot to prove and put a lot of pressure on myself. In hindsight, probably too much pressure. This cycle has been very tough as well, but I’m older and hopefully a little wiser.
Over the past 20 years, I’ve learned a lot about asset bubbles and how to manage through them. One of the most important lessons I learned is to acknowledge that asset bubbles and investor psychology are completely out of your control. You have to let them run their course. It’s hard, but don’t take it personally. You’re not crazy or stupid, even if your immediate positioning and performance suggest otherwise. As an absolute return investor, the main thing is to avoid overpaying, don’t cave into groupthink, and be prepared for the cycle’s end. When asset bubbles pop, not only does your hair grow back, the opportunities are tremendous.
Everything changes when market cycles and asset bubbles end. Stupid positioning and performance can suddenly look a lot less stupid. In his article, Seth Klarman touches on this by quoting Horace’s Ars Poetica, “Many shall be restored that now are fallen and many shall fall that are now in honor.”
Thanks to a friend for forwarding me the Seth Klarman article today. I planned on posting about recent operating results of businesses I follow, but considering we’re in a period when fundamentals don’t seem to matter, it can wait. This is probably more interesting…