Euphoria and panic

Over the past few years, we have seen world stock markets grow, with investors seeing substantial growth in their investments as a result. Since 2008, the world’s main stock markets have seen very important revaluations, such as the S&P 500, the returns of which have grown by almost 300% since it bottomed out in 2009.

Therefore, as investors, we have become accustomed to seeing our savings grow, with the occasional exception, such as the 2011 correction caused by the debt crisis, Brexit and other moments of political and economic instability in countries like Greece. However, all drops have been rectified by the market in a question of months, with the price of most shares traded growing to levels not seen since before the financial crisis began in 2008.

At Cobas Asset Management we believe that shares are the most profitable and reliable asset in the long term. Above, I mentioned a number of negative episodes that have occurred in recent years on stick markets; however, history is full of dramatic episodes that have affected the savings of investors, ranging from financial scandals, bankruptcies and wars to economic and political crises.

A value investor needs to understand that uncertainty will always be a factor when investing in shares. Volatility is inherent to listed shares and basing your investment strategy on these oscillations is an error. Remaining loyal to your principles and investment philosophy is essential in the event of stock market crises, which are inevitable, to facilitate a significant creation of value.

Many people will remember that in 2007, stock markets were at record highs. Everybody will be able to recall the headlines celebrating the IBEX-35 reaching 16,000 points and the subsequent investment euphoria, as part of which almost all savers, regardless of their financial knowledge, regarded shares as the vehicle for investing in the strong returns seen on the stock markets between 2003 and 2006.

Therefore, an “investment bubble” was created, as part of which investors who were unaware of the risks of investing on the stock market had invested a large part of their savings in financial products that, in many cases, were not suited to them.

One of the worst stock market crises in history unravelled between July 2007 and March 2009, compared by many to the 1929 crash. Markets contracted by more than 60% and investors saw the size of the investments that had cost them so much effort decrease (many committing the terrible error of selling their shares with significant losses). Furthermore, banking institutions went bust, including Lehman Brothers. In short, panic and pessimism took hold of all economic agents involved in the world of investment.

During these times of unease, when investors saw nothing but numbers in the red, there were also many brave people who knew how to ride out the hardship. They were patients, understood that a short-term downturn was inevitable, even though it lasted a period of almost two years, with the resulting psychological toll, where bad news and returns were the order of the day.

Investors that decided to maintain their investments, and those who saw a contracting market as an opportunity to do good business at irresistible prices, applied, in some cases from a position of awareness and in others with no knowledge whatsoever, the basic theories of value investing, which entails using a little common sense.

These investors understood that the depressed prices to which most businesses trading on the stock market had fallen were not justified. In other words, it made no sense that good, well-run businesses with a positive outlook were being so harshly penalised by the stock market and, therefore, the existing value in these companies was much greater than the price being paid on the market.

The correct use of value investing minimises the possibility of permanent losses

It is well known, following the recent strong performance of stock markets, that those who maintained their investments in high-quality equity assets not only recovered the losses seen in 2008 and 2009, but they have also increased in value compared to 2007 valuations.

There were even examples of these losses being recovered in a short space of time, including investment funds managed by Francisco García Paramés who, applying the value investing philosophy, recovered all losses in the preceding 20 months in a space of just 12 months.

In short, the correct use of value investing helps to minimise the possibility of permanent portfolio losses and, as many are already aware, produce long-term positive results, often in excess of average returns on the market.

In 2018, we have seen bear markets, where the main European stock markets have seen contractions in value of around 10%. Amongst the press and some investors, it is possible to see news and negative perceptions about the future performance of stock markets, predicting significant losses after these years of prosperity. It is impossible to know when the turning point will come; but what is inevitable, is that sooner or later it will come.

We should all keep the following quote by John Templeton in mind: “The four most dangerous words in investing are: this time it’s different”. We are unaware of the depth of the current correction of the market, which without a doubt, will have a short-term effect on the performance of our investments; however, we believe that, regardless of any decrease that markets may suffer, it is time to roll up our sleeves and look for businesses whose stock market value is being punished for no real and objectives reasons. Therefore, as the case has been in the past, we will see markets offering attractive investment opportunities and any contractions seen will be corrected in time.

Faced with these expectations of bear markets, we believe that the best way of overcoming stock market corrections that, as mentioned above, are inevitable, is applying our investment philosophy: purchasing shares in high-quality listed companies that are difficult to copy, with appropriate levels of debt, managed by capable and honest people and, generally speaking, that operate worldwide.

After more than 25 years managing investments and having suffered and enjoyed the different milestones seen on the financial markets, we are convinced that this is the best way of protecting invested capital.

The returns on Cobas Asset Management funds over the past 10 months have not been strong. Most of our funds have experienced contractions of between 10% and 14%. We are not happy about this, but you must be aware that choosing an investment management firm on account of short-term results is not a good indicator of long-term success. It can even be asserted that it is inevitable that firms that obtain long-term returns beyond market averages are bound to see periods in which returns are not as strong.

In “The Superinvestors of Graham-and-Doddsville”, Warren Buffet mentioned seven US investment managers that had obtained returns well beyond the market average (between 8% and 16% above the S&P 500, in a period of 13 to 28 years). What is most striking about these results is not only the excellent returns, but that none of these investment managers managed to outperform the index every year. In fact, their returns were below the market average 20%-40% of the time,

In conclusion, positive long-term returns beyond the market average are perfectly compatible with discreet short-term returns, including returns below reference indexes.

Seeing poor performance in the short term is inevitable. As you will be aware, we never try to predict where the stock market is headed. We built high-quality investment portfolios, ignoring market noise, searching for value where others are unable to see it, in the awareness that we might experience short-term returns that are worse than those seen on the market. As renowned mutual fund manager John Neff once said: “It’s not always easy to do what’s not popular, but that’s where you make your money”.

I encourage you to reflect on the following: in our daily lives, we are all susceptible to experiencing moments of euphoria and panic. If at all possible, on the stock market this is even more common; however, we must not forget that to obtain the best returns on our investments, we have to be patient and take investment decisions after performing a thorough analysis, not allowing ourselves to be guided by emotions or bias typical of us humans.