“Zero. This is the third time that Warren and I have seen our holdings in Berkshire Hathaway go down, top tick to bottom tick, by 50%. I think it's in the nature of long term shareholding of the normal vicissitudes, in worldly outcomes, and in markets that the long-term holder has his quoted value of his stocks go down by, say, 50%. In fact, you can argue that if you're not willing to react with equanimity to a market price decline of 50% two or three times a century you're not fit to be a common shareholder, and you deserve the mediocre result you're going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations.” - Charlie Munger, Warren Buffett’s vice chairman at Berkshire Hathaway, asked in a BBC interview in October 2009 how concerned he was by the recent decline in Berkshire’s share price.
Why do the autumnal months always seem to generate so much stock market volatility ? We have a pet theory. The problems get stored up in the summer months, when the sun is hot, the harvest plentiful, and the mood among investors generally upbeat.
Then autumn sets in. As the crops are gathered in, the days darken and cool. The optimism of summer is followed by a mood of retrospection and introspection. As our animal spirits start to wane with the weakening sun, problems that swelled up during the heat of summer finally start to decay and reveal themselves. Buyer’s remorse sets in. Investors en masse start to question decisions made in sunnier, happier times. This year, within a short while we will have the extra frisson of Halloween coinciding with a cold war against Chinese Communist interests (a.k.a. rapid economic ‘reshoring’) and a (proxy) hot war in the Ukraine. Months, perhaps years, of pent-up shadowy errors – made by politicians, central bankers, and investors of all stripes – may now start to walk abroad in the markets.
Many of those errors (in policy, feeding through to inevitable malinvestment) were set on their path by the events of mid-September 2008. Doomberg takes up the story:
“After a frenzied weekend of tense and complex negotiations between senior leaders of the US government and the CEOs of the big Wall Street banks produced no viable alternative path for Lehman Brothers, the company filed for bankruptcy on Monday, September 15, 2008. The filing set off one of the most memorable weeks in the history of finance. Concurrent with the failure of Lehman was the forced sale of Merrill Lynch to Bank of America, a move so rushed and dramatic it’s incredible to think it was the second most important headline on that fateful day.
“In a rare public appearance at the White House later that afternoon, then US Treasury Secretary Henry Paulson assured the nation that this crisis would pass, that he never considered bailing out Lehman using public funds, and that Wall Street would have to fix its own problems – there would be no further bailouts. The very next day, the government would bail out American International Group (AIG), an insurance giant with nearly $1 trillion in assets.
“What started as an $85 billion loan-for-equity injection eventually ballooned to a total commitment of $182 billion, and while AIG ended up paying the government back in full plus a profit over the next several years, the episode is mired in deep controversy. The bailout of AIG was actually a bailout of the rest of Wall Street, as the company became a vessel through which public funds were used to make AIG’s powerful counterparties whole, thereby stemming the financial crisis. Among the biggest beneficiaries was none other than Goldman Sachs, the investment-bank-turned-bank-holding-company-so-they-too-could-get-a-government-bailout (and Paulson’s prior employer – he left the position of CEO of Goldman to join the Bush administration, perhaps motivated in part by the massive tax loophole he was able to exploit by doing so)..
“Conflicts of interests aside, the dangerous precedent was set. Over the next decade, authorities merely postponed a true (and necessary) financial reckoning, blew giant holes in the nation’s fiscal and monetary balance sheets, planted the seeds of the epic bubble currently deflating in the markets for risk, and shattered the belief – however tenuous it might have already been prior to that fateful week – that the American financial system was fair with risks accepted by those that take them. This belief was firmly decimated by the fact that only one top banker went to jail as a result of the global financial crisis of 2008-2009. By the time the 2019 repo crisis unfolded, the Federal Reserve didn’t bother with the need for pesky legislation to assume they could bail out Wall Street once again. This time, even the names of which institutions were saved by the funds have largely been kept from the public. Nothing shall stand in the way of socializing Wall Street’s losses. That genie is well and truly out of the bottle.”
It has taken a decade and a half for the ghost of Lehman to return conclusively to the market feast.
Newspapers trying to explain away market volatility always offer an object lesson in the ongoing persistence of the Gell-Mann Amnesia effect at work. This theory is named after the US Nobel physicist Murray Gell-Mann. The bestselling author Michael Crichton explains:
“Briefly stated, the Gell-Mann Amnesia effect is as follows. You open the newspaper to an article on some subject you know well. In Murray’s case, physics. In mine, show business.
“You read the article and see the journalist has absolutely no understanding of either the facts or the issues. Often, the article is so wrong it actually presents the story backward – reversing cause and effect.
“I call these the ‘wet streets cause rain’ stories. Paper’s full of them
“In any case, you read with exasperation or amusement the multiple errors in a story, and then turn the page to national or international affairs, and read as if the rest of the newspaper was somehow more accurate about Palestine than the baloney you just read. You turn the page, and forget what you know.”
The phrase ‘survival of the fittest’ was coined by Herbert Spencer on reading Charles Darwin’s On the Origin of Species in 1864. Darwin postulated that, working over the course of thousands and millions of years, natural selection would tend to favour “Survival of the form that will leave the most copies of itself in successive generations”. Nature would come to reward a mixture of inherited “improvement” and the benefits of random genetic mutation.
A problem with human beings is that, while homo sapiens has been evolving for roughly 350,000 years, the financial markets have only been with us for two or three centuries, which in evolutionary history is no time at all. We have not, yet, learned how to cope with financial markets or things like listed company shares – especially when their prices move violently. Our brains are equipped at a mammalian level to distinguish between responses consistent with either fight or flight – neither of which is necessarily appropriate to volatile stock markets. The answer, we suggest, is to arrange your financial affairs such that you can deal with the inevitable fluctuations to which markets fall prey without even having to think about them. In other words, true diversification – across asset classes, and across individual stocks – remains, to us, the last free lunch in finance. As longstanding readers and clients will appreciate, we seek defensive solace in the shares of highly cash-generative, lightly indebted ‘value’ businesses; in systematic trend-following funds; and in real assets (‘value’ companies again, operating in the commodities space). Either that, or you develop the sort of stoic temperament that Charlie Munger so wonderfully displays. Sadly, one suspects that is beyond almost all of us.
Tim Price is co-manager of the VT Price Value Portfolio and author of ‘Investing through the Looking Glass: a rational guide to irrational financial markets’. You can access a full archive of these weekly investment commentaries here. You can listen to our regular ‘State of the Markets’ podcasts, with Paul Rodriguez of ThinkTrading.com, here. Email us: firstname.lastname@example.org.
Price Value Partners manage investment portfolios for private clients. We also manage the VT Price Value Portfolio, an unconstrained global fund investing in Benjamin Graham-style value stocks and specialist managed funds.
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