This was the week of the 1987 crash, Black Monday.  Louis Rukeyser was the man.

A few excerpts from Seth Klarman’s Q1 letter.  Found via Value Investing World.

Note – I’m not sure if the bold emphasis is from Klarman or the Value Investing World Blog but it is not from me.  If I had to emphasize certain parts of this letter the entire thing would end up in bold font.  Would love to get my hands on the full letter…

Klarman:

Most U.S. investors today have a clear opinion about what everyone else has no choice but to do. Which is to say, with bonds yielding next to nothing, the only way investors have a chance of earning a return is to buy stocks. Everyone knows this, and is counting on it to remain the case. While economist David Rosenberg at Gluskin Sheff believes government actions could be directly or indirectly responsible for as many as 500 points in the S&P 500, or 30% of its current valuation, traders have confidence in Ben Bemanke because betting that his policies will drive equities higher bas been a profitable wager. Bernanke, likewise, is undoubtedly pleased with these speculators for abetting his goal of asset price inflation, though we all know that he will not call them first when he decides to reverse direction on QE. Then, the rush for the exits will be madness, as today’ s “clarity” will have dissolved, leaving only great uncertainty and probably significant losses. 

Investing, when it looks the easiest, is at its hardest. When just about everyone heavily invested is doing well, it is hard for others to resist jumping in. But a market relentlessly rising in the face of challenging fundamentals–recession in Europe and Japan, slowdown in China, fiscal stalemate and high unemployment in the U.S.—is the riskiest environment of all.

… [O]nly a small number of investors maintain the fortitude and client confidence to pursue long-term investment success even at the price of short-term underperformance. Most investors feel the hefty weight of short-term performance expectations, forcing them to take up marginal or highly speculative investments that we shun. When markets are rising, such investments may perform well, which means that our unwavering patience and discipline sometimes impairs our results and makes us appear overly cautious. The payoff from a risk-averse, long-term orientation is–just that–long term. It is measurable only over the span of many years, over one or more market cycles.

Our willingness to invest amidst failing markets is the best way we know to build positions at great prices, but this strategy, too, can cause short-term underperformance. Buying as prices are falling can look stupid until sellers are exhausted and buyers who held back cannot effectively deploy capital except at much higher prices. Our resolve in holding cash balances–sometimes very large ones–absent compelling opportunity is another potential performance drag.

But we know that in a world in which being anti-fragile is good, what doesn’t kill you can make you stronger. Short-term underperformance doesn’t trouble us; indeed, because it is the price that must sometimes be paid for longer-term outperformance, it doesn’t even enter into our list of concerns.

Patience and discipline can make you look foolishly out of touch until they make you look prudent and even prescient. Holding significant, low or even zero-yielding cash can seem ridiculous until you are one of the few with buying power amidst a sudden downdraft. Avoiding leverage may seem overly conservative until it becomes the only sane course. Concentrating your portfolio in the most compelling opportunities and avoiding over diversification for its own sake may sometimes lead to short-term underperformance, but eventually it pays off in outperformance.

…Is it possible that the average citizen understands our country’s fiscal situation better than many of our politicians or prominent economists?

Most people seem to viscerally recognize that the absence of an immediate crisis does not mean we will not eventually face one. They are wary of believing promises by those who failed to predict previous crises in housing and in highly leveraged financial institutions.

They regard with skepticism those who don’t accept that we have a debt problem, or insist that inflation will remain under control. (Indeed, they know inflation is not well under control, for they know how far the purchasing power of a dollar has dropped when they go to the supermarket or service station.)

They are pretty sure they are not getting reasonable value from the taxes they pay.When an economist tells them that growing the nation’s debt over the past 12 years from $6 trillion to $16 trillion is not a problem, and that doubling it again will still not be a problem, this simply does not compute. They know the trajectory we are on.

When politicians claim that this tax increase or that spending cut will generate trillions over the next decade, they are properly skeptical over whether anyone can truly know what will happen next year, let alone a decade or more from now.

They are wary of grand bargains that kick in years down the road, knowing that the failure to make hard decisions is how we got into today’s mess. They remember that one of the basic principles of economics is scarcity, which is a powerful force in their own lives.

They know that a society’s wealth is not unlimited, and that if the economy is so fragile that the government cannot allow failure, then we are indeed close to collapse. For if you must rescue everything, then ultimately you will be able to rescue nothing.

They also know that the only reason paper money, backed not by anything tangible but only a promise, has any value at all is because it is scarce. With all the printing, the credibility of our entire trust-based monetary system will be increasingly called into question.

And when you tell the populace that we can all enjoy a free lunch of extremely low interest rates, massive Fed purchases of mounting treasury issuance, trillions of dollars of expansion in the Fed’s balance sheet, and huge deficits far into the future, they are highly skeptical not because they know precisely what will happen but because they are sure that no one else–even, or perhaps especially, the policymakers—does either.

It is also one of the only advantages an individual investor has over institutional investors.

You see, unlike professional money managers – whether they’re hedge funds or mutual funds – you don’t have to constantly be running in the relative performance derby and impressing your clients every minute of the day.  Not only can you take long term bets but you can wait and let them play out.

There are two posts worth checking out: (1) Your Last Remaining Edge on Wall Street by Morgan Housel and (2) Barry Ritholz’s post about that post.  So yeah, you will basically read three articles about the exact same thing but this is an important point so it’s worth repeating.

As Housel quotes Henry Blodget:

If you talk to a lot of investment managers, the practical reality is they’re thinking about the next week, possibly the next month or quarter. There isn’t a time horizon; it’s how are you doing now, relative to your competitors. You really only have ninety days to be right, and if you’re wrong within ninety days, your clients begin to fire you.

Housel goes on:

Holding stocks for less than a year amounts to little more than flipping a coin. You are almost as likely to lose as you are to win.

But the odds of success grow perfectly with time. If you hold for five, 10, 15 years or more, the odds of earning a positive return on stocks after inflation quickly approach 100%, historically.This chart shows the percentage of holding periods that generated positive returns:

The irony is that while Wall Street has more information than you, its short time horizon forces it to deal with more randomness than you have to. That’s your edge. And it’s why any bumpkin who buys an index fund and forgets about it will beat the vast majority of professional money managers over time.

Here’s another way to look at this. This chart shows the maximum and minimum annual returns someone would have earned between 1871 and 2012 based on different holding periods:

You don’t have to follow this blog very closely to know I’m a big fan of Barry Ritholtz and his blog The Big Picture.  Over the weekend he gave the following presentation, Romancing Alpha, Forsaking Beta at the Trustee Leadership Forum for Retirement Security.

It’s a great presentation that shows how our wetware (to borrow a term from Barry) leads to poor investment decisions – particularly when it comes to the mythical creatures of Wall Street: alpha generating hedge funds.  Check it out: