Markets Correct

July 20, 2011

Dear Investor:

From April 29 to June 24, the S&P 500 lost nearly 8%. The subsequent recovery has been dramatic, but markets are now showing strain. Markets never go straight up for sustained periods of time. A selloff of 20% at some point would be historically justified.

Anyone who tries to time that event, however, is likely to be miserably wrong. For every story of flawless timing that trades perfectly around a “black swan event,” there are countless busts and flameouts that no one ever hears about. Load up on credit default swaps with high leverage and time the entry perfectly: the result is a killing. Get the timing a day wrong and watch the portfolio implode: something else entirely. I doubt that many people appreciate the risks involved in these large speculative macro calls – or the dangers of the leverage used to feed them. The market will teach them all eventually.

As you know, we don’t believe anyone can predict short-term market moves. This type of speculation is called gambling — not too different from a junket to Vegas. Instead, we invest, which means buying assets trading at discounts to their intrinsic value and holding them until overvalued or fundamentally impaired. This process requires patience – and never will make an instant killing. But it has the advantage of being the only method that works over long periods of time. It is also the only strategy that involves sound judgment based on fundamentals, not speculative plunging on ephemera.

There are asset classes currently trading at deep discounts to their fundamentals that provide superior investment opportunities: Japanese and European equities, homebuilders, and large-cap multinationals. We are adding these to accounts where appropriate. Such plodding investment may not have the excitement of the trader’s roulette wheel – but it’s far more likely to work over time.