August 22, 2015

Dear Investor:

Markets have made another special update necessary. Losses have increased, with the Dow down over 10% from its high of 18,351. This counts as an official “correction” but the distinction is arbitrary–and the word is just a euphemism for a big decline. Many international markets are down 20% or more from their highs, which actually put them in bear markets—again by official (and unimportant) definition.

It sounds like a platitude to say markets have to correct in order to move higher, but it’s actually the way markets work. For three years, we have not had a sell-off of any size. Markets need to periodically shake out the weak hands in order to reward only those who can tolerate their brutal downs as well as the ups. The Dow has nearly tripled from its 2009 low around 6,500. A turn of fortune was long overdue.

The logical question posed by clients will always understandably be this: if you thought a correction was on the horizon, why didn’t you sell to avoid it? The answer is always unsatisfying but absolutely true: there is no way to time such things. Short-term market direction cannot be foretold by hunch, instinct, or reading the entrails—and not by anything else.

Like the debunked Nouriel Roubini, Mark Faber or Meredith Whitman, there are the so-called “permabears” that keep calling for a market crash until it happens. They make careers off the “cracked clock” phenomenon: even a broken one tells the correct time twice a day. I would have predicted a 20% decline two years ago. If I had acted on my illogical hunch, or those of others, I would have cost my clients a lot of money.

No great investor has ever gotten rich timing markets (if you know of one, let me know) and all research and evidence points to the futility of market-timing strategies.

So what works?

The best investors like Warren Buffett, Charlie Munger, Peter Lynch or David Tepper have always applied a very different approach which I try my best to emulate: to buy undervalued assets at distressed prices and wait for those prices to rise, which they do eventually. Most, important, to do so agnostic of temporary macro conditions, with the knowledge that agnosticism is a required discipline for things that cannot be predicted.

This strategy requires patience and the distressing reality that value investors must sit and suffer through downturns. The value investor’s best technique is to buy more shares as markets decline, not sell them in some misguided attempt to predict China’s trade data or the Yuan-Dollar currency peg. By buying more undervalued stocks as they become still more undervalued, you sow the seeds of the next big profits. Once markets normalize and rally, as they always do eventually, they bear the fruit of these efforts.

In moderately conservative and conservative accounts, I’ve been sitting on plenty of cash and bonds which I am using to buy stocks that are in freefall. In aggressive accounts, I’m reinvesting dividends as they become available.

We are getting wonderful prices on these companies as panicked sellers toss them to the wind. Emerging market stocks are now trading at less than four times operating cash flows. This is the cheapest I’ve ever seen them. Similar things can be said about energy and materials stocks. There are no guarantees in this business but I can say this: it will be hard not to make lots of money on them over the next 3-5 years—whatever unruly gusts or swells the next 3-5 months bring.

As I said in my last update, my long-time clients have been through this with me before. They know how we make a lot of money when quality assets eventually get priced correctly. We did it after 2002; we did it again after 2009. My more recent clients may have less faith in this process, given that markets have been so complacent for the past few years.

If you would like to discuss how this method works, so that you can take it less on faith and more on logic, don’t hesitate to call

A final caveat: another 10%-15% in declines would not surprise me. This is not a prediction, but—like last time—a necessary lowering of expectations in the wake of the spectacular gains of the past six years.

Keep in mind that each account is tailored to the individual client’s risk preference and personal needs in order to achieve the required plan. Corrections do not put such plans in jeopardy, though it always appears so at the time.

Please call with any questions or concerns.