Muhlenkamp Memorandum: Waiting for the Market to be Rational
As we have said before, there are dozens of ways to successfully invest, but each has its own inherent fl aws, and the investor has to understand his discipline well enough to know what those fl aws are. We have yet to fi nd a fl awless investment discipline. The inherent fl aw of value investing is that it doesn’t work well when markets are irrational or driven by non-economic considerations; and that markets can be irrational longer than we expect.
Our experience is we cannot chase performance, we have to get out ahead of it and wait for it to come to us. We have been waiting longer than we expected, but part of the problem with value investing, if it’s done properly, is the tendency to be early; and being too early can wind up being wrong. However, we think value investing in general, and our particular implementation of it, may soon be rewarded.
The markets since 2009 have been infl uenced to an unprecedented degree by governments and central banks. This was driven in part by central banks pushing investors out of bonds into everything else. Central banks bought government bonds en masse, pushing the former owners into higher-risk assets. Stock picking was less effective than it historically has been when the big money was flowing.
.. Instead of changing our process to take advantage of past conditions, we think conditions are changing to meet us. We continue to focus on bottom-up, fundamental analysis and value-driven stock picking. We own companies that are more profi table, and selling for less, than the companies which have led the market indices to new highs. We haven’t changed what we are doing to try to improve our performance, but by sticking to our discipline we should be ready as the investment “climate” brings our companies back into favor.
.. So, that’s what we are doing. Stock and bond markets have been divorced from underlying economic realities since 2008, which is irrational. Stock and bond markets are rational in the long term, and we think it is more reliable, more conservative, and more productive to invest rationally than to try and predict the next irrational move of the markets. We continue to invest our money and your money according to these principles, even though it has taken longer for the rational to override the irrational then we thought it would.