Value Library

The following is an excerpt from the ABC Perspective - April 2000 - Pg. 12

Drawing a Line in the Sand

There comes a time in life, or in business, when one has to take a stand. While it is not easy to "draw a line in the sand" and stand up for what you truly believe in, it is often, in the long run, quite rewarding.

For instance, early in my investment career, I remember asking an old friend how he, as a value investor, survived and performed so well on the aftermath of the 1973-74 bear market. My friend candidly admitted it was an excruciatingly difficult period. He aggravated but worked on an investment plan. He divided his cash reserves into three equal parts. At each successive stock decline in 1974, he invested a third of his cash reserves in unduly depressed value stocks. At that time he could not believe the incredibly low prices being paid for real business's cash flow, earnings and net asset values. But the market did not care for value then. Nonetheless, he drew a line in the sand and stuck to his style and discipline.

Clients grumbled and a number of them quit. Yet my friend stubbornly hung in. He continued to analyze stocks and invest. But stocks plunged further to unprecedented valuations. After his second cash reserve was committed, my friend, albeit a little unnerved at the low valuations, prepared for his final third assault. He had hoped he would never have to use it. But the negative psychology of the day was like a cold, dark mania. In time, he screwed up his courage and invested the final sum. The market declined further and subsequently hit a double bottom in both August and December 1974. I asked him what he did after he committed his final reserve. He smiled and told me he prayed.

When stock prices did bottom and the market for value stocks took off in 1975, his market picks were "golden". His performance turned out to be spectacular as momentum investors now rushed to buy the value stocks that he held.

While it might be trivializing an extremely stressful value investor period of 1973-74, the fact was the investment flotsam and jetsam of that period turned into the elegant swans of the 1975-76 bull market. The stress on value managers during that difficult 1973-74 stretch was intense. Investors demanded their money back in preference to the sure thing of high interest paying treasury bills. Yet, the loyal investors who believed in his investment style, albeit shaken for six to twelve months, ultimately benefited when the value market later exploded to the upside.

Now, some 25 years later I see many investment parallels. It is presently a very trying and stressful period for value investors. Everything is questioned. Every move is scrutinized under a microscope. Big money appears to be made on seemingly no-brainer high tech investments as relatively more complicated value investing struggles and is chastised. As the value criticizers grow in numbers, many value-oriented mutual funds in redemption mode are forced to raise cash by selling "old economy", value stocks such as Inco, Noranda, Hudson Bay Company, and the oils. This action further depresses value stock prices and adds to an extremely vicious circle. Value investing, to be successful again, needs a catalyst such as a downturn in technology stocks, a spate of takeovers in unduly cheap value stocks or huge corporate share buybacks. But when will this occur and what will be the catalyst?

A most interesting comment on the present environment was offered recently by Nancy Tengler, President and Chief Investment Officer of Global Alliance Value Investors of San Francisco. In a recent conference and as reported by the Financial Post, Ms. Tengler admitted that the mania for short-term growth stocks is exacerbated by the presence of momentum-based day traders and that flames are fanned further by the media, which emphasize short-term price movements. "Our challenge", concluded Nancy Tengler, "is to step back from our emotions and build a belief system that is not easily shaken". It appears to me that Nancy Tengler, like my old friend, has also "drawn her line in the sand".

Irwin A. Michael, CFA