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30-Mar-09
Days of Buy and Hold are Over
Rarely will an investor seek to paraphrase Richard Nixon. However, when Nixon observed in 1971 that "we are all Keynesians now," he established the framework which allows me to comment on the current state of investing. Given the turmoil in markets, large bear market declines, and majestic rallies, we are all traders now.
For months in my weekly newsletter EPIC Insights, I have declared that the era of buy-and-hold investing is over. People who followed prudent approaches, saved, and invested for the long haul are left with losses and frustration. While defenders of buy and hold will cite studies and academic research to justify their approach, they need only look toward their most talented, well-respected practitioner to see its weaknesses.
Warren Buffet famously studied under Ben Graham, the father of value investing, and built an enviable record. Preferring a holding period of "forever," Buffet buys the stock of excellent companies at a discount to fair value, allows the businesses to operate, and enjoys the increasing wealth that usually comes from this approach. As markets headed higher, Buffet's astute stock picking allowed investors in his holding company, Berkshire Hathaway, to prosper.
However, times have changed. Using the marketable securities table displayed in Berkshire's 2008 annual report and adjusting the core holdings to current market prices, Berkshire's $35 billion portfolio shows a gain of 12%. Assuming the average life of these holdings is 12 to 15 years, Buffet has performed in line with the Dow while badly lagging what a risk-free investor would have received in short-term Treasuries. If the greatest buy-and-hold investor cannot outperform, how will other long-term investors fare?
Yes, some positions may work out exactly as planned, but to be successful overall we must evolve with the markets. Such a view leads me to keep a short leash on every position I take. For example, two weeks ago, I purchased XTO Energy (XTO) and ConocoPhillips (COP). Believing the stocks were cheap and oil was set to push higher, solid reasoning supported each action. Over the last two weeks, XTO and COP have resulted in gains of 8% and 10%, respectively. Although I am pleased with the gains, the markets are changing and so must I.
When I entered the trade, the oil market was in contango. Contango is a bearish feature as it indicates excess supply is on the market. While I would rather not go long a market showing contango, the direction of the future curve supported me. Having seen the one-month spread narrow from $4.46 to $0.79, it appeared the contango would disappear, the oil market term structure would become more bullish, and a long position in energy companies would deliver great returns.
Despite an increase in the spot oil price, the one-month spread has widened to $1.78. Even though the fundamentals remain bullish, I see no reason to take the risk of the contango widening further, oil dropping in price, and our hard-earned gains turning to losses. Recognizing we are all traders now, I recommend selling XTO and COP as this week's fundamental trade.
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