During periods of market uncertainty, like what we are currently experiencing with fears of a Fed rates hike and myriad geopolitical risks appearing on the horizon, it can be helpful (and inspiring) to pay heed to the advice given by investment greats of the years gone by. One such great is Peter Lynch, who ran Fidelity’s Magellan Fund for thirteen years (1977-1990, retiring at the age of 46), during which period it returned 2700%! He gave an interview to the magazine Frontline in 1996 – provided below are some edited excerpts which have relevance even today:
On the secret of his success:
– “Well, I think the secret is if you have a lot of stocks, some will do mediocre, some will do okay, and if one of two of them go up big time, you produce a fabulous result. Some stocks go up 20-30 percent and people get rid of it and they hold onto the dogs. And it’s sort of like watering the weeds and cutting out the flowers. You want to let the winners run. When the fun ones get better, add to them, you basically see a few such stocks in your lifetime, that’s all you need.”
– “In this business if you’re good, you’re right six times out of ten. You’re never going to be right nine times out of ten”.
– “So I think it was just looking at different companies and I always thought if you looked at ten companies, you’d find one that’s interesting, if you’d look at 20, you’d find two, or if you look at hundred you’ll find ten. The person that turns over the most rocks wins the game. And that’s always been my philosophy.”
On the crash of ’87:
-“Well, I think people had not analyzed ’87 very well, you really have to put it in perspective. In 1982, the market’s 777 and by ’86 the market moves to 1700, and then in nine months it puts on another thousand points and it just went to such an incredible high price by historic, price earnings multiple, dividend yields, all the other statistics. Then it falls a thousand points in two months, 500 points the last day.”
-“So if the market got sideways at 1700, no one would have worried, but it went up a thousand in nine-ten months and then down a thousand in two months, and half of it in one day, and they thought, “Oh, my goodness, this is the crash. It’s all over. It’s going to go to 200 and I’m going to selling apples and pencils,” you know. But it wasn’t. It was a very unique phenomenon because companies were doing fine.”
On the environment at the start of the Great Bull Market of ’82:
-“1982 was a very scary period for this country. We’ve had nine recessions since World War II. This was the worst. 14 percent inflation. We had a 20 percent prime rate, 15 percent long governments. It was ugly. And the economy was really much in a free-fall and people were really worried, “Is this it? Has the American economy had it? Are we going to be able to control inflation?” You had to say to yourself, “These companies are going to do well once the economy comes back. We’ve got out of every other recession. I don’t see why we won’t come out of this one.” And it came out and once we came back, the market went north. “
On small investors versus big institutions:
– “There’s always been this position that the small investor has no chance against the big institutions. And there’s two issues there. First of all, I think that he or she can do it, but, number two, the question is, people do it anyway. They invest anyway. And if they so believe this theory that the small investor has no chance, they invest in a different format. They said, “This is a casino. I’ll buy stock this month. I’ll sell it a month later,” but when they look at a house, they’re very careful. They look at the school system. They look at the street. They look at the plumbing. When they buy a refrigerator, they do homework. If they’re so convinced that the small investor has no chance, the stock market’s a big game and they act accordingly, they hear a stock and they buy it before sunset, they’re going to get the kind of results that prove the small investor can do poorly.”
On market timing and handling market declines:
– “The market itself is very volatile. We’ve had 95 years completed this century. We’re in the middle of ’96 and we’re close to a 10 percent decline. In the 95 years so far, we’ve had 53 declines in the market of 10 percent or more. Not 53 down years. That’s once every two years. Of the 53, 15 of the 53 have been 25 percent or more. That’s a bear market. So about once every six years you’re going to have a big decline.
-“Now no one seems to know when they are going to happen. At least if they know about them, they’re not telling anybody about them. I don’t remember anybody predicting the market right more than once, and they predict a lot. So they’re going to happen. If you’re in the market, you have to know there’s going to be declines. That’s a euphemism for losing a lot of money rapidly. That’s what a “correction” is called. And a bear market is 20-25-30 percent decline. They’re going to happen but when they’re going to start, no one knows.”
-“If you’re not ready for that, you shouldn’t be in the stock market. I mean stomach is the key organ here. It’s not the brain. Do you have the stomach for these kind of declines? And what’s your timing like? Is your horizon one year? Is your horizon ten years or 20 years? If you’ve been lucky enough to save up lots of money and you’re about to send one kid to college, you decide to invest in stocks directly or with a mutual fund with a one-year horizon or a two-year horizon, that’s silly. That’s just like betting on red or black at the casino. What the market’s going to do in one or two years, you don’t know. Time is on your side in the stock market. And when stocks go down, if you’ve got the money, you don’t worry about it and you’re putting more in, you shouldn’t worry about it. You should worry what are stocks going to be 10 years from now, 20 years from now, 30 years from now.”
-” People spend all this time trying to figure out “What time of the year should I make an investment? When should I invest?” And it’s such a waste of time. I did a great study. In the 30 years, 1965 to 1995, if you had invested a thousand dollars, and you had incredible good luck and invested at the low of the year, your return would have been 11.7 compounded. Now some poor unlucky soul, picked the high of the year every single time, 30 years in a row, would have got a return of 10.6. That’s the only difference between the high of the year and the low of the year. People spend an unbelievable amount of mental energy trying to pick what the market’s going to do, what time of the year to buy it. It’s just not worth it.”
When it starts going down and people get laid off, a friend of yours loses their job or somebody says their house price just went down, these are little thoughts that start to creep into your brain as human nature hasn’t changed much in 5,000 years. There’s this thing of greed versus fear. The market’s going up, you’re not worried. All of a sudden it starts going down and you start saying, “I remember my uncle told me, you know, somebody lost it all in the Depression. People were jumping out of windows. They were selling pencils and apples.” People start to think about these things with the market going down. These ugly thoughts start coming into the picture. You have got to get them out. You have to wipe those out and you — you either believe in it or you don’t.”
On the best strategy for investors:
-” They should buy, hold, and when the market goes down, add to it. Every time the market goes down 10 percent, you add to it, you would have had a better return than the average of 11 percent, if you believe in it, if it’s money you’re not worried about. “As the market starts going down, you say, “Oh, it’ll be fine. It’ll be predictable.”
– “Well, if people don’t have the stomach, the volatility’s too much for them with the stock market, they can avoid it. They could buy money market funds and they’d get a little bit better than inflation. They will not get, in my opinion, the same return the next 20 years, the next 30 years they would get by buying stocks. Over the long period of time Treasury Bills and money markets have yielded a little bit higher than inflation, bonds have yielded five or six percent, and stocks have yielded a total of 11. The differences are massive over 30 years, but that’s not a bad return to get a positive return. If you’re worried, it’s better than losing money.”
On investing in a bear market:
-” Well, from ’66 to ’82, the market basically was flat. But you still had dividends in stocks. You still had a positive return and made a few percent a year. That was the worst period other than the 1920s, in this century. So companies still pay dividends, even though if their stock goes sideways for ten years, they continue to pay you dividends, they continue to raise their dividends. So you have to say the yourself, “What are corporate profits going to do?” Historically, corporate profits have grown about eight percent a year – i.e. double every nine years. They quadruple every 18 and go up six-fold every 25 years. So guess what? In the last 25 years corporate profits have gone up a little over six-fold, the stock market’s gone up a little bit over six-fold, and you’ve had a two or three percent dividend yield, you’ve made about 11 percent a year. There’s an incredible correlation over time.”
On the importance of saving:
-” People have to save more. The public’s not saving enough. Our whole system’s all backwards – If you borrow money to spend to buy an extra house, it’s tax deductible, you save money, they tax you on it. I mean the public has figured out very well there’s no inducement to save. Our system is very confusing. We have the highest capital gains rate in the history of this country right now. We have to have a higher savings rate. No one’s encouraging savings. And it’s the one thing I remember from college is savings equals investment. For every savings of a dollar, money goes into capital investment, that yields more productivity, yields more jobs, yields better standard of living. We are not saving enough money. That’s the most single important thing people have to do, they have to save some more.”
Absolute gems of wisdom which can help us navigate through the uncertain period ahead. Based on historical data, it seems that sharp declines are overdue (10%+ and perhaps even much more), particularly given that Fed is expected to end QE by October and then gradually start reversing zero rate policy. However, a 2008 “end of the world” type scenario is unlikely given that valuations are not as stretched and the monetary response to pre-empt such an event would be swift and aggressive (see chart below for historical bull and bear markets – the latter are all range trading markets). A more volatile and range trading market (with perhaps an upward bias due to the “New Neutral” environment espoused by PIMCO and summarised in last week’s letter) for several years is the likely scenario ahead.
In this environment, as Peter Lynch suggests, it would be best to deploy an income generating strategy – this can be achieved through a combination of dividend paying stocks and global (DM and EM) high yield credit. For the more active investors, reducing risk exposure on the back of market rallies (like now!) and then adding to risk positions on sharp declines (10%+?) could be appropriate to enhance return on the portfolio. In addition, while EM might exhibit higher volatility, the relatively more attractive valuations (compared to developed markets) combined with higher growth prospects should provide for higher return over time. Lastly, for the overly bearish or nervous readers I will end with another timeless quotation from Peter Lynch:
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” – Peter Lynch.