Benjamin Graham on bear markets

Any naughty active investor who hasn’t yet read The Intelligent Investor by Benjamin Graham should probably put down this blog and go pick up the latest edition of that classic. 

The Intelligent Investor was published 70 years ago. Yet somehow it still seems relevant for every generation.

Indeed one schmuck by the name of Warren Buffett has called it “By far the best book on investing ever written.” 

True, much of The Intelligent Investor is outdated. And you’ll read nothing in there that you can’t find rehashed on the Internet.

Yet there’s still something uncanny about its relatively ancient wisdom. The voice of Graham describing a different time and place does make you think twice about the markets today.

I suppose it’s like seeking solace in the 2,000-year-old Meditations of Marcus Aurelius.

A lover of the classics, Graham might well have liked that analogy.

Known as The Dean of Wall Street, the original value investor considered his time better spent ‘conversing’ with the long-dead philosophers of Athens – the ‘eminent dead‘, as Buffett’s sidekick Charlie Munger calls them – rather than engaging in Wall Street tittle-tattle.

Certainly more so than making money.

Getting richer was low on Graham’s priority list by the end of his professional life.

The even more intelligent investor

Despite his enduring writing, the real reason we still know about Benjamin Graham is of course because he was Buffett’s mentor.

Graham taught the world’s sometime richest pupil how to kickstart a fortune by buying unloved companies trading at less than book value.

A survivor of the Great Depression, Graham called these companies ‘cigar butts’.

The idea was to find a company with enough value left in it to get a last puff by realising its assets. Just like a 1930’s hobo might enjoy a discarded stub. The profit could come through other investors re-rating the shares when they too saw the value. Other times, Graham got hands-on as an active investor. He did this via his proto-hedge fund: the Graham-Newman Corporation.

Pioneering stuff. But by the end Graham didn’t see much point in most other people trying.

An interviewer for the Financial Analysts Journal asked Graham in 1976: “Can the average manager obtain better results than the Standard and Poor’s Index over the years?”

“No,” replied a man who made millions from inefficient markets and taught others how. “In effect that would mean that the stock market experts as a whole could beat themselves – a logical contradiction.”

Graham also pointed to the market-lagging performance of many active fund managers. Investors might wonder why they paid these professionals so much more than the new-fangled ‘indexed funds’ that were just then appearing.

By the 1990s even Buffett had reached a similar conclusion.

Benjamin and the bear

I was thinking about Graham the other day, as I mused to myself about how long the bear market in my own portfolio has persisted.

Next month – barring some impossibly unlikely miracle – will mark two years since my portfolio peaked on a unitised basis.

I’m still down around 20%.

My net worth slump adds to the pain, thanks to swan dives in the price of assets I don’t count within my actively-tracked portfolio. Stuff like unlisted private investments and Bitcoin.

Yes, I could bump up my personal balance sheet by adjusting for the alleged increase in value of my flat.

My home is, after all, also an investment and an asset.

But the truth is I don’t trust my bank’s recent robo-assessment of my flat’s price appreciation since I bought in 2018. (In fact, I still slightly mark it down in my net worth spreadsheet).

All told, not the prettiest picture for someone on the wrong side of halfway through his investing journey.

Down but not out

Does my 24 months hacking sand in the bunker bother me?

Yes and no (and yes again!)

In the old days I wouldn’t have cared at all. I usually loved buying during market routs.

This time is different, partly I suspect because my earnings – and hence my fresh savings – are very modest compared to a portfolio that’s been pumped-up by two decades of (overall) strong returns.

I think it also feels different because usually I fare better during market declines than my deadly rival benchmark – a global tracker fund – and this time I’ve done worse. Blame those US mega-tech cap stocks that have bounced back faster than anything else – and against all precedents – to pump up the US index.

Finally, I made a hash of the dip-buying that I did begin in late 2021.

I actually anticipated the market froth stage quite well, and had positioned myself accordingly. But I misjudged how pessimistic markets would get about most stocks, and bought back in too early.

Honest mistakes

Being an active investor who meticulously tracks their returns means you can’t fool yourself for long.

Yes, any active investor must expect periods of underperformance.

Even the (few) great market beaters have them. Benjamin Graham underperformed on occasion. Buffett too has lagged for years at a time.

But I know I played the good hand I had given myself badly at the start of this decline.

An unforced error. When that happens it’s hard not to wonder if you’ve lost your edge.

Benjamin Graham and Mr. Market

One reason late 2021 to early 2022 went off the rails for me is that – in retrospect – I think I got cocky about my ability to read the machinations of Mr Market.

A mister who, conveniently for this post, is yet another legacy of Benjamin Graham.

In The Intelligent Investor Graham wrote these classic lines to anthropomorphise the capricious market:

Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometime his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposed seems to you a little short of silly.

If you are a prudent investor or a sensible businessman, will you let Mr. Market’s daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price and equally happy to buy from him when his price is low. But the rest of the time you will be wise to form your own ideas of the value of your holdings, based on full reports from the
company about is operations and financial position.

Graham’s ‘Mr Market’ parable is still regularly cited. Even more so after it resurfaced in the Buffett biography The Snowball. All but the newest Monevator readers will be familiar with the concept, and many with the Mr. Market term too. That’s how enduring his metaphor has become.

However familiarity can breed contempt.

Having made several successful market calls over the years (here’s one) I got cute in late 2021 and supposed I could perhaps understand what unpredictable Mr. Market was up to.

But I couldn’t!

So I bought stocks that were down 50% that fell another 30-50%. Not with anything like all my money. But with enough for a prang that took off the wing mirrors and more.

Mr. Market and me

The bigger picture – more relevant to the majority of passive investors who read Monevator – is that one should not let Mr. Market’s mood swings get to you.

I was wrong (so far) in contrarily betting against him.

But it’s usually even worse to go all-in along with him, whether it’s by loading up when he’s euphoric or by dumping the lot when he’s on one of his historic downers.

Remember the pandemic doom-fest of March 2020?

Do not sell, my co-blogger semi-famously wrote.

That was the more important (and potentially more wealth-preserving) message than the one I wrote with the sun shining a month before, that warned giddy investors that the good times wouldn’t last forever:

A proper prolonged crash will come again. That isn’t a reason not to invest – bear markets are part and parcel of enjoying the gains from shares – but it is a reason to make sure your portfolio is robust to all reasonable scenarios.

Most of the time, for most people, sticking with the plan through everything will prove more profitable in the long-run than trying to white-water raft along the market’s ebbs and flows.

(Perhaps I’m discovering that’s true for me too…)

Benjamin Graham is not bovvered

I re-read another passage from Benjamin Graham last night. One that’s less well-known.

Living through the Wall Street Crash of 1929 – and eventually prospering again in its aftermath – helped Graham reach his then-novel perspectives on bull and bear markets, as we’ve seen.

So he had the scars to prove it when he wrote:

The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book [that is, his portfolio], and no more.

Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage.

That man would be better off if his stocks had no market quotations at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgement.

I tried to say this in my early post about buying in bear markets, but it took me thousands of words.

It seems unfair Benjamin Graham should be both a brilliant writer and an investing legend!

Anyway ignore the noise and other people’s opinions. That’s the takeaway.

In Graham’s day, noise was the gossip around Wall Street bars and in the newspaper reports. What he’d make of CNBC is anyone’s guess.

Still contrary after all of these years

Incidentally, I followed up that post about the inevitably of a bear market in February 2020 with one the next week that centred on one of Benjamin Graham’s own personal favourite quotes:

Many shall be restored that now are fallen and many shall fall that now are in honour.

(It’s from Horace. Not Jim Cramer or Bill Ackman.)

In my article, I wondered how long the tech stock super-rally could continue. As things turned out it still had a bumper of a year left in it, thanks to pandemic pandemonium and a final splurge for free money.

But fast-forward to today, and many beaten-up tech stocks remain in the dumpster. High-growth tech holdings still weigh down the portfolios of UK investor favourites like Baillie Gifford’s former high-flyer Scottish Mortgage.

This despite a huge rally in those truly giant technology companies.

In addition, non-US markets – and in particular UK shares – look relatively far cheaper. Call me stubborn, but I cannot see this continuing forever.

Consider this recent chart from Fidelity:

Of course, while CAPE valuations – yet another Graham innovation – are the best predictor of long-term returns we have – low CAPE being better – they are far from foolproof.

But there are other reasons to think that the US market is overdue a period in the doldrums. Such as the fact that historically, market yings tend to eventually yang, and vice versa:

Source: Hartford Funds

Make America de-rate again

The US has been on a winning streak for a dozen years. It feels inevitable, but history says it’s not. And I’m betting that way too.

I do own US growth stocks, but aside from Tesla I currently have very little exposure to the ginormous tech behemoths. And I’ve got all sorts of other odds and ends from other markets around the world.

Then again, maybe it is different this time? Perhaps we’re moving to some dystopia from the mind of Philip K. Dick where half a dozen $10 trillion companies rule the world?

Or maybe it’s a transition to a utopia of abundance – once nuclear fusion and AI reach their zenith – as imagined by the likes of Ian M. Banks.

Well maybe. More likely the US market is out over its skis.

Time will tell.

p.s. If after all this you’re intent on guessing when our current bear market has ended, you might want to read the thoughts of a more contemporaneous oldie, Jim Slater.