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It Rarely Pays to Be Pessimistic

May 07, 2014 | About:

“Through all its vicissitudes and casualties, as earthshaking as they were unforeseen, it remained true that sound investment principles produced generally sound results. We must act on the assumption that they will continue to do so."

-Benjamin Graham

During the past few years, many pundits have consistently expressed a more pessimistic view of the economy. They have been anticipating all kinds of negative casualties, such as the debt ceiling problem, the U.S. government fiscal problem, or some other shock to the economy. We have also witnessed almost unprecedented uncertainty. Remember the volatile summer of 2011 when the U.S. seemed to be heading into a double dip, when European’s mess seemed like it could only get worse? Remember the Japanese Tsunami? China’s possible hard landing?

And now we have the Ukraine crisis, which looks like a serious issue. The economy is still not galloping. Befuddled, someone posted the following:

“GDP miss. Fed pulls back $10 billion. Market? Up. What the hell, market. Get it together.”

Fascinating, isn’t it?

What’s more fascinating is that there are quite a few renowned economists and fund managers who have been bearish since the financial crisis. John Hussman (Trades, Portfolio) is the perfect example. He wrote an article called “the Stock Market Has Never Been This Overbought” back in October 2009. Between 2009 and April 2014, he wrote numerous commentary articles; almost each one of them laid out a problem. He has been claiming that the U.S. stock market is “overvalued, overbought and overbullish.”

Similarly, Charlie Minter and Marty Weiner from the Comstock Partners have been raising the red flags for a long time. They are as bearish as John Hussman (Trades, Portfolio).

The list of perma-bears can go on and on. The most interesting thing is that what the bears have been saying is probably true. All the scary warnings and potential scenarios that may unfold in the future are not based on lousy thinking — they are based on, in my view, very sound analysis. But if you have followed the investment advice from them, your investment results would have been less than satisfactory. So here is the paradox: The perma-bears are right in terms of analyzing the problems we have, but in light of these problems, U.S. stocks have continued to do well. Why is that?

Well, if you look at the background of those perma-bears, you will notice that most of them share a background in macroeconomics. Therefore, they look at things from a macro perspective. Nothing wrong with that. Macroeconomics is important and we need to pay attention to macros.

But macroeconomics has its limitations, which Yogi Berra shrewdly pointed out as a baseball player: “In theory there is no difference between theory and practice. In practice there is.” This is why macroeconomics is full of surprises, and this is why value investors tend to shun macro forecasts.

Macroeconomics aside, I think the problem with the perma-bears lies in the fact that they often ignore human potential. The capitalist system in the U.S. works so well that it can unleash an enormous amount of human potential. Everyday, there are some people in this country that try to perform the same tasks in a faster and better way. When they find a way to do things better and faster, they get rewarded. The American Capitalist system promotes creativity and productivity, amid all the macroeconomic problems. This remarkable characteristic of the system is the reason stocks have performed well amid all the uncertainties and casualties.

As Chuck Akre (Trades, Portfolio) has pointed out in his presentation at the Value Investor Conference, American businesses have earned approximately 10% return on capital over the past 75 to 100 years, during which we had world warss, oil embargos, terrorist attacks, cold wars, etc. If American businesses continue to earn low double-digit or high single-digit returns on equity, stocks will do just fine. You can be right about the occurrence of horrible events but if you are permanently pessimistic about the stock market, you will most likely not do well.

So here we are today, still facing many problems. First of all, Warren Buffett said in a CNBC interview that the Fed has sown a lot of seeds for inflation. It’s easy to sow the seeds, and it will be extremely hard to unsow the seeds. And we all know what inflation and high interest rates can do for stock markets. It is a real concern, but no one knows the possibility and when.

Another concern is China. We have seen signs of collapse of the real estate market in China. The Chinese economy is slowing down. China is also going through a massive rebalancing, and that has huge implications for American multi-national companies. Again, no one can predict what will happen, but the result is more likely to be ugly than pretty.

Furthermore, the geopolitical, nuclear, chemical and cyber risks are all real. It is scary to think about the implications.

Even with all the above problems and a ultra-low interest rates, I think Mr. Buffett is right - stocks are probably fairly valued. And if I look out 10 years from now, I can’t see any reason why the U.S. economy is not better than it is today. It seems obvious to me that the standard of living will be higher, corporate profits will be higher, and American businesses will continue to do well with a few hiccups on the way.

In the end, you may ask, as investors, what should we do given what we have learned from history, and given the unknowable future?

My answer is simple: It rarely pays to be pessimistic. So be optimistic, but proceed with caution.

Rating: 5.0/5 (18 votes)



AlbertaSunwapta - 3 years ago    Report SPAM

I tend to agree however calling Hussman a permanent-bear is short-sighted, from a historical perspective and would require Prem Watsa, the buyer of blackberry stock of all things, to also be lumped into that category. :-)

Personally I see nothing wrong with taking steps to protect one's capital and subsequently under performing the market if it means one can sleep at night. Sometime macro events rule, sometimes micro event rule. I can predict the future or which one will dominate over the market's direction at any particular point in time. I imagine owners of diversified, balanced portfolios have similar sentiments.

Where I fear to tread is in buying time dependent hedges, etc. where I not only have to have the over/undervalued state of the market right but I also have to get the timing of the investing masses right.


Furthermore, to play the devils advocate I must again ask:

Why should investors ever sit in cash?

If a value investor sells out of a fully or over valued position, why not put the proceeds into a market index until one finds another opportunity?

Why do value investors, focused on specific corporate fundamentals and admitting that they don't include the entire market within their circle of competence, nor feel that they can predict the entire market, not use indexes to stay "all in, all the time"?

In other words, if one cannot predict macro movements in the market, why not just stay fully invested all the time? Holding any amount of cash, as I am right now, seems to reflect an intrinsic macro forecast predicting a market decline, otherwise wouldn't it make sense to buy the market or increase one's position in an existing holding.



Here's some interesting ancient history:


Loews' chief insists that his short-selling, which has been disastrous so far, will be vindicated in the end


Told Ya So

9/02/2002 @ 12:00AM


"For years the bears were derided for not getting the New Economy. Now, with the S&P 500 down 40% from its peak, they’re vindicated. Are stocks today cheap enough to tempt them? We revisited ten Cassandras who have warned in FORBES about overpriced stocks. Most find a few worthwhile names to buy but remain stubbornly bearish overall.


Jtdaniel premium member - 3 years ago

Hi Grahamites,

Thank you for the good writing. I recently looked through my portfolio and watchlist, along with the common GF value screens, My conclusion was that the "dividend growth investors" are running out of options for new money (although I doubt that many of them would agree). Of the dividend-paying stocks in my portfolio, I would only add to IBM at its prevailing price. It would take a 10 - 15% pull back to reach anything else I already own (Wal-Mart and Heineken). In terms of value, quality and my limited knowledge, I found no yielders on the screens that I would prefer to IBM.

It could be that a combination of greed (for high yield) and fear (of Amazon) has created an interesting contrarian play in no/low yielding, brick and mortar retailers. It doesn't take long to pick up on this theme while browsing the Buffett-Munger and Undervalued Predictable screens. One tactic would be a basket play on the best of breed in different areas of retail (i.e. Buckle, Dollar Tree, PetSmart, and Bed, Bath and Beyond). Another strategy would be to identify a line of retail that Amazon would be unlikely to enter -- this is where Batbeer2's America's Car Mart idea makes so much sense to me. Who would buy a used car without taking it out for a spin and negotiating for a lower price?

Grahamites premium member - 3 years ago

AlbertaSunwapta: Thanks for a thought-provoking comment. A few points

1. Agreed it's probably a little unfair to call Hussman a permanent bear. My point is he has been applying his economic thinking to the market and he has wildly underperformed the market. In fact, I think his annualized return has been close to something like 0%.

2. With all respect, I don't view holding cash as a market timing call. For some people it does but for me, holding cash is more like a tool to prepare myself when opportunities abruptly come so I don't have to sell my current positions, especially if my holdings are wonderful compounders. So I'm usually not fully invested but my cash position raraly reaches over 20%. I think you can find opportunities in most markets, even in a bull market that we are in right now, unless it has reached to an extreme, such as the case in 2007. With regards to index fund, I don't have particular feelings either way. I think parking your fund in an index fund when you can't find opportunities is quite ok.

Grahamites premium member - 3 years ago

Jtdaniels: Thanks for your comments. I'm not a dividend growth type of guy so can't add too much value on the topic. But I do agree with you on IBM. In fact I'll publish another article on IBM, not from a dividend yield perspective though.

On specialty retail stores, I think your approach is sensible, given proper valuation levels to each of the names you mentioned. Although I have observed that Amazon over the years have expanded to almost all areas of retail. Considering they started as a bookstore and now essentially sells almost everything, I won't feel too too safe about BBBY and Pet Smart. If I own shares in BBBY and Pet Smart, I would worry about what would stop Amazon from invading their markets if they are profitable markets?

Snowballbuilder - 3 years ago    Report SPAM

@Grahamites I always appreciate your articles .

but i think an investor should be rational not optimistic (neither pessimistic).

charlie munger once said his biggest hedge is to be extremely rational and patient.

if i look around i still found more "born bull" then "pessimistic" and i think both side are quite dangerous.

i just try to be rational , let my holding compound and build up cash to be ready when "some day"

fear will be again on the street .

i simply patiently wait the next big fat pitch .

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