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The following commentary was originally posted on FoolFunds.com, the website of Motley Fool Asset Management, LLC, on Aug. 8. With permission, we're reproducing it here in an edited form.
"Again and again after freedom has brought opportunity and some degree of plenty, the competent become selfish, luxury-loving and complacent, the incompetent and the unfortunate grow envious and covetous, and all three groups turn aside from the hard road of freedom to worship the Golden Calf of economic security." -- Henning W. Prentiss, Jr.
Our greatest tendency, one we hope you share, is to buy aggressively when market blowouts occur. Such blowouts tend to happen in the face of some really big thing. In the last few weeks, the markets have faced the following really big things: political wrangling over raising the U.S. debt ceiling, the potential collapse of the eurozone (even following its six separate "crisis-ending" actions over the last two years), a rating cut of U.S. debt, and rising unrest and inflation in China. It's a scary time. Horrifying, actually.
How have we responded to this? We are buying.
Over the last few months, we have held rather large cash positions. We've done this for a very basic reason: We had a difficult time finding companies that we thought were bargains. In our analysis, many companies, especially in the smaller-capitalization range, had priced in happy sailing and good times ahead. This, in the face of some obvious massive risks facing many economies around the globe, seemed to us to be a bit Pollyanna-ish.
We do not invest on macroeconomic themes, but we do consistently attempt to think about risks and opportunities. Our inclination is not to forecast events or the market's reaction to them. We try to remain impervious to investing fads, to avoid the popular, and to buy companies that few seem to like. Hell, many times even we don't like 'em.
Haven't you heard the news?
There will be much debate in the upcoming months and years about the whos, whats, and whys surrounding Standard & Poor's decision to strip the United States of its AAA credit rating and -- just to drive the point home -- placing a negative outlook on its new AA+ rating. Further debate will swirl about whether the S&P was even justified in doing so. Nonetheless, the downgrade is a historical fact at this point, and the global financial system must adjust to a new reality. The cost of credit for virtually every American is likely to rise. This represents an additional psychological impediment to the formation of capital, as well as for the generation of employment.
Investors in every market will have to reevaluate whether they wish to maintain these assumptions. America's central role as the anchor of the global economy will be thrown into question, as will its standing as the most attractive market for other countries to invest their savings. Certainly there is no other country ready or even willing to serve as the core of the global financial system (Russian and Chinese bleating notwithstanding). It could just be that the world adjusts to the reality that its central financial instrument is no longer "risk free."
PIMCO's Chief Executive Mohamed El-Erian noted in a Bloomberg interview this weekend that there is a potential silver lining from the downgrade -- perhaps it will serve as a wake-up call for America's policymakers. It seems that if a Democrat official says something is red, a Republican will insist that it is blue, and vice versa. Neither can miss the unambiguous message of the downgrade: American economic strength and its global standing are crumbling. How will our political leaders respond to this definitive "Sputnik moment"? For once, it is hardly overstating the case to say that our financial future hangs in the balance.
I repeat: And so we buy.
Since the last week of July, even in advance of the ratings cut, stocks worldwide have been in freefall. When this happens, many investors tend to think that the market is omniscient. Sometimes the market is correct, but many times, the massive moves to and fro are based on little more than stupidity, and clarity is usually only available in hindsight.
As opportunities arise, we're more than happy to swap our cash for shares, or to move from one existing position to a new, more attractive one. The point is, the market is afraid, and when the market sells off indiscriminately, you have to know that our instincts will be to buy big.
In September 2008, Warren Buffett stepped in front of a metaphorical train to take positions in several struggling American firms, including Goldman Sachs (NYSE: GS ) . Over the next few months, many in the media hammered Buffett for his "bad" investment in the firm, which had seen its share price deteriorate. His critics' point of view was conventional: The economy was going to hell in a handbasket, and Buffett had made a terrible bet. This past quarter, Berkshire Hathaway's (NYSE: BRK-B ) profit from its Goldman bet alone was $806 million.
By the way, lest you think this is hubris, let me make an impassioned plea to you. Mutual fund returns are driven partially by management decisions, but partially due to the timing of when clients invest and redeem. If you find yourself more fearful than eager during the inevitable times that the market drops (and more specifically, when our funds do), you may be better served investing elsewhere. Our goal is not to attract as many assets as humanly possible. Rather, we believe that all of our goals will be best served with the highest percentage possible of our clients having philosophical alignment with us.
Editor's note: Bill Mann is not able to engage in discussion on the boards or in the comments section below. Bill owns shares in Berkshire Hathaway.