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Berkshire Hathaway
Ben Graham & Liquidity Bubble

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By valueguy88
November 21, 2005

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Remember the articles from Graham and Schloss on the Schloss Archives for Value Investing?
http://www1.gsb.columbia.edu/valueinvesting/research/schloss_archives.html
(no longer available but once was)

I decided to revisit some PDFs I've saved in a quest to draw a connection between Graham's views and today's liquidity bubble. What would Graham do with more value investors today, or perhaps just more investors or just more speculators, all that reaching for yield stuff, the debates about lowering standards, people like Whitney Tilson who resort to buying AIG and AXP instead of holding cash. (Not to pick on Whitney, he's just a well-known example). I expected not to find an answer.

WELL Surprise, surprise !!

It looks like one PDF titled "securities in an unsecured world" may provide some wisdom. This is a 13-page transcript of a lecture Graham, seemingly taking place in 1963 or 1964 and organized by some Doctor or professor. One principal discussed here is quite well known from The Intelligent Investor but:
1) It is often forgotten by many value guys today, and
2) The way in which he phrased it in this speech was different and particularly relevant today:

"I do believe it is possible for a minority of investors to get significantly better results than the average. Two conditions are necessary for that. One is that they must follow some sound principles of selection, which are related to the value of the securities and not to their market price action. The other is that their method of operation must be basically different than that of the majority of security buyers. They have to cut themselves from the public and put themselves into a special category."


Take a look at condition 1. In The Intelligent Investor, I believe he used the words "inherently sound and promising." But in this version here, condition 1 says that you have to be a value investor! I used to think that value investing = (1) + (2).
So if (1) is value investing in and of itself, why the heck is there even a second condition?

Condition 2 says you have to be BASICALLY DIFFERENT, meaning that it's not enough to be slightly different. So if you're buying BUD or WMT or homebuilders with *ALL* your money, sure, you're buying stocks at a discount, but these aren't hated by everyone, only some people, and they aren't as undervalued as stocks have gotten in the past (like 1999 WMT, 2002 tech...I ain't talking 1974). You're buying assets and you're part of the liquidity bubble. You might get significantly above-average results with BUD and maybe even WMT, but that all depends on the definition of "significantly" in the context of a market where a super-fat pitch could come easily via some "credit event" or something.

Graham uses the words: cut themselves from the public

Who today is cut from the public? Only the really bearish types, who forecast an actual strong decline in housing, and a recession, and a stock market downturn. That includes gloom-and-doomers, and those slightly less bearish than them, but not people who simply speak of lower returns in the future.

- Everyone can see flat residential property prices
- Everyone can see low yields
- Everyone can see high commodity prices being a drag on GDP

To be Graham-like you have to be more bearish, more scared.

Another snippet from this talk is relevant EVEN in the case you're gonna make above-average returns with BUD and WMT and Homebuilders and REITs and car part companies...etc, etc.
Again, like magic, Graham puts a twist to a well known principle of his as if he had said it in preparation for 2003-2005! It's the infamous 25%/75% rule:

"The first point is that the investor is required by the very insecurity ruling in the world today to maintain at all time some division of his funds between bonds and stocks. (Cash and various types of interest-bearing deposits may be viewed as bond equivalents.)

There you have it: CHC - Cold Hard Cash -

If Graham were here today he'd probably have 50%-75% in cash.

vg


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