How low can we go?
Tom Cowan — the founder of TDM — wrote the below to one of our clients in response to an email he received on April 3. It was too good not to share here.
Thanks for the email, we too remain cautious on the overall market and like everyone, are not sure if the market will end up in GFC territory of being down approx 50%.
Having said that, as you know, when looking to deploy capital (and that is our job in a falling market despite how uncomfortable at times it can feel), we are looking at each business individually and not from an overall market perspective
I have a few charts that tell a bit of story and to keep in mind as this continues, as to why we don’t just think about the S&P 500 (or other indexes for that matter). Some businesses are getting a massive tailwinds (think Woolworths) and some will have no revenue for a number of months (think most consumer facing businesses or heavily exposed verticals like travel). Because of this dispersion in outcomes related to the current Covid induced environment, an index fails to tell the story — Woolworths is at a record high, Flight Centre was at the same price in 1999!
Not only do the indexes not give us a true picture as investors as we try to find a dislocation between value and price on a five year view, different indexes also show different things.
Below is the ASX small cap index — almost back to GFC levels and well below 2007 highs;
People use all sorts of indexes — if I am looking at one for a snapshot, I personally prefer the Russell 2000 for the US rather than the S&P500 to get a better picture. It shows 2000 small to medium sized US companies and excludes the largest 1000 (ie: companies 1001–3000). It too is back to 2013 highs.
The chart below shows the GFC from the date of Lehman Brothers went bust versus the GVC (the V is for ‘virus’!)
Interesting at this stage — 33 days in — both events are down 33%. In the GFC there was only a period of 66 days from 12 January 2009 that the indexes went below this watermark. During that time, the indexes bottomed down 50% and were only in the range of 40 to 50% down for 23 days!
The index was back to the levels pre-Lehman at day 399 — so only a tick over 12 months. My point being is, when there is fear, both in the market and society more generally, it can and often does feels like the world is collapsing, with no end in sight, but the relative pain (and deep opportunity) is actually short lived (and only seen retrospectively). We must remind ourselves markets lead other indicators — investors start to ‘look through’ as soon as they gain any comfort on uncertainty.
And this is not an isolated data point. It was the same for the MSCI world index — we are now only back to 2013/14 highs.
But most importantly as I mentioned, we are laser focused on individual businesses, not market trends.
So I went back to the data from the GFC to try and prove the point as to why a/ you can never pick the bottom and so you have to keep chipping away at incrementally deploying money as the price falls, and;
b/ recovery (share price) never takes as long as you think it will. If you wait, and unwilling to continually ‘catch the falling knife”, you miss out. Plain and simple.
Mineral Resources is a great example — it fell from $7 to below $1.60 but within 12 months it had gone up 4 times! As you can probably remember we started buying at approx $3 and it fell another 40% to c$1.65. We continued to keep averaging in for a number of months, and our average purchase price ended up at approx $2.25. The point being, we ended up doing OK even though we didn’t get the exact timing spot on!!!!
While we weren’t invested in Salesforce during the GFC ,the chart is interesting. I am using Salesforce, as there weren’t many Software as a Service businesses listed back then, and I think it is a useful proxy for our companies now.
It also fell 50% from its highs … the rest, well, is history …
Within 18 months is went up approx 6x and now trades c$150 (up from $6). What we also know if that the economy in 2010 was far from booming … but that didn’t stop this amazing growth business.
All the businesses we are deploying capital into at the moment are off between 40 and 60% and are trading at extremely attractive prices. Prices that you only see “GFC” type events that cause significant fear and panic thus price dislocations. And while the overall index may not be down the same due to the ‘mix’ issue I referred to — many are experiencing a ‘GFC’ type event and are trading at prices reflecting this.
It is not meant to feel warm and fuzzy deploying capital in times like this, but it is our job to do so. As Howard Marks once wrote in reference to the GFC,
Thinking strategically, we decided that if the financial world ended — which no one could rule out — it wouldn’t matter whether we’d bought or not. But if the world didn’t end and we hadn’t bought, we would have failed to do our job.
For what it is worth, his most recent memo in regards to ‘balancing offence and defence’ in times like this is also worth a read.
Our key source of competitive advantage as a business is that our clients have trusted us to take a long term view. The evergreen pool of capital structure was set up from the start so that when valuations start to get “toppy”, we can hold cash for long periods of time, waiting for market corrections. It is where we have made most of our money — being patient and deploying capital until there is significant price dislocation. It provides both great upside and a significant margin of safety if we are wrong.
I hope this helps explain why we are chipping away slowly deploying capital into some amazing growth businesses even though we don’t know if they have hit rock bottom yet. It will probably get worse from here but sadly we don’t know that for sure. All we know is that as of today, these businesses are dirt cheap and on a five year view will be trading many times where they are today. Hope this gets you as excited as we are about the opportunity ahead.
Happy to chat anytime
TC
