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Don't Look Back in Anger or Forward in Fear But Around in Awareness

(Guest Commentary by Rick Konrad – June 10, 2011)

Dear Subscribers and Readers,

For those who want to learn more about picking stocks, evaluating companies, industry trends, and other issues related to the stock market, we have brought in Mr. Rick Konrad to pen a guest commentary.  Rick has been our regular guest commentator for several years and offers his unique insights to us twice a month.  We highly appreciate your investment insights and general wisdom, Rick!

In this commentary, Rick injects some common sense and logic into the general fear surrounding the U.S. economy and the country's relative stance in the world.  Rick reminds us that we have been here before; and that comparisons to the Great Depression are simply misguided (which I totally agree with).  Rick argues for a commonsensical approach—and he brings up a great stock idea, Markel (MKL), as an example.  Without further ado, following is Rick's biography:

Rick is author of the excellent investment blog “Value Discipline,” founder of “Value Architects Asset Management”, and is a regular guest commentator on MarketThoughts.com (please see “Geopolitics, Economics and Emotions” for his last commentary).  Prior to his founding Value Architects, Rick was a professional portfolio manager for institutional investors for over 25 years.  A more complete profile of Rick is available on his blog.  You can also email Rick at the following address if you have any questions or thoughts after reading his commentary.  Rick is a very genuine teacher of the financial markets and treats it very seriously.  Rick has also run the education program for the CFA Society in Toronto (which is the third largest CFA society in the world besides the New York and London Societies) and had graded CFA examinations.

Disclaimer: This commentary is solely meant for education purposes and is not intended as investment advice.  Please note that the opinions expressed in this commentary are those of the individual author and do not necessarily represent the opinion of MarketThoughts LLC or its management.


Let us not look back in anger or forward in fear, but around in awareness.

-James Thurber

It is better to have asked some of the questions than to know all of the answers.

-James Thurber

James Thurber was known as a terrific writer, editor and cartoonist for the New Yorker magazine.  Blinded in one eye as a child and unable to participate in sports, he developed a very creative imagination and a keen sense of humor. Yet, when I look at these quotations, I think there is great wisdom that is applicable to today's economics and investments.

Emotions are very high at the moment. I hear it in my conversations with some clients and brokers. According to a recent CNN/ Opinion Research poll:

http://tinyurl.com/3pzz8x6

Nearly half the population believes things are bad -- and are going to get a whole lot worse in the not-so-distant future.

Forty-eight percent [of Americans] say that another Great Depression is likely to occur in the next year - the highest that figure has ever reached. The survey also indicates that just under half live in a household where someone has lost a job or are worried that unemployment may hit them in the near future. The poll was conducted starting Friday, when the Labor Department reported that the nation's jobless rate edged up to 9.1 percent.

"The poll reminded respondents that during the Depression in the 1930s, roughly one in four workers were unemployed, banks failed, and millions of Americans were homeless or unable to feed their families," says  Keaton Holland, CNN's polling director. "And even with that reminder, nearly half said that another depression was likely in the next 12 months. That's not just economic pessimism - that's economic fatalism."

According to the survey, more than eight in ten Americans say that the economy is in poor shape, a number that has stubbornly remained at that level since March.

Looking at all the economic evidence that I can muster, and discussing business conditions anecdotally with many companies as part of my everyday routine, I find it impossible to come to this conclusion. Are we slowing…absolutely but depression, I find no evidence. Yet, many others, “the man on the street” draws an entirely different conclusion.

In another poll, we also see the contradictory beliefs of those surveyed:

According to a recent Washington Post-ABC News poll:

71 percent of Americans say that the U.S economy would suffer serious harm if Congress fails to lift the debt limit. Even still, 51 percent of Americans oppose a deal to lift the debt limit, even if it includes spending cuts. 

How is it that our thinking can be so contradictory? Clearly, emotions can get in the way of rational thinking.

Many of my clients and brokers have made reference to the terrible job situation in this country and noted the fact that the unemployment rate ticked up in May to 9.1%. Yet, no single person was aware that the total job creation for 2011 through the end of May was 783,000 jobs just slightly behind the 955,000 jobs created for all of 2010.

Many recent articles have focused on the plight of graduating university students struggling to find work (Congratulations to Henry who will be graduating on Saturday! And is employed!!) Here is an example from New Republic:

“Sally Cameron thought she had done everything right. After studying French and Arabic at a tony liberal arts college, she knew that graduate school would help her career chances. But when she hit the job market, her Ivy League management degree didn't seem to matter. The worst recession in decades had pushed the unemployment rate to nearly 10 percent and good jobs were scarce. Sally paid the rent by tending bar and filled her time with volunteer work.”

Though the story sounds like many stories we have read in the past few weeks, this story was published in the Washington Post in 1982. The essence of the article is as wrong then as it is now. University graduates generally find themselves in the top three deciles of income.

How do we avoid stumbling into these mental pitfalls?

In a television interview, Warren Buffett was once asked, "Why do smart people do dumb things?"  WEB's response was that greed, fear, envy, and mindless imitation of others (my emphasis) are the factors that cause us to go off track. Buffett also concluded that rather than superior intelligence, the capacity for unconditionally rational thought, followed by proportional action, is what separates the winners from the wannabes.

Thurber's quotes come into play here. All of us have opinions on the markets, on the economy, and on individual stocks. How often are we basing our views on mindless imitation of others as opposed to unconditionally rational thought? Is it reasonable for us to believe that depression is a likely outcome for next year?

In Barry Ritholtz' excellent blog, The Big Picture, he has a wonderful post, "Investment Advice from George Carlin." Please see http://tinyurl.com/4ydsadp. Among the snippets of advice, "Have a Healthy Perspective- Your Own". Illustrating the fallacy of perspective, the quote is priceless:

“Some people see the glass half full. Others see it half empty.
I see a glass that's twice as big as it needs to be.” ~ George Carlin

None of us have all the answers, including this advisor but most of us who have been in this business for a long period of time have a series of questions that we ask management teams or ourselves. After all, knowing what we do not know is even more important than knowing what we think we know.

Trying to view the entire investment landscape from a tiny frame of reference is a little like gazing at the grandeur of the Grand Canyon or travelling through the Rockies...the enormity and scale diminishes and humbles us. Making the right call requires you to take the time to question your reasoning in order to gain a mental and a market edge. Most of all be rational and logical in your approach to find understanding.

Cognitive dissonance arises when a person holds two cognitions—whether ideas, attitudes, beliefs, opinions—that are psychologically or rationally inconsistent. The dissonance causes mental discomfort that our minds try to reduce.

Many of our decisions start with logic but then use emotion in the final round of making a choice. It is also very common for emotion to override logic or to use pseudo-logic to support emotional choices.  The tendency for most of us is to use mental shortcuts, or heuristics to take ourselves to a quick conclusion. Because of our internal biases, these mental shortcuts on which we base our thinking are viewed as almost incontestable. Much as the adage coined by Walt Kelly in a Pogo carton declared: “We have met the enemy and it is us.”

Perhaps, I am guilty of being a born optimist. Years ago, I had spent some time as an institutional salesman working with a partner who had been a terrific mentor. He was very successful at the time but had left the business in 1974 when the securities business and the markets had fallen apart. He returned to the business a year later. I asked what brought him back? “Trucks on the Trans-Canada Highway…I was watching them heading out of Ontario and going west and it struck me that business was still taking place…somebody was buying and needed it shipped.” Simple logic indeed, but much more sensible than most economists and analysts could ever muster.

Maybe it's simple logic and avoiding over-thinking that will keep us invested.

In terms of stock ideas, one name that we own is Markel, a specialty insurance underwriter. Markel (MKL) tends to write insurance in rather funky, and unusual risks, providing coverage for children's summer camps, cheerleading schools, martial arts schools, farrier liability (people who shoe horses) etc. The primary objective is finding risks which are reasonably predictable as to their frequency, result in significant claims and hence are important to the insured, and can be priced for an underwriting profit.

The company has demonstrated excellent underwriting discipline despite what seems to be a perennially soft (poor pricing) insurance market. The company's management worships Buffett and emulates Berkshire in its approach to writing insurance as well as in investing. The underwriting record has demonstrated underwriting profitability (in insurance parlance, having a combined ratio below 100) for seven of the last ten years.

The policyholder “float” is that cushion of capital that allows for long term investing to occur. For Markel, this is just under $5 billion. The float provides cost-free investment leverage which leads to growth in equity. The equity portfolio is run by Tom Gayner, another Buffett protégé with a terrific long term investment record.

Finally, Markel has been developing some private equity expertise in Markel Ventures. Not unlike Berkshire's model of acquiring non-insurance businesses with decent cash flows at attractive prices, Markel has pursued this as an alternative to using listed stocks.

The equity has doubled since 2004 on essentially flat revenues for the entire period. Markel writes premiums when it sees profitability not just to get business on the books.

Though the bond portfolio would lose value in a rising interest rate environment, and represents about two thirds of the investment portfolio, it is high quality at AA and has a relatively short duration (interest rate sensitivity) of 3.5 years.

The stock is as cheap as it has been through this decade based on price to book value:

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Current
1.4 1.7 1.5 2.2 1.8 2.0 1.9 1.3 1.2 1.2 1.2

We have known and respected management through this period. We admire their discipline and their philosophy. We think it is a very high quality investment that will not be terribly affected by the day to day vicissitudes of the market.

Disclaimer: I, my family, and/or clients own a long position in Markel.

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