By Drew Wilson
On November 9th, LCH.Clearnet.SA raised the initial margin requirements on Italian bonds erasing $3.7 billion – nearly 2.5% – of Coca Cola’s market value (not held in FAM Funds). What? Who is LCH.Clearnet? And, what do their Italian debt policies have to do with the world’s desire for a cool, refreshing Coke? Truth is, not much. Coca Cola shareholders were left understandably dazed and confused. Overall, 2011 left many equity investors dazed and confused. Similar to Coca Cola, most of the extreme declines in stock prices had little to do with the underlying economic value of the businesses they represent. FAM’s focus on the values of individual companies provides us with opportunities when these irrational negative swings occur due to news outside the stock market.
The S&P 500 Index was certainly not immune to volatility. Those who owned securities tied to the S&P experienced a wild ride to nowhere. The number of days the S&P moved up or down by more than 2% in 2011 was among the highest in the last two decades – yet the index finished nearly exactly where it started. Several things contributed to the fluctuations including a downgrade of U.S. credit ratings and acute political dysfunction in Washington; but more often than not, equity markets reacted to European headlines.
The euro zone faces serious issues that impact the global economy, so it’s rational that prices of some financial assets respond to the events unfolding there. However, the indiscriminate buying and selling of entire asset classes – such as U.S. stocks – is clearly irrational. This herd-like movement in-and-out of the market has been so prevalent that pundits have labeled each trading day as “Risk On” (market moves up) or “Risk Off” (market moves down). It’s possible that this volatility will continue in 2012 as euro zone struggles and global economic uncertainty continue, and as we cycle through our presidential election.
For value investors like FAM, price drops present opportunity. Equity markets tend to be efficient, meaning businesses sell for what they’re worth and bargains are scarce. But on days when the headlines spook investors and they sell stocks, the high-quality, well-managed companies that we seek get “thrown out with the bath water.” We are equipped for these opportunities in two key ways. First, we hold cash in the Funds so that we are able take advantage of indiscriminate selling. Second, we continue to work diligently to build our portfolio of ideas so that we are ready whenever and wherever bargains surface. In 2011 alone, we spoke to and/or visited nearly 70 new companies covering almost every sector. So when the market declines because the crowd “runs for the hills,” remember we are prepared to scoop up the bargains they leave behind.