Practically everything in markets is cyclical. Bull markets become bear markets which turn into bull markets…and the cycle repeats. What’s old is new again, so to speak.
An inflection point marks the shift from a bull to a bear market (or vice versa). It’s the turning point in the market cycle. They also tend to be turning points for investors as well. Often to their detriment.
Just ask John Neff. He experienced numerous inflection points throughout his career. Each moment his strategy seemed to stop working. One thing stood out that was key to his success:
Periods of outperformance for us often followed “difficult” inflection points. For instance, the Nifty Fifty was the craze in the early 1970s. We underperformed significantly in that run-up, but as the market finally started caving, we got more aggressive and bought lesser recognized growth stocks out of the ashes in 1973 and 1974. We more than recouped our 1971–73 short falls in 1974 through 1976.
But it was not always so straightforward. For instance, in 1980, oil was supposedly going to rise to $60 a barrel, and everything electronic was a hot item in the market. We did not do well that year. Those sectors, however, got killed in 1981, and we did very well in the ensuing years.
But then, of course, came 1987. Equity market prices rose to 22–23 times earnings, and we built a 20 percent liquidity position in 1987; we simply could not find reasonably priced stocks to buy, so we fell behind in the first three quarters of that year. Following the famous crash in October 1987, we more than recouped our underperformance through 1988.
Then, in the early 1990s, the financial intermediaries went bust. Thirty percent or more of our portfolio was positioned in financial intermediaries—thrifts, banks, and insurance companies. Shareholders complained that these financial intermediaries were all going to fail. Some did, but obviously they all did not, and they were eventually good investments.
So, you have those inflection points when sometimes performance suffers. But you have got to stick to your guns. We were a low-P/E fund, and that strategy was in the mutual fund charter so that the shareholders knew what they were getting. All we had to do was execute our strategy well.
The normal response, when something is not working, is to fix it. Make a change. Doing nothing is rarely the answer, except with investing.
Underperformance and losses are the biggest reasons our portfolio needs fixing. We hate when our returns fall short of others and nobody likes losing.
We become myopic. Doubt creeps in. We focus on the short term at the expense of long-run returns. We ditch a perfectly good investment plan because its short-term returns are hard to stomach. The portfolio gets rearranged.
Of course, without a plan, it devolves into return chasing 101 or a flight to safety or random dart throws at best. Whatever relieves the fear out missing out or further bleeding becomes the solution. Unfortunately, this typically results in doing worse than doing nothing.
Neff could have easily followed a similar path. His strategy appeared to no longer work. He was underperforming or downright losing money. He didn’t know what the markets would do next.
But he had two things going for him. He had a sound strategy he believed in and discipline. He knew that searching for low-P/E stocks with a high total return (growth plus yield) worked over time. So he stuck with it.
His experience taught him that great returns followed “difficult” times. The market cycle eventually delivered a growing list of opportunities with the potential for higher returns. All he had to do was execute and be patient. Inflection points were the perfect time to double down on his strategy.
Investing is an imperfect game. Returns are inconsistent from year to year. Underperforming relative to others is common. Rough times are bound to happen. You can do everything right and still not make money. The entirety of it messes with our heads.
Yet, investing doesn’t have to be complicated. It’s often as simple as following the same process over and over again regardless of the short-term results. The long-term returns, the good, bad, and ugly, average out.
A Conversation with Legendary Value Investor John B. Neff
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