Before the global financial crisis, most participants in the world of finance felt they understood how things worked, and that in addition to the underlying processes, they could rely on institutions and currencies. Then the crisis occurred and a lot changed. Things happened during the crisis that were described as “five-standard-deviation occurrences” (or three or eight). In other words, things happened that had never happened before and had been considered capable of happening only once in several generations or centuries. But they happened, and sometimes a few in a single week.
These were negative “black swan” developments, and they had a number of ramifications. First, they imposed substantial losses. Second, they called into question the predictability and understandability of the financial world and introduced new levels of uncertainty. And third, they set off a search for things that would provide certainty and safety in the newly uncertain world. This search led many to look to gold.
Berkowitz works seven days a week and often starts sending e-mails before 4 a.m. After his power walk with Fernandez each morning, Berkowitz works out in his basement gym with a personal trainer and is at his desk by 8:15. When the market closes, he meets again with Charlie for an hour, then spends an hour or two with his family. He's usually in bed by 9 p.m., reading annual reports or other filings. Once his eyes get tired, he puts on Bowers & Wilkins headphones to listen to conference calls. Berkowitz says he listened to Bank of America's recent earnings call over and over -- nine or 10 times -- to understand how new CEO Brian Moynihan is handling financial reform: "I'm impressed," he says.)
I have always tried to focus on the handful of issues about which I know a decent amount. This has been overwhelmingly about identifying hugely mispriced major sectors or asset classes among equities. This developed over the years into a study of bubbles and busts. As we built up our data and analysis, my (and our) knowledge and comfort zone extended to similar outlier events in other asset classes, including currencies, commodities, bonds, and some real estate markets. The rule, though, was not to stick our necks out unless the pricing is truly extreme for these non-equity price series, a policy that has given us, touch wood, a good safety margin. In equities, we have been a little braver and sometimes paid a high price for being early. But we missed very few, if any, major mispricing.
An investor’s goal is to accumulate capital over time. Investing at its core is the act of forgoing current consumption in order to satisfy future liabilities or to consume more down the road. If capital accumulation is the prime objective, investors must think clearly about what builds capital. Unfortunately, there seems to be a great deal of confusion over the topic, much of it surrounding the role of dividends. If you listen to the press or read missives from investment firms, you might conclude that dividends play a prime role in capital accumulation. In fact, well-known strategists have pointed out that dividends have accounted for 90 percent of equity returns over the past century. This statistic is potentially very misleading and warrants further examination. Here’s the ending without the plot: price appreciation is the only source of investment returns that increases accumulated capital over time.
With the economy showing clear signs that the recovery is gaining traction, corporate earnings continuing to surprise on the upside and equity valuation levels quite attractive, we think the burden of proof is now on the bears as to why 2011 should not be a good year for U.S. stocks. That is not to say that we won’t have corrections along the way. We certainly will. It also doesn’t say that investors still don’t have plenty of things about which to worry. They clearly do. But, on balance, we believe the good will far outweigh the bad in 2011 and stocks will, in our judgment, make solid upward progress, with the S&P 500 more likely than not closing the year above 1400.
Source: http://www.lmcm.com