O. Mason Hawkins and G. Staley Cates, whose Southeastern Asset Management funds have excellent track records over the past decade, say they are adding to their equity positions amid the global economic fears.
“As the largest owners of the Longleaf Partners Funds, we have used the recent price downdraft to meaningfully add to our stakes,” Hawkins and Cates write in their third-quarter letter to shareholders. (A tip of the cap to The Stingy Investor for highlighting the letter, which is available here.) “Broadly speaking, the return on corporate ownership vis- à-vis the return on lending seldom has been so compelling. With the S&P 500’s growing, after-tax free cash flow yield around 10% and the pre-tax, fixed 10-year Treasury at 1.8%, shareholders receive over five times the return of bondholders, before adjusting for taxes or future growth. More specific to the collection of businesses we own, we have both little uncertainty about how they will fare over the next five years and the rare opportunity to purchase them at half or less of appraised value. We encourage our partners to join us in adding capital at this opportune time.”
Hawkins and Cates say that during the third quarter, correlation levels of the S&P 500 hit 90% — three times the historical average of 30%. In the past, when correlations have gotten that high, the firm’s funds have suffered, as they did in the third quarter, they say, but those periods have been followed by very strong performance.
But, they add, trying to time those correlation waxings and wanings would be unwise. “We are incapable of knowing what stocks will do in the short run,” they say. “To make investments based on correlation changes would require two correct calls — when to sell and when to reinvest. Being accurate in either prediction is a low probability, but when the two probabilities are multiplied, the chance of success is remote. Patience and discipline historically have rewarded our partners who believed in intrinsic value-based investing and who stayed owners through full market or correlation cycles. Price declines are painful, but do not equate to capital losses if investors stay long-term and business values remain intact.”
Hawkins and Cates say that the current market fears seem in large part to be a result of the 2008 financial crisis and market plunge being fresh in investors’ minds. But, they say the current situation is much different than 2008. “Cost structures are already sized to recession levels; inventories are lean; balance sheets are strong with almost all of them de-risked; and industry-leading companies have become more dominant over the last few years,” they write in discussing some of their holdings. “While these companies have tremendous operating profit upside when economic growth improves, our appraisals do not assume a normal GDP bounce will help in the next few years. Adapting to a possible 2012 recession would be like stepping off of a curb rather than falling from a skyscraper for these businesses and their values.”