The word bubble, in the context of financial markets, gets thrown around a lot these days. Some of this is understandable considering the global economy was, and still is, recovering from the incredible recession of 2008-2009. Our senses have been heightened to watch out for what may be coming next. Regardless, the excessive usage begs the question: What defines a true bubble?
Admit it, if you’re using some sort of asset allocation strategy this question has crossed your mind. I’m not talking about indirectly owning Berkshire through a fund*, but a direct concentrated holding of the stock itself. Aside from having one of the greatest investors of all time run your money there are some additional fringe benefits. At the very least it gets you a ticket to the shareholder meeting held in Omaha every spring. Dilly bars anyone? Many have written about various pros and cons of Buffett’s businesses. The shareholder letters are publicly available to anyone who wants to read. But how has Berkshire performed as an asset in the context of an overall portfolio?
If you’re interested in asset allocation strategies Meb Faber’s book Global Asset Allocation is worth a read. Generally speaking it’s short and easy to understand. The first few chapters deal with the basics of investment planning (inflation, historic rates of return of bonds, bills and stocks, etc.). Nothing new, but it lays the foundation for the content that proceeds. Whenever I read Faber’s work he always provides a few illuminating morsels of information that seem so simple you wonder why they haven’t been discussed more broadly. Here’s a few interesting points:
- There are only two states that any given portfolio or asset can be at: all time highs or drawdowns
- The traditional 60/40 stock/bond allocation has spent only 22% of it’s time at all time highs and the remaining 78% in a period of drawdown
- The largest financial asset class in the world is foreign ex-US bonds
- US stocks represent about half of all global equities
Roger Lowenstein has perhaps captured the most complete and definitive story of hedge fund Long-Term Capital Management. The firm started out as a small group of well pedigreed and incredibly intelligent bond traders at Salomon Brothers and morphed into a private hedge fund that nearly brought the financial system to its knees in the summer of 1998. While the rise of this firm was spectacular the decline was even more so.
Peter Bernstein’s masterpiece Against The Gods is without a doubt one of the great works in business literature. It’s an insightful and illuminating investigation into the meaning of risk and the ideas and techniques humans have developed over centuries to quantify and manage the unknown. Through a comprehensive collection of history and philosophy Bernstein investigates the controversy between two groups that take different approaches to decision making
- Those who believe the best decisions are based on numbers
- Those who base their decisions on more subjective beliefs about the uncertain future