The shareholders of Berkshire Hathaway have just celebrated their latest ‘Woodstock for capitalists’ in the form of the company’s annual general meeting. Fund manager Jeffrey Miller of Eight Bridges Capital Management made the following comments having watched Berkshire’s webcast, which found their way into Barron’s:

“The most interesting part was when he was asked why Berkshire had changed from investing in companies with high returns on capital and no-or-low capital requirements to those that require massive amounts of capital, like railroads and pipelines. His answer: because Berkshire is too big now to invest in those great low-capital businesses (even though they are superior to what he is buying recently and are what created the track record of which so many are envious). My takeaway: smaller is better in asset management, because it opens up many more opportunities that are unavailable to investors that grow too large – like Berkshire Hathaway. Buffett hesitated before he answered, because the answer revealed an uncomfortable truth – that Berkshire is no longer able to maximize returns for its shareholders, but Buffett is unwilling to return the capital to them to go and find other investments.” [Emphasis ours.]

That size can be a barrier to high investment returns is no secret, and it’s an observation that Warren Buffett has himself made before:

“If I was running $1 million today, or $10 million for that matter, I'd be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I've ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It's a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”

But Berkshire Hathaway today is a $350 billion company, and elephants don’t gallop.

David Fuller's view

Here is a PDF of Tim Price's report.

I had not seen this quote immediately above and I did not find the date for it, but I assume that it had to be in a relatively early period of Buffett’s career.  The 1950s, for those who remember, were the momentum years of an earlier secular bull market which was ending in the mid-1960s.  The approximately equivalent years of the last secular bull market were post 1987 and well into the 1990s. I would not be surprised to see a similar environment following 2020, but that can only be a guess so please don’t hold me to it. 

The biggest stock market profits are made by those who have the nerve to buy shortly after a significant bear market.  Think about it – that is when all the speculative froth has been shaken out, except for the short sellers.  Cash levels will be high.  Monetary policy will turned accommodative. 

Only those who are blinded by fear and inexperienced in terms of sentiment near the end of bear markets will be too cautious or traumatised to participate.  For the most recent examples, consider sentiment in 2002 and early 2009. 

So, when you next find yourself in that situation, and assuming that you have enough experience to recognise the end of a bear market, and are not fearful of the super bears who will have the loudest voices and most of the headlines, how will you know what to buy?  There are three ways to participate very successfully in the recovery following a significant bear market: 1) be very smart and well informed; 2) be very lucky; 3) be very observant. 

Most of us may not be among the fundamentally smartest investors, and luck is too chancy.  However, all of us can be very observant, provided we look at price charts on an uncomplicated, factual basis.  For instance, starting with stock market indices if you are an international investor, look to see which national indices show the clearest evidence of base formation development and relative strength following the period of climactic lows.  You could participate in a good ETF or tracker.  If you are restricted to one stock market for any reason, pick the sector which bottomed slightly before or at least in line with the national index and shows relative strength during the first several weeks of recovery.  If you want an individual share, select it on the same basis, with particular emphasis on relative strength following the climactic low. 

Needless to say, this approach is not telling the market what to do.  Instead, you would be observing which markets, sectors or shares were clearly favoured as smart money resumed buying.  You can assume from relative strength that a sufficient number of astute investors favour these markets sectors and shares for recovery.  Furthermore, if you are dealing with more than one market or sector, let alone individual shares, weed out those which do not maintain their relative strength over the medium term or longer. 

Some veteran subscribers may remember this approach and how successful it has been in previous market cycles.   

(See also: The Curse of Success(ful Investing, from DQYDJ)