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What will we call the second week of October 2008?

13 October 2008 Ricco Friedrich, Head Value Management Funds, Sanlam Investment Management

The precipitous sell off in equities during the second week of October 2008 (far worse than any week during the Great Crash of October and November 1929 or the Black Monday crash of October 1987) was driven by fears of a very bad global recession. The US alone experienced $40-billion worth of mutual fund redemptions in the past week. Ricco Friedrich, value fund manager at Sanlam Investment Management (SIM), believes that behavioural factors and cognitive biases (patterns of deviation in judgement) are driving share prices lower.

Friedrich says that, due to our inability to measure the collective wisdom of all investors’ emotions, we are unable to say how long this will last, where the bottom will be or how quickly the recovery will come. “It is precisely for this reason that the only sensible approach to investing (of which we have been an avid proponent) is to seek out companies that are trading at discounts to intrinsic value.

“This was not unlike the period in which one of the world’s greatest investors invented ‘value investing’, with Benjamin Graham explicitly stating that you should not try to time the market but rather look at what a company is worth (in a worst case scenario). So, will history repeat itself – will investors go and dig out their copies of Security Analysis again?”

So now we need to sit back and wait for the “game of consequences” to play itself out. “In some cases these consequences go back to when President Lyndon Johnson decided to sell Fannie Mae to fund the Vietnam War, or to the unprecedented rise in US debt to GDP that has resulted in the current market turmoil. The consequences of both these events took over 40 years to come to the fore, so patience may be required,” said Friedrich.

“The way forward is likely to be a bumpy one, with the lasting affects of tighter credit impacting on growth in corporate profits (particularly those companies that are dependent on debt to grow). Market valuations already partly reflect this. Many “healthy” companies having been hit by last week’s panic selling, and for those investors who can exercise patience, there are many great bargains to be had.”

Summing up the journey to this lowpoint, Friedrich says that, only six months ago there was much talk by economists and strategists on whether the US would experience a recession, how “deep” it would be and how long it would last.

“At the same time many arguments were put forward about why a “slowdown” in growth would be constrained to the US (and later Europe and then the developed world), but the emerging markets would “decouple” and continue growing. These supporters of the so-called de-coupling theory have been silenced by their intellectual ignorance. In all fairness, no one could have anticipated the severity of the events that would unfold, but this is precisely why human beings fail miserably at trying to forecast the future.

“Call it what you want, but I have not come across a better and more apt description of a “black swan” event (Nicholas Taleb’s claim is that almost all consequential events in history come from the unexpected—while humans convince themselves that these events are able to be explained in hindsight). The citing of a single black swan disproved hundreds of years of belief that all swans were white.

“So maybe they will call this “Friday, blood Friday”, but, as with previous market crashes, this presents the very best buying opportunities,” concludes Friedrich.

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