2008. Crazy…But Predictable.

December 23, 2008 by Joe Ponzio

I have a personal goal – something I’ve been doing for years. Every day, I try to learn something new. I don’t always focus on business or investing (though those are two of my greatest passions). From time to time, I’ll try my hand at something new, and I am all over the board with my learning. Sometimes I’ll read a biography or history book; sometimes I’ll learn about spot welding or video game design. I’ll take mixed martial arts classes. I’ve built remote control cars.

(Inadvertently, some of these little diversions of mine creep into my investing by helping to increase my sphere of competence and confidence in various businesses and industries.)

The other night, while searching for capoeira studios in Chicago (it’s pretty cool, but I doubt it will help with investing), the television caught my attention. CNBC was airing A Year of Fear and Hope, and I started to marvel at how ridiculous 2008 has been.

Let me preface this by saying that I understand how grave the situation is for many people, and I certainly do not intend to make light of the economic woes of people around the world. People have lost their homes…their jobs…their retirement savings.

Still, the reasons behind the events of 2008 have been nothing short of ridiculous. (That’s why I’m conflicted on the bailouts – we need them, but we shouldn’t need them.)

The various personalities on CNBC were talking about how shocked they were – how mind-boggling the situation was – as scandals, failures, and bailouts kept popping up. They were talking about the year’s events and I kept thinking: Oh yeah. I almost forgot about that.


Warren Buffett is quoted as saying:

It’s far easier to tell what will happen than when it will happen.

Nobody could have predicted that the Dow would fall 48.2% from its October 11, 2007 high of 14,279.96 to its November 21, 2008 low of 7,392.27 – a level that was first reached on May 27, 1997. (Of course, I’m hesitant to say that the November low was the lowest we saw in 2008 – there are still a few days left in 2008 and we’ve seen plenty of 1,000 point swings!)

Even Buffett himself couldn’t have predicted the when – he started accumulating cash in Berkshire back in 2003, four or five years too early. Few, if any, big money, time-tested business investors tried to predict the when by shorting. Instead, they clung to cash, either because they knew that the chickens would eventually come home to roost, or because their insistence on having a wide margin of safety caused them to find few opportunities.


2008 was not entirely unpredictable. Some events – like the collapse of certain financial institutions, the fall of the auto makers, or the drop from near-$150 oil – were highly predictable. The when was unknown; the what was not rocket science.

Take, for example, General Motors. In July, I had put together a report – Owner Earnings vs. Free Cash Flow – in which I discussed how the value had deteriorated over the years and why its business was suffering.

In this case, GM’s automotive business is even uglier than we thought. The company’s operations required nearly $11 billion of cash in 2005 and 2006. In 2007, the business was hammered even worse, requiring nearly $47 billion of excess cash just to keep the cars coming off the assembly line.

How did it cover this shortfall? It began selling businesses, selling finance receivables, playing games with the pension and OPEB, refinancing debt, and working some tax magic…

Price follows value. When the value deteriorates rapidly (as is often the case when a business’ operations are cash-hungry beasts), the stock price is usually not too far behind.

Or, look at the price of oil. In July, it approached $150 a barrel, almost double what it had cost a year earlier. Over the long-term, capital markets work on supply and demand; so, a simple supply-and-demand question would have stopped people from ditching their Hummer for a Prius simply because “oil was going to $200 and gas was going to $10.”

The question: Did the demand for oil double in the past year? I understand that more goes into the question than I’ve put here (eg., the dollar, was oil undersupplied last year). Still, the more likely conclusion was that there was a bubble in oil prices and that it would eventually regress to the norm. (That, of course, speaks to the danger of so many moron managers with so much money – they can push an economy on the brink of collapse simply because they don’t want to be the last one in oil when it hits $150.)

Just don’t tell our secrets to the mutual fund managers that were invested in $147 oil, or in General Motors or other debt-laden, cash-hungry businesses – they’re sleeping.


They were some of the biggest players in the world of finance. Well, that’s what I’ll be telling my kids one day. The Are You Kidding Me?!? factor I talked about in this post is waning; still, I am amazed at how stupid these managers can be.

Let’s face it – we’ve all made investing mistakes in the past. Nobody is immune. The question investors need to ask – and it’s the number one question we consider when determining clients’ allocations – is: How would your life change if this particular investment dropped 50%? If a 20% drop in your portfolio is enough to make you sick, you shouldn’t have more than 40% of your portfolio in stocks because, at any given time, your $50 stock can drop to $25, regardless of whether or not the world appears to be going to hell in a hand basket.

In the case of these investment and banking institutions, they didn’t ask the most basic of investment or money management questions. And it didn’t take a 50% drop in their investments. A much smaller drop caused them to go into panic mode because they had already planned for (or spent) the profits they expected to make. Sure, they’ll blame it on the fact that the credit markets froze; but, Wells Fargo, JP Morgan, and US Bank played in the same sandbox, and they’re still here.

Shhh. You’ll wake the mutual fund managers!


Right now, the Bernie Madoff $50 billion ponzi scheme is front page news (and yes, I’m aware that my last name is Ponzio, not to be confused with “ponzi” schemes. I tried to change my last name to Enroni, but I had problems at the DMV.) In a ponzi scheme, the fund manager sends fake statements to people and, when people want to sell, pays selling investors with the money raised by new investors. Madoff allegedly did this for some thirty years.

If the allegations are true, Madoff joins the ranks of some real pieces of trash on Wall Street – guys like Angelo Mozilo, who cashed out roughly $200 million of Countrywide stock options in 2007 while Countrywide failed, and who was lucky enough to sidestep the spotlight because the financial crisis hit.

That, of course, brings us to another lesson from 2008: Just because you can doesn’t mean you should. I’m not talking about Mozilo or Madoff – they did or allegedly did something you can’t do. I’m talking about corporate executives, like the clowns at Bank of America whom have diluted their shareholders to the point of absurdity. In time, they may make money from purchasing Countrywide (though I think they grossly overvalued the “brand”) and I’m sure they’ll make money from their acquisition of Merrill Lynch if they can restore some of the respect that accompanied Merrill’s name.

But at what cost? Just because you can issue stock to acquire troubled or failing businesses, should you? And if you do make such bonehead moves, should we be surprised that your stock drops 75% while the value of your business – and hence, the value of the stock – plummets?

I’m not saying that Bank of America isn’t cheap – it may very well be. Still, there is no way to know for certain if management is going to continue to dilute shareholders for acquisitions simply because it can. I like the fact that they are looking for blood in the streets; but, not all blood is created equal.


I remember watching CNBC back in 2001 and 2002 – everything was a “debacle.” Today, everything is “unprecedented.” I’m certain that, as Wall Street regains its footing, it will do something stupid again in a few years, and we’ll have a new buzzword on television.

As amazing and volatile as 2008 was, and though many of the debacles were unprecedented, it was not entirely unpredictable. Whether you made or lost money in 2008, the most important thing is that we take the lessons learned and apply them in the future.

We all remember that 1+1=2 – it’s a lesson we learned when we were just a few years old. From here on out, always remember the lessons from 2008:

  • price follows value in the long-term. Focus on value; the price will take care of itself. This is true even if Wall Street or the media is throwing the markets in your face.
  • never invest in something you don’t understand. Robert Crawford wrote this explanation on how to value financial institutions. Even with his help, I never truly understood financial institution valuation; so, I avoided the slaughter of 2008. Ignorance is bliss – especially when you’re on the sidelines while so many investments and companies crumble.
  • losses are real, even if you don’t realize them. Many investors are afraid to sell anything or refocus their portfolio because doing so would “make the losses real.” Bad news: If you overpaid for your investment, the losses are real. Just ask anyone that purchased Cisco Systems early in 2000 as it was approaching $80 a share. These investors overpaid for their stock and are still down 80% or so after eight years.
  • losses are not real unless you realize them. Notwithstanding the above, short-term quotational losses are not real if the value of your business (i) is growing and (ii) is greater than the current market price…unless you sell.
  • you don’t have to own stocks. Many financial “professionals” will tell you to have 60% in stocks and 40% in bonds, or to subtract your age from 100 (or 120) to determine what percentage of your portfolio should be in stocks. If they took their heads out of their…computers…for a second, they’d realize that stocks and bonds have nearly the same returns over the long-term. In February when I wrote Stocks Stink. Buy Bonds!, the stock portfolio slightly beat the bond portfolio. Today, the all-bond portfolio beats the stock portfolio. And that’s over forty years! If you aren’t going to try and beat the markets, you probably shouldn’t be in the markets.

It’s interesting that, no matter what is going on in the markets or the economy, the fundamentals remain unchanged. Is it a different market? Perhaps, and that will change the way that people gamble on stocks. Intelligent investing hasn’t changed one bit.


I’d like to wish you all a Merry Christmas, Happy Chanukah, Happy Kwanzaa, Buon Natale, Feliz Navidad, Boas Festas, Joyeux Noel, Froehliche Weihnachten, Mele Kalikimaka, Shub Naya Baras, Kala Christouyenna…and Happy New Year to the 4,000,000+ visitors around the world that make F Wall Street so much fun!

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