Be Prepared!

Be Prepared!

Volatility returned to the markets in the first quarter of 2011. Consider briefly what the markets had to digest: unrest in the Middle East and North Africa, the sequence of disasters in Japan, ongoing worries about the solvency of peripheral Europe, higher oil prices, and fears of a slowing economic recovery in the United States and globally. For the one-month period from the middle of February to the 16th of March, the volatility index (VIX) rose from a low of 14.22 to 29.40 before retreating and ending the quarter at 17.74. For its part, the small-cap Russell 2000 Index rallied 6.5% into the middle of February, corrected 6.3% into the ides of March and finished the first quarter with a gain of 7.9%.

To be sure, it has been an eventful few years for equities, to say nothing of the global economy and geopolitics. Predicting what will be the next macro drivers of the markets has always been a favorite past time for many strategists, fund managers, and market commentators. It is not ours. Our expertise is in smaller-company stock investing. We typically have little, if anything, to say about the economy in general and even less to say about large-scale, macro trends.

That being said, we are in the business of responding rationally to opportunities as they are created and being prepared to do so when they occur. In today's interconnected world, where unpredictable random events across the globe are being priced into the markets at lightning speed, one's ability to react is paramount to achieving consistent long-term results. Our discipline of responding rationally and not predicting is built for just this type of environment.

Do Your Homework

"The investor's primary interest lies in acquiring and holding suitable securities at suitable prices. Market movements are important to him in a practical sense, because they alternately create low price levels at which he would be wise to buy and high price levels at which he certainly should refrain from buying and probably would be wise to sell."
--Benjamin Graham, The Intelligent Investor 1949

From our perspective, it is critical to do one's work ahead of time with a long-term focus, so we can take advantage of any market dislocations when they occur. For more than 35 years, we have adhered to a process by which we identify what we consider to be quality businesses and patiently wait for the market to offer a price at a discount large enough to afford us that critical margin of safety. By doing our research first and patiently waiting for the right opportunity, we have been able to take advantage of many of the market dislocations over the past several years. It is these bargains that should likely drive results for the foreseeable future.

For example, the European sovereign debt crisis in 2010 created opportunities in high quality industrial exporters in Europe. The double-dip economic fears that gripped the markets in the United States last year created opportunities in the technology sector, while the BP disaster in the Gulf of Mexico pressured some of our favorite energy service companies. More recently, the disaster in Japan has allowed us to increase our exposure to some of our favorite Japanese equities, while simultaneously increased nuclear fears have created opportunities in the natural gas industry. As is usually the case, our long-term thesis remains unchanged for many of these businesses, yet the market has given us another opportunity to buy these businesses at severe discounts to what we believe they are worth. It is a process we repeat everyday.

May You Live in Interesting Times

To be sure, we do live in interesting times, in a world that is increasingly connected. The events of the first quarter of 2011 from North Africa to Japan are still reverberating in the market place. Who knows what the next untimely or random event might be? Our job is to be prepared for those opportunities when they are created, with an eye towards absolute performance and a focus on managing risk.

Stay tuned…
FDG