Currently, I am reading his annual letter. In his letter, he always says that his fund performance is likely to be better in a bear market than in a bull market, but I don't know why. Could someone explain this to me?
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Probably because he tends to shy away from the big multiple companies that tend to be popular/overbought in bull markets.– quidFeb 21, 2017 at 0:10
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9"Relatively better in a bear market than in a bull market" is simply another way of saying "less volatile than the market as a whole".– hobbsFeb 21, 2017 at 2:43
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5 Answers
Buffett is a value investor. His goal is to buy good companies when the market is overly worried and prices them below intrinsic value. When the market is highly priced it is much more difficult for him to find things that he thinks are at an attractive price. When people are very worried and the market has crashed, stocks are then priced below their intrinsic value and he can use the cash he keeps in the company to make attractive purchases.
Remember that Buffett is not concerned with the ups and downs of the price of Berkshire Hathaway stock, he is concerned with the economic value of the assets that the company owns. So if all stock prices crash and he can buy things that are at bargain prices, he is happy no matter what Berkshire stock price does in the short run.
One consequence of value investing is that because you are buying assets at bargain prices, the total value of your assets drops less in a bear market than the highly priced stuff that drives the major indexes.
From the letter you link:
Our performance, relatively, is likely to be better in a bear market than in a bull market so that deductions made from the above results should be tempered by the fact that it was the type of year when we should have done relatively well. In a year when the general market had a substantial advance I would be well satisfied to match the advance of the Averages.
Putting those two sentences together, the word relatively means that his funds perform better than the market in bear markets and perform about the same as the overall market in bull markets. It does not mean that absolute performance is better in bear markets than bull markets.
Later on he states
This policy should lead to superior results in bear markets and average performance in bull markets.
answered Feb 21, 2017 at 0:32
Warren Buffet and Berkshire Hathaway took a 50% loss in each of the last two bear markets. His stock even lost 10% in 2015 when the S&P lost 8%.
He doesn't have a track record to support the claim that his stock performs relatively better in a bear market, so perhaps it's best to take his letter with a grain of salt.
Edit: As one commenter points out, Mr. Buffett is comparing the book performance of his fund to the market performance of an index. That is an apples to oranges comparison. It's deceptive at best.
answered Feb 21, 2017 at 2:25
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If I have $100 and put it under the bed it will return 0%. Relatively good in a bear market and relatively bad in a bull market.
To understand his comments about bear-market performance it's important to take them in context. (My research method was Crtl+F: bear; read around the highlights. This is not a complete survey of 60+ years of letters.)
In his earlier letters, statements about bull market performance are always made in reference to Buffet's belief that many of BH's current holdings are in undervalued securities. Ex:
To the extent possible, therefore, I am attempting to create my own work-outs by acquiring large positions in several undervalued securities. Such a policy should lead to the fulfillment of my earlier forecast – an above average performance in a bear market. It is on this basis that I hope to be judged (p 6; emphasis mine).
Similar statements are made throughout the earlier letters, along with this interesting note:
In a year when the general market had a substantial advance I would be well satisfied to match the advance of the Averages (p 6).
So to your question of why BH fund performance is likely to be better in a bear market than in a bull market, I believe the implicit assertion is that undervalued securities are more resilient in a bear market (presumably because they don't have as far to fall, and are also less likely to be subject to a bubble). Buffet is also explicitly asserting that when facing a choice to either (a) position BH to weather a possible downturn or (b) position BH to enjoy a bullish stock that is outpacing the market, he would choose the former over the later.
As to your assertion that he always says this, I can find no reference to bear market's in the letters past 1960.
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1Warren is focused on book value, that's one key measure he uses for his results, not stock price. In the long run they will correlate, but not always in the short turn. Essentially he has better opportunities to buy undervalued investments in a bear market, which is incremental to Berkshire's book value. That value won't always be reflected in the stock price in a bear market, but over time it will be. Feb 22, 2017 at 1:16
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"Essentially he has better opportunities to buy undervalued investments in a bear market" @RandyHill That's true, but it's not what Buffet was saying in the passages OP is asking about. Specifically, Buffet is referring to the performance of securities already held under hypothetical future market conditions (bull vs bear), not the acquisition of new securities. IE: He's saying if things go bad BH will be okay, not damn, it would be great for BH if things went bad, the latter being very poor PR.– MichaelFeb 22, 2017 at 2:06
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Michael, again I think you are mis-reading his intent. He doesn't care about short term price performance. He cares about the accretion of value from buying at a bigger discount to intrinsic (actual) value. Imagine a stock trading at $100 that he thinks is fairly valued. In a bear market it drops to $50, so every $50 he invests in it is worth $100 in intrinsic value. If he can buy $2B of stock at 50% of intrinsic value he's increased BRK's value by another $2B, regardless of where the purchased stock or BRK trade over the next months. Bear markets are where he creates the most value for BRK. Feb 22, 2017 at 19:53
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@randy I think you're projecting your own meaning onto his intent. did you read the letters? Everything you're saying about market theory is true, but I do not think that's what he's communicating in the statements OP asked about. Again: in the letters he is talking about performance of existing securities under future market conditions, not acquiring new securities should market trends turn. Saying that he likes to buy stocks at a discount during a bear market is true but also off-topic– MichaelFeb 22, 2017 at 20:34
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I've read every letter, from Buffett Partnership through Berkshire annual reports, etc. When he uses the term "workouts" he's talking about buying special situations (mergers, spinoffs, liquidations, etc) that are easier to find in bear markets, and typically short-term investments that are offer less variance and higher returns than general stock picking (what he referred to as general issues). He stopped doing workouts in the 70s, his portfolio simply got too large for most of them to have an impact, which is a shame. Feb 22, 2017 at 21:13