Are We Too Bearish?

They say that a pessimist is a man who looks both ways before crossing the street. We say, “Guilty as charged.”

With most of “the street” constantly encouraging investors to run out into traffic with their eyes closed to oncoming risks, we work hard to look both ways before crossing. We also do our best to look across the street to see what the other side has to offer, although admittedly, our looking ahead can be quite challenging.  So occasionally, we also look behind as well, to remind ourselves where we’ve come from and how we’ve gotten here.  Sometimes, looking back can be just as informative as looking ahead as investment cycles rarely offer anything truly new.

Last week, I had a terrific dinner with some new friends in Charlotte after flying in from New York. I was introduced to a couple of family offices as the local bear. Truth be told, it wasn’t the first time. And it will unlikely be the last.

At the end of the day, our job in this business is to make money for our investors. Hopeless optimism in “buy and hold” has gotten investors nowhere over the past decade. It has, however, worked out quite well for the banks and brokers selling optimism.

Good businesses can be bad investments, just as bad businesses can be very good investments. The difference is ultimately in the price you pay. At the right price, we too, can and have been giddy bulls. (I know many of you are shaking your heads, but it is true and we will demonstrate this). At some higher price, we become less excited, and at a still higher price, we begin to earn the reputation of the local bear (which honestly, we don’t mind). Over the last few years, we’ve expressed each of these opinions across multiple asset classes, but I suppose some of our bullish notes have been lost or forgotten over the years. So, I thought I’d spend the next few days providing a brief history of The Broyhill Letter.

Our first letter to investors was penned in the fourth quarter of 2006 – a solid four years from the end of the prior bear market in stocks. The world was flush with liquidity and we were concerned. The investment theme we presented was “The Return of Junk: Risk in Credit.” You might say that we were bearish. You might say that we were a little early. I would say that we were being prudent stewards of capital given the budding risks to the financial system. Here are a few excerpts:

Investor’s insatiable appetite for higher yielding, lower quality debt is the driving force behind the current buyout boom in which private-equity firms gobble up corporate stock and finance the acquisition with heaps of new debt. But as the domestic equity markets cheer the surge in leveraged buyouts, and the size of announced deals gets larger with each passing Merger Monday, the fundamental wisdom behind each deal gets smaller. There will be an accident at some point, possibly sooner rather than later.

Okay.  So this one was pretty bearish.  But again, the call was largely based on price, which was simply too high at the time.  Spreads were at all time lows while sentiment was wildly optimistic.  Some would say we are back to those heights today.  We would say, not yet.  In fact, we have been bullish on credit for a while now, after being bearish in the years leading up to the crisis.  And even in a monster year for equities like 2012, investors did quite well for themselves (and we’d argue much better on a risk-adjusted basis) in high-yield credit and non-agency mortgages, as we noted here and here.

We’ll follow up with our letters from 2007 tomorrow.  Until then, please look both ways before crossing the street.  There may be fewer cars on the road in Lenoir, NC but we’d argue that most of these  drivers don’t belong on the roads in the first place!  Some might make the same argument for money managers in NY?