All-Star Managers Report on the Rally

Each quarter, Morningstar stock analysts review the shareholder letters and holdings of a select group of fund managers in an attempt to learn more about their stock-selection process. The past two years have been enlightening, to say the least, as we followed the managers from the beginning of the recession (and some well-publicized missteps) to the market depths reached in March and now on to stabilization and possibly the beginnings of recovery.

Managers Warn against Market-Timing
After the massive stock market rally that took place in the second quarter, some of the managers on our roster of favorites are probably justified in defending their decision to stay invested in the face of the deteriorating macroeconomic picture in 2007 and 2008, and despite the losses incurred in the interim.  Third Avenue Value's (TAVFX) Marty Whitman explained the reasoning behind his decision to remain invested, writing that "Fund Management cannot make sound investment decisions if it assumes that draconian general market declines are just around the corner," and casting a skeptical eye toward claims that such a thing can be done. According to him, "the sole reason why TAVF Management does not pay any attention to general market factors, is that we are no good at making such prognostications. We don't think anybody else--perhaps with the exception of a few geniuses who are unknown to us--is any good at it either."  Weitz Partners Value's (WPVLX) Wally Weitz agreed that market-timing is nearly always an exercise in futility, observing that "taking the extreme position of going to 100% cash in the fall of 2007, or even in the summer of 2008, would have saved us considerable grief. Unfortunately, though, if we had tried to get out of stocks every time we sensed stock market 'danger' over the past 39 years, we probably would have produced much lower returns and higher tax bills." Weitz also invokes Warren Buffett's statement that he "would not have been pleased if [his potential successor] had moved to cash" during this period. Fund managers also made their case for security analysis, or as Mario Gabelli of  Gabelli Asset (GABAX) called it, "Plain Old Stock Picking." According to the management team at  Mutual Shares (TESIX), "macroeconomic developments do matter, but not to the exclusion of company specifics, as seemed to be the case for much of 2008 and the first part of the year."

The list of managers we follow is below:

All-Star Managers
Fund	YTD Performance
Fairholme Fund (FAIRX)	31.36%
Gabelli Asset (GABAX)	25.19%
Longleaf Partners (LLPFX)	47.99%
Mutual Shares (TESIX)	22.79%
Oakmark Select (OAKLX)	44.12%
Sequoia (SEQUX)	17.62%
Third Avenue Value (TAVFX)	38.56%
Tweedy, Browne Value (TWEBX)	19.04%
Weitz Partners Value (WPVLX)	32.36%
Yacktman (YACKX)	49.48%
S&P 500 Index	20.47%
YTD performance as of 9-20-09.

Investing after the Rally
The decision to remain invested seems a bit wiser with the S&P 500 up nearly 60% from the lows reached in March, but rising prices obviously lead to fewer bargains in the stock market. Jeremy Grantham of GMO proclaimed in July that the market had reached a "boring fair price," making it "difficult to be inspired" by equity investments.  Sequoia's (SEQUX) managers were slightly more positive, pronouncing themselves "generally comfortable with the overall level of valuation in the market even after the rally." Our equity analysts agree that the market as a whole is fairly valued, but believe that  bargains remain in individual stocks, some of which can still be purchased at a discount to fair value. John Raitt of The Oakmark Funds (OAKLX) elaborated on the wisdom of security analysis and the value of a margin of safety, writing that "for those who fear that further market declines could cause long-term capital losses, we note that the average stock in our portfolios now sells at a historically high discount to value...for those who worry that they may have missed the recovery, we would point out that broad market indexes and stock valuation remain substantially below their levels of 12-18 months ago."

A Return to Business As Usual?
Barring another near-collapse of the financial system, it appears that the economy may be back on an extended road back to normal, or perhaps a "New Normal," as the future state of the economy has been dubbed by the managers at PIMCO. Mario Gabelli points out that the past two years may not have been so unusual after all, positing that "when viewed against an extended backdrop, the twenty month old Great Recession of 2007-2009 looks almost garden variety... From the 19th century through the Great Depression, sharp and prolonged downturns occurred regularly and shared a number of characteristics. They were often preceded by speculative bubbles...and combined with financial panics." Whether or not the latest financial crisis was truly unusual, we think it's safe to say that the time-tested investing principles developed by Ben Graham, and employed by the managers on our list and our staff of equity analysts, will remain valid for the foreseeable future. We look forward to checking in again following the third quarter.