What a difference a month can make!

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So is the title of the latest Patient Capital newsletter to shareholders, observing that September 2010 brought the highest U.S equity returns in a staggering seven decades! But this is Patient Capital, not Kudlow and Cramer. The core message of this installment is as follows.

This hoped for rescue is based on the prospect of a prolonged period of abnormally low interest rates and “quantitative easing.” Quantitative easing is a method whereby the Central Bank purchases government debt and funds the purchases with money that it prints or “creates out of thin air.” The expectation is that the increase in the money supply translates into higher demand and stronger economic activity. The very real and significant risk is the prospect of substantial inflation in the future and a loss of credibility and alternatives if the stimulus does not revive economic growth relatively quickly.

We are not as confident in the ability of Central Bankers to fix a problem they themselves had a huge role in creating! Furthermore, there is substantial historical evidence that economies that experience deflated asset bubbles take several years to recover. Long term empirical data shows that time and patience are the true remedies. Thus we remain cautious in our outlook and believe that investors may be disappointed by the pace of future economic expansion.

Just in case you’re wondering what Patient Capital knows or why anybody should listen to them, you may find it of interest that they were for the most part in cash prior to the Global Financial Crisis, and managed to return %4.5 in 2008, the same year the TSX lost %33 (and the DOW lost 40%, and basically everybody under the sun got slaughtered….except these guys). See their performance here and read the entire newsletter here.

While we’re on the subject, let’s take a quick look at what not losing capital in 2008 means compared to “missing out” on a large subsequent rally the following year. After all, in 2009 Patient Capital only returned %16 compared to the TSX’s 35% gain. If we were a particularly clueful deputy editor at say, Business Insider, we’d run a blurb with some sensational headline like Patient Capital gets clobbered by the TSX in ’09! But did they really?

Let’s say you put $1,000,000 into Patient Capital (their minimum account is $500,000) at the beginning of 2008, and another $1,000,000 into the TSX index:

  • By the end of 2008 your Patient Capital stake would be $1,045,000 and your TSX stake would be cut down to $670,000.
  • After the monster 2009 rally, your Patient Capital would be $1,212,200 and your TSX stake, even after doubling the return of your Patient Capital in ’09,  would almost be back to where you started, at $904,500

This example exemplifies the two rules espoused by all “value investors”:

  1. Never lose money
  2. See Rule #1

This is not to say that value investors are never “down” in the value of their investments, but that they strive first to avoid “permanent loss of capital” and only then aim for a reasonable return on investment.

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