TIP612: Investing In Fear: Profiting From Maximum Pessimism w/ Lauren Templeton

Lauren Templeton: Japan had really been dismissed as sort of industrial backwater. These were the exporters of trinkets to America. There was a lot of prejudice and hard feelings towards Japan post-World War II. But what he saw in Japan was what he saw in America growing up and as a young person, he saw the industrious nature of the Japanese, the hard work, the work ethic, the high savings rate, all of these things. And he wanted to see that repeated in his investment. ... He did pioneer international investing. He always said to me he wanted his universe of stocks to select from to be as large as possible. ... He identified an accounting anomaly in Japanese stocks and that they were not accounting for all of the assets on their balance sheet. They were unconsolidated. They were not consolidating their subsidiaries. The earnings power of these companies was greatly underestimated. And to think about the amount of work that he had to do in the 1950s to make it through all of that, to identify the accounting anomalies, to travel to Japan, to meet with management, to analyze these companies, today it's still difficult.

Lauren Templeton: I think sometimes listeners are confused when you hear this term maximum pessimism. So I think it's helpful to just state his quote, which was, 'Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell.' So when he said that investors are always asking the wrong question, the right question is where is the outlook most miserable, that was his question to identify where to find the mispricings... He also understood that some of his investments would not work out. So he thought he was correct about 60% of the time. And he also knew that he would more than likely end up in some value traps using these deeply discounted methodologies. However, he thought the rest of the portfolio would go up exponentially. And that's how he thought about it.

Lauren Templeton: John Templeton believed deeply in the scientific method. And the way I think he used it when it came to investing is really just in trying new strategies... So let me give you an example. He's well known for running the IPO lockup strategy during the tech bubble in the late 90s, early 2000s. That strategy, he would short stock seven days before the IPO lockup expiration, he would cover 10 days later. That strategy is aligned with his core principles that he believed in, but it was a different way to play it... Another strategy that I saw him use effectively was buying closed-end mutual funds, not levered closed-end mutual funds, trading at a 30% discount to NAV during a market sell-off... I was often receiving faxes or letters from him about some research project he had read about somewhere... The strategy didn't work because we couldn't get locates on the shorts. So we were having to put on all the shorts synthetically and that's quite expensive and the expenses ate into the return. So it was not a successful strategy. He shut it down and moved on.

Lauren Templeton: John Templeton believed deeply in the scientific method. And the way I think he used it when it came to investing is really just in trying new strategies. When I say new strategies, he did not ever stray from his core principles or the investment philosophy that he believed in. But he was always trying new strategies. So let me give you an example. He's well known for running the IPO lockup strategy during the tech bubble in the late 90s, early 2000s. That strategy, he would short stock seven days before the IPO lockup expiration, he would cover 10 days later. That strategy is aligned with his core principles that he believed in, but it was a different way to play it. ... He had a set of core principles, and that's how he viewed the investment world and landscape. There were lots of different manifestations of that as far as strategies that he would pursue in different market environments, but they were always very aligned with those core principles.

Lauren Templeton: If you're in the Bahamas and you're not in one of the big financial centers, especially when he moved to the Bahamas in the 1960s. You're so removed. You're not taking the same meetings. You're not taking the same sales calls. You're not going to the same lunches everyone else is. ... You're having a completely independent experience. It's a slower life. You can focus on reading and making good long-term decisions. And when he said my performance was better because I received the Wall Street Journal a few days later, I do think he was talking about not reacting, but just removing yourself even physically from the crowd can be so important. ... And to us as a firm, we think there are three sources of alpha, better information, better model or process, or better behavior. And our focus is on better behavior. ... The other part of distancing yourself from the crowd and why it is maybe important to not live where everybody else lives and think independently is the FOMO part, the fear of missing out. So when everybody around you is making money at absurd valuations and stocks, it's really hard. I think that's the harder part.

Lauren Templeton: When people think about value investing, they think about going into these moments of maximum pessimism. How do you have the conviction to put capital to work when the markets are really scary? And that is one part of it. But the other part of distancing yourself from the crowd and why it is maybe important to not live where everybody else lives and think independently is the FOMO part, the fear of missing out. So when everybody around you is making money at absurd valuations and stocks, it's really hard. I think that's the harder part. How do you distance yourself from the crowd and sit there and be patient when it feels like physical punishment to do so, when everybody else around you is making money? That is definitely more challenging. And I think perhaps there is some wisdom in physically distancing yourself from the crowd during those scenarios.

Lauren Templeton: During the great financial crisis, we were really looking at share prices and solving for 10 years of fundamentals. And we were seeing that share prices were forecasting zero to negative growth in trough margins in a lot of the stocks we were looking at. So the way you would reverse engineer that is after you've gone through that process and reverse engineered the DCF, you would ask yourself the question and reframe the argument, do I really believe this company is never going to grow again? So that is the way inversion would work for us.