06 Mar 2009 Clipper Fund - Annual Report ( Portfolio )
While capital market downturns are nothing new, the dislocation and panic that swept through the markets in 2008 were unique in scale, severity and pace.

Turning to the economy, as is often the case, the capital markets have been leading indicators. What began as a financial crisis tied to falling real estate prices is swiftly becoming a broad-based economic crisis. Consumer and corporate spending are in a free fall. Auto sales for example fell a staggering 35% in the fourth quarter alone. Unemployment is increasing sharply as are virtually all other negative indicators. As these metrics deteriorate, however, it is worth remembering that the front side of a recession is always the scariest.

As always, the only value of mistakes lies in the lessons learned. Looking back at the crisis of 2008, the lessons can be reduced to a single word: liquidity. In a nutshell, we learned that while the answer to the question, How much long-term debt is appropriate for a given company? varies by industry and business, the answer to, How much short-term debt is appropriate for a given company? should almost always be zero. In 2008, even companies with plenty of earnings and equity relative to their debt found themselves shut out of the credit markets.

Because a bear market presents the opportunity to benefit from earnings growth, dividend yield and multiple expansion, I had always been a bit jealous of the opportunities that my father and grandfather were given in the terrible bear markets of the last 60 years. Now that our generation has finally been given the same opportunity, I recognize the wisdom of the saying, “Be careful what you wish for.” In a time of fear and panic, investments will never seem as straightforward as the example given above. More important, even if investors can recognize such opportunities with their heads, their stomachs often have other ideas. As legendary manager Peter Lynch observed, “The key organ (for investment success) is your stomach. Everyone has the brainpower, but not everyone has the stomach for it.”

In today’s bear market, investors are racing for the exits. Cash is pouring into “riskless” securities like short-term U.S. Treasuries with virtually no yield. Although such a choice feels good, it is, given the near certainty of inflation, likely to prove very costly. Meanwhile, investments in high grade common stocks, which feel like a terrible choice, are likely to prove very profitable and are almost certain to outperform cash over the next decade.