East Coast Asset Management's Q3 Letter

Found via Market Folly.

We live in a post credit bubble world. When the bubble popped in 2008, a meaningful percentage of the excess debt was transferred through bailouts and bankruptcies from over-leveraged businesses and individuals to government balance sheets. These sovereign central banks have further expanded their debt burdens through stimulus actions to help mitigate the inevitable slowdown as the world recalibrates to normal spending levels. We are in Phase 2 of this cycle where these sovereigns now must figure out how they can afford to pay off these debts. There are only three solutions to deal with this new reality: tax more, spend less, and/or “inflate away” debt.

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The inevitable “inflate away” central bank strategy being followed presents us with the long-term risk of purchasing power loss. The best way to counterbalance that offensive action on the GO board is by owning a healthy allocation of global, competitively entrenched businesses that have pricing power. Ownership of these businesses today at free cash flow yields ranging between 7 – 20% strikes us as a very common sense approach that maximizes our options. We do not view the outcome of our decision to own equities at these levels as potential for victory or defeat. We view the decision as an essential move which gives us the ability to gain strategic progress and a relative advantage over many of the large risks that exist in today’s investment environment, both seen and unseen.

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Not only are investors being herded by the predator of global macro fear and uncertainty but they are also being curtained by the fear of bubbles. Just as bubble net feeding is an effective technique for humpback whales to scare school fish into a herd, it is also particularly effective for corralling investors away from common sense and truth. The tech bubble of 2000 and the credit bubble of 2008 are open wounds for many investors. Investors remark “I cannot live through another episode like that” and thus frenetically seek the center of the bait ball. Bubble net feeding continues to plague investors in a major way. Fear and uncertainty that it could happen again have paralyzed the vast majority of investors. We observe a complete disregard for what an investment is worth based on its own merit.

For me the most important ten investment words ever uttered came from Warren Buffett when he said “investing is most intelligent when it is most business-like.” Today, business-like investing is looked upon as an ancient practice with very little merit. Even some of the most astute investors have joined the global macro circus looking for innovative ways to speculate on various macroeconomic outcomes. Beyond looking for tail-winds and tail-risks, we really don’t think devoting a lot of our daily resources to macro-economic hunches is going to reward our investors over the long-term and we feel it would greatly limit our success. We are however putting our efforts into overdrive on uncovering some of the finest businesses in the world that given today’s prices will deliver attractive compounding opportunities.