In 2005, Frank Martin, founder of private, independent RIA Martin Capital Management in Elkhart, Ind., wrote an essay in his annual report to his clients called “The Perfect Storm,” which warned of a potential financial crisis related to the market’s disregard for risk. Founded in 1987, MCM provides investment management services to wealthy families and institutions. Martin moved much of his clients’ assets to cash in 2005 and 2006 , and in 2008, his clients’ portfolios were only down 7.8 percent. “When everyone moves one way you move the other way,” he said. His new book A Decade of Delusions: From Speculative Contagion to the Great Recession (Wiley& Sons) chronicles his investment decisions over the last 10 years, during the dotcom bubble of the early 2000s to the financial meltdown of 2008, drawing from his firm’s annual reports. Martin, who has been in the investment industry for 42 years, believes the conditions are right for another perfect storm, and he’s currently assembling a team of investment experts to prepare for it, led by Adam Seessel, founder of Gravity Capital Management, a long/short hedge fund, and portfolio manager of the RiverPark/Gravity Long-Biased Fund. The team is building an inventory of ideas of what to buy when the storm comes and everyone begins to hate stocks like they did in the 1930s and ‘40s. In this interview, condensed and edited for space, Martin talks about how he carried his clients through the last decade and what he’s expecting in the future.
Registered Rep.: In your new book Decade of Delusions, you talk about how you anticipated the perfect storm of 2008. What was your strategy back then with your clients’ portfolios?
Frank Martin: The book really is about winning by not losing. Over the last decade, we were able to double clients’ money, but the risks were that less than 50 percent was invested.We got returns with one hand tied behind our proverbial backs. We bought medium-quality companies; in bear markets, you don’t buy high-quality companies. You buy less attractive companies because they have a better bounce back.
RR: Looking back, what were the positives and negatives of how you handled things in 2008?
FM: There’s a price that has to be paid for looking good in bear markets, and that’s leaving the party before the police arrive. When you’re at the party and everyone’s getting drunk, the trick for the smart guy is to leave before the party’s over. The successes in ‘08, ‘09, and 2000 and 2002 were related to a fierce sense of independence. Obviously, when you leave the party early, you don’t get those last drinks. When I left the party in ‘05, ‘06, I wasn’t keeping up with the averages because I had so much money in cash. I knew that eventually cash was going to be king, and I was going to have buying power when nobody else did.
RR: What’s your strategy now?
FM: Now, I’m 70 percent short-term Treasuries. That’s the worst place to be, but I go wherever the line is the shortest. I’m likely to overpay for the asset in the long line. I’m more concerned about the return of my principal than the return on my principal. I want to trade whatever I own for liquidity. I’m a value investor, but you can’t decide to be a value investor the day before.
RR: Why do you think we’re headed for another perfect storm?
FM: For the retail investor, he’s not getting back to his old highs of 2007. If he doesn’t get back up, he’ll go into despair. This won’t be a typical bear market recovery. This will be a long, layered period of disillusionment and despair.
In 2008, we never did pay the piper, and we’re back to speculating. It’s the same old game. We had an opportunity to learn our lesson, but we didn’t and look where we are now. There’s a decent possibility of going into another recession.
The stimulus and bailout—were those really the best moves or should we have let the markets clear? I’m a counter-factualist, and I wonder what would’ve happened if we hadn’t panicked. The bailout was a moral decision. They made a decision that the country might’ve experienced anarchy. They did stop it for a moment.
The conditions are right for the perfect storm. Whether it blows in tomorrow or six months or a year from now, I can’t tell you. But the storm clouds are up there, and if a tornado drops, we shouldn’t be surprised.
RR: Do you think it will be as bad as 2008?
FM: I don’t think what’s ahead, if it’s anything like I imagine, will make us flash back to September 2008. What’s happening now may be sneaking up on some people, but it shouldn’t be sneaking up on very many people. It will be more of a death of a thousand cuts. People won’t be desperate; they’ll be overcome with despair.
If the market’s crashing, stock picking seems an afterthought. But when the market’s very expensive as it is, there’s only so many things you can be buying. It’s hard to find things on the bargain rack when everything’s expensive.
RR: What was the impetus behind forming this new investment team?
FM: I think I will, in the not so distant future, become redundant. That is, I think if the perfect storm really does blow through and things get desperately cheap and everyone hates common stocks like they did in the ‘30s and will hate them for a long period of time, our firm won’t need someone like me saying, “there could be a rainy day,” because the rainy day will have arrived. In that environment, we don’t need a macro guy to tell us what we already know. What we need is a team that we know can find the ideas, because we’re going to be fully invested before that’s through. We’re going to go from 70 percent cash to 100 percent invested I would guess here in the next year or two, subject to whenever it does happen, and it’s not going to happen overnight.So I needed a team in place that could have free reign to find the names, the businesses to put in the portfolios. Adam (Seessel) is a guy who had figured out Apple in the early 2000s, so he seems to be able to find the sweepers.
RR: In the book, you openly admit your mistakes and shortcomings. What are they?
FM: I err on the side of caution, even today. Most people I serve are very wealthy. They give as much to sleeping well at night as eating well during the day. I don’t want to keep them up at night, and I could’ve been better with a few sleepless nights. I could’ve taken a bit more risk and gotten more return. In 2010, thanks to a mistake I made, in buying put options, it went up fourfold in two months, and I didn’t take the gains because I was worried about what I’m worried about today.
RR: John Bogle, the founder of The Vanguard Group, wrote the forward in your book. How do you know him and what’s he like?
FM: He’s been my mentor for a long time. Jack is the father of indexing, and I’m a small active manager but we still get along. He’s the ultimate high-road kind of guy. He’s Mr. integrity in the industry. He was making concessions to his wife because at 82, she wants him to slow down. “I finally agreed,” Bogle said. “And I’m coming in at 8 now instead of 6:30.” I get up at 4:30 a.m. because I like my quiet time. Maybe we could take a chapter out of Jack’s book.
