Beating the Street (20 page)

The next day I was still recovering from this experience. We'd driven to Basel, where Sandoz, the famous Swiss pharmaceutical and chemical company, has its headquarters. Back in the U.S., I'd called Sandoz to set up an interview. Normally, the people in charge of a company understand right away why I might want to see them, but Sandoz was different. I was connected to a vice-president, and when I told him I wanted to visit the company, he asked: “Why?” “I want to learn more about what you do so I can decide whether to buy more shares,” I answered. Once again he asked: “Why?” “Well, because I'd like to be fully up to date,” I continued. “Why?” he wanted to know. “Because if I buy it and the price goes up, I can make money for the shareholders.” “Why?” he asked, and I said good-bye. I never got to see Sandoz, although subsequently I heard it loosened up its visiting rules.

We continued on through the Alps to Italy and got to Milan, where I saw Montedison, another hydroelectric company. In its 300-year-old boardroom there was a fascinating contraption that dripped water in rhythm with the amount that was actually flowing through the dam. Besides Montedison, I saw IFI, another company in the neighborhood, as well as the famous mural
The Last Supper.
I also saw Olivetti. I'm probably one of the few tourists who would list Montedison, IFI, Olivetti, and
The Last Supper
as their favorite northern Italian attractions.

Italy was suffering from high inflation and impossible politics, but the inflation rate was going down and politicians were becoming more businesslike, and the people had started buying their groceries in supermarkets. It occurred to me that Italy in 1985 was a lot like America in the 1940s and 1950s, a place where appliance companies, electric companies, and supermarkets would be the fast growers of the future.

Carolyn went to Venice, where I couldn't find any companies to visit (the Doge's Palace and the Bridge of Sighs are not yet publicly traded), so I headed for Rome, where I saw Stet and SIP. On October 9 we were reunited in Rome and boarded the plane that returned us to Boston on the 10th, where I promptly saw four more companies: Comdisco, A. L. Williams, Citicorp, and Montedison. This was the same Montedison I'd seen a week earlier in Milan.

This whirlwind tour of Europe had caused me to miss Ned Johnson's 25th wedding anniversary, and he was my boss, but the absence was for a good cause. The stocks I bought as a result of my European trip did well, beginning with Volvo, Skandia, and Esselte.

Ten percent of Magellan's assets were now invested in foreign equities, and the many happy returns I got from these stocks helped the fund keep its number-one ranking. My top eleven foreign purchases, Peugeot, Volvo, Skandia, Esselte, Electrolux, Aga, Norsk Hydro, Montedison, IFI, Tobu Railway, and Kinki Nippon Railway, made more than $200 million in profits for the shareholders.

The two Japanese railroad stocks were recommended to me by George Noble of the Overseas Fund. I researched them further on a separate trip to Japan, which was just as hectic as the European foray—I'll spare you the details. Tobu Railway was the biggest gainer of all: 386 percent in five years. Alas, it was a small position, with only .13 percent of Magellan's assets devoted to it.

In 1984, Magellan had managed a 2 percent gain while the S&P 500 lost 6.27. In 1985, the auto stocks and the foreign stocks contributed to a 43.1 percent gain. My largest positions were still in Treasury bonds and the autos, with IBM thrown in for some reason, which couldn't have been a good one. I was also buying Gillette, Eaton, Reynolds, CBS, the old International Harvester (now Navistar),
Sperry, Kemper, Disney, Sallie Mae, the New York Times Company, and Australian bonds. I bought enough SmithKline Beckman, Bank of New England, Metromedia, and Loews for those companies to appear in the top 10. Among the many stocks I wish I hadn't been buying were One Potato Two, Eastern Airlines, Institutional Networks, Broadview Financial, Vie de France, Ask Computer, Wilton Industries, and United Tote.

Another $1.7 billion had come into the fund in 1985, to add to the $1 billion in 1984 and the same amount in 1983. The net asset value of Magellan now equaled the gross national product of Costa Rica. To absorb this money, I was constantly on the offensive, reevaluating the portfolio, finding new positions or building up the old ones. This leads us to Peter's Principle #11:

The best stock to buy may be the one you already own.

Fannie Mae is a good example. During the first half of 1985, Fannie Mae was one of my typical minor holdings, but then I rechecked the story (see
Chapter 18
) and discovered it had improved dramatically. I elevated Fannie Mae to 2.1 percent of the fund. I was still partial to the autos, even though Ford and Chrysler had doubled or tripled in price, because the earnings were on the upswing and all the fundamental signs were favorable. But soon enough, Fannie Mae would take over where Ford and Chrysler left off as the key to Magellan's success.

In February 1986, Magellan passed the $5 billion mark in assets. I had to buy more Ford, Chrysler, and Volvo to maintain their weighting in the fund. I was also buying Middle South Utilities, Dime Savings, Merck, Hospital Corporation of America, Lin Broadcasting, McDonald's, Sterling Drug, Seagram, Upjohn, Dow Chemical, Woolworth, Browning-Ferris, Firestone, Squibb, Coca-Cola Enterprises, Unum, DeBeers, Marui, and Lonrho.

Foreign stocks now made up 20 percent of the portfolio, beginning with Volvo, which for most of the year was the top holding. Besides the autos, others in the top 10 included the Bank of New England, Kemper, Squibb, and Digital Equipment.

A $20 million position, equal to the size of the entire Magellan Fund in 1976, was now insignificant. To move this mass of billions, I had to have some $100 million positions. Every day I would go down the alphabetical list of holdings to decide what to sell and
what to buy. The list got longer and longer, and the holdings bigger and bigger. I was aware of this intellectually, but it didn't really sink in until a particularly hectic week in the market, when I happened to be visiting Yosemite National Park.

There I was, standing in a phone booth overlooking a mountain range, giving a day's worth of transactions to the trading desk. After two hours, I'd only gotten from the A's through the L's.

My visits with companies, either at our place or at their places or at investment seminars, also had escalated from 214 in 1980 to 330 in 1982, 489 in 1983, back down to 411 in 1984, 463 in 1985, and 570 in 1986. If this kept up, I figured I'd be seeing an average of two companies a day in person, including Sundays and holidays.

After five years of selling, selling, selling, my trader on the sell side, Carlene DeLuca, left the trading desk to marry Fidelity's former president, Jack O'Brien. On her last day at the office, we decided to let her do a few buys just to see how the other half lived. She wasn't prepared for this strange experience. On the other end of the phone, a prospective seller would offer some shares for, say, $24 apiece, and Carlene would hold out for $24.50.

Magellan was up 23.8 percent in 1986, and another 39 percent in the first half of 1987. With the market rolling along to an all-time high of 2722.42 on the Dow, and the herds of bulls appearing on the covers of every major magazine in the country, I made a major tactical shift—the first in five years. It seemed to me that we were far into the economic recovery and that people who were going to buy new cars had done so, and the analysts who followed the autos were making optimistic earnings projections that my research told me were unsupportable. I began to deemphasize the autos and to upgrade the financial companies—particularly Fannie Mae, but also the S&Ls.

Magellan became a $10 billion fund in May 1987. This announcement provided more grist for the naysayers who predicted it was too big to beat the market. I can't quantify the contribution that skeptics made to my performance, but I don't doubt it was substantial. They said a billion was too big, then 2 billion, 4, 6, 8, and 10 billion, and all along I was determined to prove them wrong.

Other large funds had closed the door to new shareholders once these funds had reached a certain size, but Magellan was kept open, and even this was perceived as a negative. The critics said it was Fidelity's way of capitalizing on my reputation and attracting more fees.

By 1987, I'd satisfied myself that a fund as big as the GNP of Sweden could outperform the market. I was also exhausted from the effort, and yearning to spend more time with my wife than with Fannie Mae. I might have quit then, three years earlier than my actual departure, but what kept me on was the Great Correction.

I can't pretend I saw it coming. Here the market was wildly overvalued and poised for a 1000-point decline—a situation that is obvious in hindsight—yet with my usual clairvoyance about the Big Picture, I managed to miss it. I entered this treacherous stretch fully invested in stocks, with almost no cash on the sidelines. So much for market timing.

The good news was that in August I cut back on the dozens of S&Ls in which I'd invested 5.6 percent of the fund's assets. It had begun to dawn on me (and on Dave Ellison, our in-house S&L expert) that some of these S&Ls were making very stupid loans. The bad news was that I put the proceeds into other stocks.

Before the Great Correction, Magellan was up 39 percent for the year, and I was mad about it because the S&P 500 was up 41 percent. I remember Carolyn saying, “How can you complain about lagging the market by 2 percent when you've made thirty-nine percent for your shareholders?” As it turned out, she was right and I shouldn't have complained, because by December I was down 11 percent. This brings us to Peter's Principle #12:

A sure cure for taking a stock for granted is a big drop in the price.

My own history of handling stock-market declines begins in a fool's paradise. Within a few months of my having taken over Magellan, the market fell 20 percent, while the stocks in the fund were actually up 7 percent. This short-lived triumph convinced me that I was somehow immune to the setbacks that befall the run-of-the-mill stockpicker. This fantasy lasted only until the next big decline, from September 11 to October 31, 1978.

That decline was a doozie, brought about by a weak dollar, strong
inflation, congressional dickering over tax cuts, and a tight-money Fed. Short-term Treasury bills were paying higher rates of interest than long-term bonds, a rare situation known as an inverted yield curve. The stock market fell a long way, and Magellan fell even further. This was the beginning of the real trend that lasted through the rest of my career as a fund manager: whenever the stock market did poorly, Magellan did worse.

During nine major declines, including the big one in 1987, this pattern persisted. The stocks in the fund would lose more than the average stock, and then outperform the market on the rebound. I tried to prepare the shareholders for this wilder ride in Magellan's annual reports. Perhaps there's some poetic justice in the fact that the stocks that take you the farthest in the long run give you the most bumps and bruises along the way.

I was delighted when 1987 was over. It was something of a triumph to bring Magellan back to a 1 percent gain and maintain the string of 10 profitable years. I'd also beaten the average equity mutual fund in each of those years. And once again, Magellan's rebound had outdistanced the market's.

The Great Correction had temporarily solved Magellan's size problem. What was an $11 billion fund in August had become a $7.2 billion fund by October. The GNP of Costa Rica was lost in a week.

In
One Up on Wall Street
I describe how I was golfing in Ireland when the calamity occurred. I had to sell a lot of stock to raise cash to pay off the shareholders who got scared out of their assets. Magellan had $689 million in sales in October and $1.3 billion in redemptions, reversing a five-year trend. The sellers outnumbered the buyers two to one, but the vast majority of Magellan investors stayed put and did nothing. They saw the Great Correction for what it was, and not as the beginning of the end of civilization.

It was the end of civilization for some stockplayers who owned shares on margin—i.e., they borrowed money from brokerage houses to buy them. These people saw their portfolios wiped out when the brokerage houses sold their shares, often at rock-bottom prices, to pay off the loans. It was the first time I truly understood the risks of buying on margin.

My traders came to work on a Sunday to prepare for the sell-off that was predicted for Black Monday. Fidelity had spent all weekend planning what to do. I'd raised my cash position to a relatively high level (20 times the fund's greatest single previous one-day redemption)
before I left for Ireland. This was hardly enough. A flood of redemption orders had been called in by phone. I was forced to sell a portion of the fund on Monday and another chunk on Tuesday. So at the very moment I would have preferred to be a buyer, I had to be a seller.

In this sense, shareholders play a major role in a fund's success or failure. If they are steadfast and refuse to panic in the scary situations, the fund manager won't have to liquidate stocks at unfavorable prices in order to pay them back.

After the market stabilized, Ford was still my top position, followed by Fannie Mae and Merck, and then Chrysler and Digital Equipment. The best performers on the immediate rebound were the cyclicals. Chrysler, for instance, rallied from a low of $20 to $29, and Ford from a low of $38¼ to $56 ⅝. But people who stuck with these cyclicals were soon disappointed. Three years later, in 1990, Chrysler was selling for $10 and Ford for $20, less than half what they'd sold for in 1987.

It's important to get out of a cyclical at the right time. Chrysler is an example of how quickly things can go from good to worse. The company earned $4.66 a share in 1988 and people were looking for another $4 for 1989. Instead, Chrysler earned $1 and change in 1989, 30 cents in 1990, and in 1991 it lost a bundle and fell into the red. All I could see was disappointment down the road. I sold.