Back to School...
As students head back to the classroom we think it makes sense for us to look at some long term principals of investing that often get overlooked. As our clients know, we believe deeply in the value our investment process provides. Our quantitative system that allows us to objectively scale in and out of various investments has helped us avoid much of the market’s volatility while still participating in the upside. We believe successful investing is part art, part science. Our process is the science. Our experience, access to quality research and the input of some of the best minds in the industry provides the art.
The four most dangerous words in investing are “it’s different this time.”
– Sir John Templeton
Looking back over the past 100 years in the US stock market there have been many times of great uncertainty where it may have seemed foolish to invest due to the risk. The Great Depression, World War I, World War II, Impeachments, and Hyper-inflation to name just a few. Every one of these events could have been used as a reason not to invest and each time that would have been a mistake.
By the same token, there have also been times of great euphoria where old paradigms of valuation and traditional fundamentals seemed outdated. Consider the technology/internet bubble of the late 90’s and the real estate bubble in the mid 2000’s. In both cases investors would have been wise to follow long vetted fundamentals for valuation. Indeed, it wasn’t different in those cases it just seemed different in the very short term.
Whether things are going exceptionally well or poorly in the markets, people often take their most recent experience and extrapolate it forward. Just as trees don’t grow to the sky, markets don’t go straight-up either. Similarly, just because we’ve had two 50% stock market corrections in the past 15 years doesn’t mean another is just around the corner. The point is that all of these “abnormal” events are part of the uneven and unpredictable pattern that is the stock market.
If investors insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful – Warren Buffett
As we wrote about in last quarter’s update, one of the most reliable indicators for future investment returns is the general bullishness or bearishness of Wall Street strategists…when they are bullish be bearish and vice versa. Merrill Lynch tracks the consensus of these analysts’ opinions and they remain near extreme levels of bearishness. Another way to track sentiment is to turn on CNBC and compare how many commentators are calling for corrections vs how many suggest the market is likely to advance.
We also keep track of how different asset classes have performed each year. Many of you have seen the chart that looks like the periodic table of elements we learned in chemistry. Each asset class is represented by a different color square and they are arranged each year in descending order by return. Just a cursory glance suggests that when something has done particularly well for a few years it tends to do less well over the next several years and vice-versa. Despite this, when an asset class has done well for a few years in a row, investors tend to gravitate towards it in hopes of not missing out. This often is the exact wrong move – a classic case of driving while looking through the rear view mirror.
Our Portfolios
As we overlay some of the lessons above on our quantitative process we see some areas of real opportunity. First, the overwhelming majority of inquiries from our clients is about reducing or managing risk in the event of a large pull back. It seems the majority of talking heads on TV are calling for some sort of significant correction. Rarely do meaningful corrections happen when everyone is expecting it. So, from a contrarian standpoint & from the moving average process we have portfolios leaning towards the more aggressive side.
From a valuation standpoint some interesting divergences have occurred over the past few years. Since the peak in 2007 and subsequent 57% correction, the S&P 500 (US Stock Market) is now about 38% higher than its previous peak in ’07. This has many people thinking valuations are extreme. What you don’t hear about much, though, is that the international markets are still significantly below the highs of the mid-2000’s. Developed market international stocks (EAFE) are now 32% below their ’07 peak; Emerging markets are 35% below their previous peak; and a broad basket of commodities as measured by S&P GSCI commodity indexed trust is a whopping 67% below its peak. Each of these markets are now in an uptrend and we have been increasing exposure to these areas long before it is mainstream. Again, we are invested here not because we “think” things are bound to turn, but because our moving average process has indicated these investments are finally in an uptrend after years of decline. The point isn’t that we will be 100% right on these calls, instead it is to illustrate that not everything is at all-time highs and we have a process for finding and scaling into these assets.
Financial Planning
If you have not engaged with us on in depth financial planning, we would encourage you to do so. We have a variety of tools that can assist in all aspects of planning. Whether you are trying to determine if you are on track for your retirement or we are needing to do a deep dive on estate planning to optimize the passing of assets to the next generation, we have the most sophisticated tools available to assist. Our planning services are complimentary to you and we would encourage you to take advantage of our capabilities.
As always, thank you for entrusting us with your confidence and investments,
Brett, Steve, Becky, and Aaron
