2013 Q4 Newsletter
Simplicity is the Ultimate Sophistication
Ever since the S&P 500 bottomed out at 676 in the midst of the financial crisis in March of 2009, we have been preaching a very consistent message: Do Not Panic, Stocks are Ridiculously Cheap, Stay the Course, This Too Will End, etc. After surging more than 30% over the past twelve months, the S&P 500 closed on December 31st, 2013 at 1848. Disciplined, long-term, patient, and diversified equity investors like us have seen our portfolio values nearly triple in value in less than five years. By contrast, those poor and timid souls who fled equities for the “safety” of cash, bonds, gold, hedge funds, or other alternative investments have fared much, much worse. In hindsight it is clear that we were right…and they were woefully wrong.
However, we have been doing this long enough to know that a rising market presents investors with an entirely new set of challenges. My former coach and good friend Barry Alvarez taught me that the word WIN is actually an acronym for What’s Important Now. Rather than dwell on the past, winners always focus on the future. So with the turning of the calendar to 2014, I am officially declaring the Great Recession and subsequent Great Recovery over. History. Finished. Done. Although both were doozies, just as with every single crisis that preceded it, it came, it went, and the market went on to reach new all-time highs. With that in mind, let us head into 2014 armed with What’s Important Now to us as investors:
(1) Equities are Still Not Expensive. Twice in my career as an investment advisor (in 2000 and again in 2009) stocks have gotten so ridiculously cheap that I felt compelled to sound my barbaric YAWP from the rooftops of the world about it in my best Walt Whitman voice. Although they no longer appear ridiculously cheap, they certainly do not appear expensive either. At somewhere around 15 times consensus 2014 earnings, the Price/Earnings ratio of the S&P 500 currently sits smack dab in the middle of its long term range of 10-20. With corporate earnings and dividends continuing to grow while interest rates still hover near all-time lows, we find equity valuations attractive, especially compared with their chief alternative…bonds.
(2) Bonds are Still Expensive. Although yields have climbed off of their record lows, investors in 10-Year Treasury Bonds are still willing to lend money to the US Government in exchange for a return less than the long term average inflation rate. It seems logical that as bond investors come to the realization that the global economy is well into a robust recovery, they will eventually demand a higher rate of return and drive bond yields even higher. Just ask any bond investor what rising interest rates did to their bond portfolios in 2013.
(3) Another Correction is Coming…But I Have Absolutely No Idea When. Just since 1980 the S&P 500 has dropped 20% or more on seven different occasions. It doesn’t take an engineering degree to calculate that equity investors should expect a temporary market decline of at least 20% about once every five years. So be it. The next correction may occur next month, next year, or five years from now. But successful investors must be perfectly comfortable watching a $1MM equity portfolio dip temporarily to $800,000 before it eventually climbs to new highs. If the thought of this gives you heartburn, we need to have a conversation…and soon.
(4) Avoid Performance Mania. In a little over sixty days, the March 2009 lows will become the starting point for the trailing five year performance of all investments. Brokers, mutual fund companies, and friends at cocktail parties will soon start bragging about the exceptional past performance of certain cherry-picked individual stocks, sector funds, and leveraged funds. The fear that overcame undisciplined investors over the past several years will soon begin morphing into greed. The next time you hear tales of spectacular past performance, I urge you to pass along this warning: Investors who abandoned beautifully diversified equity portfolios in favor of technology stocks after their incredible run in the late 1990s saw these same companies painfully plummet by as much as 80% in the Dot Com Bust of 2000. A diversified portfolio is always the best long-term solution.
Given all of this, how will we proceed in 2014? By doing exactly what we have always done. We will review your individual financial situation, establish an appropriate asset allocation mix, utilize equity-dominated, low-cost, institutional quality, globally diversified, portfolios, systematically re-balance, and patiently adhere to our disciplined approach that has served us so well. The exact same philosophy and approach that guided us through the Great Recession and Great Recovery will continue to guide us through whatever 2014 has in store for us. As Leonardo da Vinci observed, “Simplicity is the ultimate sophistication.”
Senior Portfolio Manager
Disciplined Equity Management
Plan Wisely, Invest Intelligently, Diversify Broadly, Ignore the Noise