2014 Q4 Newsletter
It is hard to believe that 2014 has come and gone already. If you paid attention to the news, you know that the year began with much of the US engulfed in a Deep Freeze that halted domestic economic activity for much of the first quarter. Just as the US began to thaw out, overseas we witnessed brutal acts of terror in Iraq and Syria, an outbreak of the Ebola virus on three continents, and the death of hundreds aboard not one, but two separate Malaysian Airlines flights. By year end, the Federal Reserve had completed its last round of Quantitative Easing, the Republicans had swept the midterm elections, and oil prices had plummeted by over 40%.
Of course, the media largely ignored the remarkable 5% spike in GDP during the third quarter, the fastest period of economic growth in over a decade. Even more impressive were the number of new technologies (horizontal fracking, drones, 3-D printing, cloud-based computing, etc.) that have suddenly become mainstream and started generating billions of dollars in revenue in industries which did not even exist just a few years ago.
Despite some wild volatility that included near 10% corrections during just a few days in both October and December, the S&P 500 finished the year about 13% higher than it started…just a tad above its long term average annual gain of 10%. Amidst another round of unprecedented worldwide crises, somehow, someway the Great Companies of the World still found a way to earn more money, increase dividends, and create real wealth for long term, patient, disciplined equity shareholders like you and me. In the words of the late Robin Williams in The Dead Poet Society, “Twas always thus, and always thus will be."
Some year-end thoughts on 2014:
Performance. The bulk of the market’s gains in 2014 were concentrated in US large stocks while small, international, and emerging markets stocks all posted smaller gains or losses. Therefore, it should come as no surprise that our globally diversified equity portfolios lagged the S&P 500 in 2014. This is perfectly fine with us. Remember our goal is to provide you with broad exposure to the global equity markets via multiple asset classes to maximize the probability of achieving your goals. The fact that our portfolio components all behaved differently during 2014 simply confirms that our portfolios are properly diversified.
Capital Gains. Our disciplined approach forces us to re-balance our portfolios periodically to keep them in line with the asset allocation we have determined is most appropriate for you. For those of you with fixed income allocations, higher stock prices force us to realize gains to keep your portfolio in line with your targets. Even within pure equity portfolios, disparity in performance amongst the equity asset classes forces us to move money between them to maintain proper diversification. Although we always do our best to defer capital gains, we never allow the tail (paying capital gains taxes) to wag the dog (prudent portfolio management).
Valuation. With the market hitting new all-time highs during 2014, we have been asked if the market is currently overvalued. The primary determinant of stock prices is the earnings and dividends of the underlying companies. After declining drastically during the Great Recession, 2014 marked the fifth consecutive year of robust earnings and dividend growth for the Great Companies of the World that we own. For example, the S&P 500 is currently trading at about 16 times the 2015 consensus earnings estimates, just a tad over its long term average P/E ratio of 15. Although no longer dirt cheap, the market is certainly not wildly overvalued…especially compared to near record low bond yields.
The Next Correction. The market experienced two micro-corrections during 2014, then recovered all of its losses (and then some) in a matter of a few trading days. History tells us that another more meaningful 10%, 20%, or 30% correction looms somewhere on the horizon, perhaps even during 2015. Yet as Peter Lynch so wisely stated, “More money has been lost by investors trying to avoid corrections than in corrections themselves”. Rather than try to predict and/or avoid them, lifetime equity investors like us embrace corrections as nothing more than wonderful opportunities to accumulate additional shares of the Great Companies of the World at discounted prices.
Here’s to a prosperous 2015!
Senior Portfolio Manager
Disciplined Equity Management
Plan Appropriately, Invest Intelligently, Diversify Broadly, Ignore the Noise