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March 18, 2016 Individual Stocks, Mutual Funds

The Disconnect Between Main Street and Wall Street – March 18, 2016

2016 has started off on two separate paths.  Economically, things seem to be still moving forward at a moderate pace – we’ve now had a record 72 straight months of employment gains – and all signs point to continued growth.  Consumer confidence remains elevated, job growth is consistent, corporate profits outside the troubled energy sector are solid, interest rates remain low and consumers are spending on their homes, helped by a huge drop in gasoline prices.  In fact, the estimated global savings from the drop in oil is estimated to be $1.5 trillion.

On Wall Street, however, manic behavior continues to rule the day.  The year started out a very negative note and stocks sank, only to reverse trend when investors realized ala Chicken Little it was a pine cone not the sky that was falling.

This is not to say there aren’t any important issues for the markets to contend with, but rather that they seem focused in certain areas, not the market as a whole.

For instance:

  • Many speculative biotech and internet stocks seemed to be rising on nothing but hot air last year, but when faced with a few doses of reality have come crashing down to earth, with many showing losses of 50% just this year.

  • Oil prices seemed immune to soaring production, until suddenly they were not, which sent prices crumbling until recently stabilizing as wells are shut down.

  • Dozens of privately held companies with little or so in sales were valued at over $1 billion – called Unicorns – until suddenly investors have realized it was a bit of the greater fool theory, which has sent the values of many private companies sinking back to earth.

  • Investors have ignored the negative impact of excessive issuance of stocks options (discussed in our last July letter on Watered Stock) for years, only to suddenly realize they are a factor to contend with, as witnessed by LinkedIn’s recent one day decline of roughly 50% and questions about Twitter’s excessive use of options contributing to its 50% drop over the past several months.

  • Rising losses in the oil patch were certain to cause big losses for banks lending to many speculative oil companies, but it wasn’t until early this year that banks and investors suddenly paid attention, sending many of the related stocks sinking.

Within portfolios we are focused on sticking with disciplines and on identifying opportunities to buy (or sell) during the market’s manic up and down moves that often bear little if any relation to the underlying fundamentals.

Generally speaking, we continue to believe that stocks look attractive both on their own and relative to the record low interest rates now being paid on bonds.   Over the past 15 years, despite solid earnings and dividend growth, stocks have returned on average less than 5% per year, as valuations shrank by a third or more from their very inflated 1999/2000 levels.  Now that valuations are closer to historical averages, we believe stock returns over the subsequent decade are more likely to match the projected growth in earnings of 5-7% plus 2%-3% dividends, leading to a total return which looks much higher than bonds.

In summary, 2016 is starting off as yet another year when the market acts much more manic than the underlying economic fundamentals would suggest.  This is further evidence that the day to day market action is fairly meaningless for long term investors, especially when the positive outlook for economic growth is taken into consideration.


January 10, 2016 Mutual Funds

Rocky Start To The Year- January 10, 2016

We’ve barely had time to  turn the calendar to 2016 and already investors have been confronted with the worst start to year in the stock market in history, with the market down over 5% in the first week.

While certain factors are being pointed to as the cause – China’s economic and market woes, the Korean nuclear test, a further decline in oil prices – none really well explain a decline of this magnitude.  Stocks couldn’t even regain their footing after Friday’s better than expected job growth figures were released.

As we’ve often stated in the past, predicting or understanding short term market moves is essentially impossible, and in this case we don’t want to read too much into the market drop.  As we work through the rest of January we will get our first read on the outlook for the 2016’s corporate profits, and this might help the market find direction.

With the market selling off, we have used the weakness as an opportunity to add to our holdings at these attractive prices.

We have added to positions in small and mid-cap funds, as well as those focused on companies with good records of dividend growth, where appropriate and where there was available cash.

While this sort of market action is of course very disconcerting, the long term solid fundamentals of the companies we are invested in has not changed, and with valuations reasonable, inflation and interest rates low and cash levels at mutual funds and pensions at above average levels, the positive case for stocks is unchanged.

September 1, 2015 Individual Stocks, Mutual Funds

Why Are Corrections So Unpleasant? – September 1, 2015

We all have seen or read about the long term charts and data that show how stocks have dramatically outperformed cash, bonds, gold and even real estate over long periods of time.

The following is a summary of returns on just $100 invested three different ways in 1928 (right before the crash of 1929).

The value of each investment in 2014 is as follows:

US Treasury bills: $1,973

US 10-year government bonds: $6,972

U.S. Stocks: $289,500

No, that’s not a typo… the difference in returns between these three $100 investment choices when combined with the magic of compounding leads to dramatic differences in investment outcomes.  In fact, the differences are so astounding that one is compelled to get out a calculator and check the math, which I did!

But, as corrections such as that experienced since early August or real meltdowns as in 1987 or 2008 show, it can be a case of easier said than done to feel like stocks are the best place to put your money.  The volatility we experience on a day to day basis while hard to even find with a magnifying glass on a long term chart can be very nerve wracking.  The positive feelings we experience during market rallies seem to be less than the angst we feel on the down days… what could be behind that?

In fact, this disparity in how we feel has been confirmed by Nobel Prize-winning Psychologist Daniel Kahneman, who found that a loss causes roughly twice the negative feeling as a similar gain’s positive feelings.

And in today’s world when we check our account values sometimes every minute or hour, we often see a loss, causing us angst.

For instance, over the past 50 years or so, the stock market has fallen on almost 50% of all trading days. Given that, it’s no surprise we often feel whipsawed. Even though we know that the gains on the up days more than make up for the losses on the down days, the losses sting twice as badly as the gains nonetheless.

If we could force ourselves to look just weekly we would reduce the potential to see a loss to about 45%, monthly to around 40% and annually to just over 25%, essentially cutting in half the number of times you’d see a negative return.  I know it’s not easy to not look, but the more we can take our regular checks with a grain of salt, the better off our emotional state is likely to be.

Moreover, keeping our emotions in check is key because the risk to stock investing comes from getting overly anxious during one of the many downdrafts and selling out, not from the markets in general.

We have always found that when markets get as rocky as they are now, it’s good to go back to the basics of how to profit from stocks:

  1. Be a long term investor.

  2. Understand that volatility is your friend, not your enemy, as it leads to higher returns over time and provides investment opportunities along the way.

  3. Reinvest your dividends.  The compounded return from stocks when you reinvest dividends is almost double that when you don’t!  We reinvest dividends on all domestic holdings unless there is income being paid out.   $100 invested in the S&P 500 in 1990 turned into about $600 through this year but almost $1000 if you reinvested the dividends.  By consistently reinvesting dividends you purchase shares automatically on downturns and then receive more dividends on your reinvested dividends, boosting returns.

  4. Don’t time the market; no one has been shown to have the ability to regularly get in and out of the market in a profitable manner.

  5. Ignore the media.  No one on TV has any idea of where the economy or stock market is really going, and all their forecasts do nothing but confuse investors into getting off track with their long-term plans.

Sometimes just having an awareness of why corrections are so difficult can help us work our way through them.  The reality is that we can’t avoid them, and when we step back we can see that over time the markets have rewarded us nicely, despite the occasional heartburn they cause.


August 23, 2015 Individual Stocks, Mutual Funds

What Is The Correction Checklist Telling Us? – August 23, 2015

Even though we know that 5% or 10% market corrections are a very normal part of the market cycle, it doesn’t make them any less disconcerting and unpleasant.  Last year we had a roughly 10% correction later in the year, in 2012 the markets were down 6% in May, in 2011 we saw a multi-month drop that totaled roughly 20%, in 2010 the market had a two month drop of 13%, and unfortunately on and on.

This year, after trading in a fairly narrow range, stocks went into a sudden and large swoon last week, falling about 6%.  Emerging markets are feeling the brunt of the selling this year, and are now down 15%. Smaller stocks and the Dow have fallen sharply and are now down 5% and 10% respectively this year.  The S&P 500 has fared the best, and is down about 3% this year.  While our portfolios are holding up thus far better than all these indices, we are of course not immune to the selling and many positions have dropped notably in recent weeks.

As we’ve discussed before, some corrections are market events, some are sparked by real fundamental concerns, and many are sparked by external factors.

To get a better sense of how to analyze the correction, we follow a checklist.

  1. First, are there any visible economic/market concerns outside the U.S.? Here we’d say Yes.  There are clear fundamental concerns surrounding China and their economic slowdown.  Their slowdown has reduced demand for raw materials, putting commodity prices into a downward spiral, pressuring many emerging economies who depend upon raw material exports.  The drop in the Yuan’s value has caused other emerging market currencies to weaken as well.   We don’t want to dismiss these problems, but they appear manageable and likely to have only a limited direct impact on our economy.

  2. Second, are there economic problems here at home?  Here we lean towards No.  Most economic indicators are pointing to reasonably solid consumer demand, aided by falling gasoline prices and an uptick in wages and employment.  While the recovery remains uneven, we haven’t noted anything new of substance to raise a red flag.

  3. Third, has the inflation outlook worsened?  Here we think the clear answer is No.

  4. Fourth, have interest rates jumped higher?  Here we see that rather than going up they are going down, notwithstanding the potential for a small Fed rate hike.

  5. Fifth, has the profit outlook worsened?  Perhaps a bit, but while profits are under some pressure from the strong dollar having a negative impact on overseas sales, lower raw material costs, low borrowing costs and moderate demand appear as positive offsets.  We don’t see a big change here one way or the other.  We are also seeing dividends continue to rise.

  6. Lastly, are valuations out of kilter in the markets?  Here we would say No, as while valuations are high in some areas they are low in others, and the positions we own and the market indices appear reasonably valued to us based upon historical norms.

One anecdotal reason which might have helped spark the selling is some loss in market leadership.  Energy stocks are suffering, media and entertainment stocks have been weak since Disney’s report about ESPN, Financial Service stocks are now weaker due to falling interest rates and industrials are suffering from the strong dollar and weaker emerging market demand.  This is creating some winners and losers that causes some investor angst.

All in all, we thus are viewing this market correction as primarily a market event, yet well aware there is simply no way to know how long it might last.

As with other corrections in the past, we follow a consistent strategy:

  • We look to invest cash as opportunities appear to buy our favorites at lower prices.

  • We often add a new position in something we’ve been watching but waiting for a lower price.

  • We may sell one or two positions to generate money to add to holdings that we think will rebound more when the markets turn around.

  • We rarely do any selling to raise cash for withdrawals/distributions unless very unexpected, as we plan ahead for these and maintain holdings in bonds to cover expected withdrawals.

  • We avoid making emotionally driven decisions about asset allocation or other overall strategies as they rarely prove beneficial over the long-term.

We are well aware it can be hard during market corrections not to get caught up in the negative headlines put out by the media and commentators, but we should remember their job is to sensationalize the market’s upturns and downturns, not help you make wise investment choices.

We remain optimistic about the long term prospects for the U.S. economy and for the companies we are invested in.  We are focused on creating a growing dividend income stream in portfolios to use for both meeting spending needs and to reinvest in our holdings, and thus all accounts will be automatically adding to positions with the dividend income during this drop, something history tells us will enhance our long term growth.

While our correction checklist tells us there are no obvious reasons for alarm during this correction, we know every client’s situation is unique, so please let me know if you’d like to discuss your investments in greater detail in light of recent market events.


July 1, 2015 Mutual Funds

Greece Is The Word

In the summer of 1978 in mid-June the still popular movie Grease was released and became an unexpected hit, for both the film and the music. All that summer Grease is the Word was heard around the country as the song quickly became #1 on the charts. Fast forward to the summer of 2015 and Greece is still the word, thought today as an economic tragedy unfolding across that small country.

In fact, Greece has now officially defaulted on its debts, as it has skipped a payment to the IMF due yesterday, of about $1.5 billion.  Greek banks and markets are also closed for the time being.

Aside from the terrible humanitarian aspects of the economic freeze on Greek citizens, investors around the world are wondering with concern what the potential fall out could be outside of Greece.

While markets sold off sharply on Monday, they calmed down on Tuesday and now that the default process has begun, there have been no immediate side effects

In the most simple terms, based upon similar historical events, there is a very high probability that in the long run the impact will be minor but in the short term there is no way to know exactly how this will play out.

Historically, external crises of this type which we have seen in places such as in Russia, Asia, Venezuela etc the markets were initially volatile before ultimately returning their focus to more typical factors such as the domestic economy and interest rates.

In strict terms the size of Greece’s economy and it external debts are not large by any measure.  In fact, 75% of Greece’s external debt is owed to the EU and the IMF, which limits the likelihood of their debt default spreading too far through the financial system.

And lastly, this external shock to the global economy is at least coming at a time when we are generally seeing improved economic data both in Europe and in the U.S., making it easier for the negative impact to be absorbed.

Obviously the volatility associated with what is happening in Greece has shaken up an otherwise fairly quiet period for the markets, but we don’t expect the impact to be long-lasting as Europe works through this latest test of their economic union.  We would expect, however, that Greece will be the word we hear quite often all summer.

Within portfolios, we are encouraged this year by the market leading performance of a few of our funds, such as Health Care, Biotech and Small Cap, which is helping us show better than average returns.