Wednesday, December 23, 2015

Our 2015 Year-End Letter, Part One

Wow! Here we are. I can’t believe it’s been a whole year since I penned last year’s year-end letter! Indeed, life is like a roll of toilet paper; i.e., the closer you get to the end the faster it goes.

So, let’s see, today is December 23rd… by the time I finish writing about the U.S. economy, the global economy, maybe a little on a few specific countries, on the Fed, on politics, on inflation, on commodities, on bonds, on stocks, on sectors, on and on and on, it’ll probably be New Years Eveish before I’m ready click the send button and deposit the link to this year’s opus into your email box.

Maybe I should mix it up this time and have it published in hard copy; send it to you as a late Christmas present---maybe you’re the nostalgic type who likes the feel of the pages between your fingertips. Maybe your idea of a good time is curling up by the fire with a treatise on the aforementioned topics---one the size of Gone With the Wind... Hmm… Nah…

Of course I know better. So much so that I’ve decided to really make this year’s compilation palatable---by not compiling it; by delivering it to you in relatively short, concise, hopefully appetizing slices. Beginning here with some basics…


I recently picked on the late Albert Einstein; suggesting that he either thought successful investors were utterly insane, or that he was oblivious to the fact that sticking to one’s discipline---essentially doing the same things over and over again and expecting that results will differ in the short-run---is the essential element to long-term investment success.

I addressed the fact that the past two years have been a virtual standstill for the portfolios of globally diversified investors. I suggested that, if asked to, I’d be happy to produce a few charts illustrating similar periods of the past. Well, nobody asked, which means you are all either very patient, very comfortable with the work we do (talking to our clients of course), didn’t even read the commentary in question, or any combination of the three.

I, alas, really wanted to say that I produced the following charts upon request. Oh well…

We'll begin by taking a look at the New York Stock Exchange Composite Index from 12/31/2013 to the present:

click to enlarge

NYSE FLAT 12-2013 TO 12-2015

Yep, nothing! Well, okay, a lot if you look at all the ups and downs---but nothing in terms of growth over the past two years.

Per my December 20th commentary, too many individual investors left to their own devices would be throwing in the towel right about now, if they hadn’t already. Here’s that short essay in its entirety:
In yesterday’s commentary I touched on Einstein’s insight into an aspect of human nature that can kill one’s odds of achieving long-term investment success:

“Human beings must have action; and they will make it if they cannot find it.”

In last Monday’s Wall Street Journal, Wesley Grey made the point beautifully. Here’s a snippet (HT Jeff Miller):

Imagine the following theoretical investment opportunity: Investors can invest in a fund that will beat the market by 5% a year over the next 10 years. Of course, there is the catch: The path to outperformance will involve a five-year stretch of poor relative performance.  “No problem,” you might think—buy and hold and ignore the short-term noise.

Easier said than done.

Consider Ken Heebner, who ran the CGM Focus Fund, a diversified mutual fund that gained 18% annually, and was Morningstar Inc.’s highest performer of the decade ending in 2009. The CGM Focus fund, in many respects, resembled the theoretical opportunity outlined above. But the story didn’t end there: The average investor in the fund lost 11% annually over the period.

What happened? The massive divergence in the fund’s performance and what the typical fund investor actually earned can be explained by the “behavioral return gap.”

The behavioral return gap works as follows: During periods of strong fund performance, investors pile in, but when fund performance is at its worst, short-sighted investors redeem in droves. Thus, despite a fund’s sound long-term process, the “dollar-weighted” returns, or returns actually achieved by investors in the fund, lag substantially.

In other words, fund managers can deliver a great long-term strategy, but investors can still lose.

Yep, those stretches of poor/flat performance can drive a person insane!

So here’s a look at what waiting out those flat periods of the 80s would’ve delivered to investors who---unlike those who traded the CGM Focus fund during the 00s---had stayed with their discipline:

click to enlarge


Here’s the 90s:


So, now you’re thinking that periodic dead zones are always followed by stretches of great results. Well, look what happened after the flat periods that occurred from 1999 to 2001:

NYSE FLAT 1999 to 2001

Can you imagine? Waiting patiently, maybe having studied the 80s and 90s, and then experiencing the bursting of the 90s tech bubble!

Well, that’s what we did, while convincing clients who were still working to not only continue funding their retirement program’s, but to take full advantage of that bear market by increasing their contributions if they could. And while rebalancing (buying on the way down) the portfolios of retired clients who had enough fixed income exposure to continue their retirement distributions without having to sell stocks during a down market.

Then the ensuing rebound:


Which included a flat stretch, that was followed by a bear market for the ages:

NYSE FLAT 2005 TO 2008

Repeat the above "Can you imagine?" paragraph here; replacing "tech bubble" with "real estate/mortgage bubble".

Then the ensuing rebound (taking us to 2015):


Which included a few flat stretches:

NYSE FLAT 2010 TO 2012

And, again, here we sit today:

NYSE FLAT 12-2013 TO 12-2015

In case you're wondering, the NYSE Composite Index was at 585 when our story began. It sits at 10,258 today.

So, going forward, what should we expect from the market? I wish I knew. I can make a compelling case for either direction (in the near-term) from here.

As I’ll illustrate in another section soon, U.S. stock valuations, in the aggregate, are not presently compelling (which is cause for concern). However, the near-term odds of recession are slim and sentiment kinda stinks (which, believe it [the latter] or not, are two reasons to relax).

I personally find great comfort in the simple fact that the success of our typical client’s long-term portfolio is tied to the fortunes of literally hundreds of the world’s very best companies. The vast majority of which will be profitably selling their wares to a world of desiring consumers for eons to come, while paying dividends to their shareholders (and/or buying back shares and/or buying other companies) regardless of what their stock prices do along the way.

Here’s a snippet from a recent essay where I drove that point home:
Tell me you’re not at least a little nerve-wracked over the stock market these days. I’m not hearing anything because you can’t tell me that. As much as we know that equity investing is a long-term affair—and that volatility is inevitable—let’s face it, when it’s “bad” it stinks!

When the stock market’s “bad” we wish we weren’t in it. When it’s “bad” we’re sad.

When our clients take a look at their monthly statements—or, worse yet, when they daily pull up their accounts online, they, save for a few, don’t see the individual companies they hold. They see the names of funds that  assemble the stocks of the individual companies they hold; names that aren’t what you’d call “household”—names that don’t engender any pride of ownership.

So, while we may be sad when the market’s “bad”, would we indeed be as sad if we knew we owned a company that has a couple hundred billion in cash and utterly dominates the world of wireless devices—even when its share price is in decline? Well, we might, but we shouldn’t. How about if we owned the retailer that is largely responsible for the pain dealt to the market this week by the likes of Macys and Nordstrom? We might, but we shouldn’t. How about if we owned the world’s largest and most profitable banks? The chip maker that dominates cloud technology? The leader in home improvement goods? The place where you connect with hundreds of friends you didn’t know you had? The company run by the world’s most successful investor? Again, we might, but surely we shouldn’t.

If you’re our client, here—in order of their weighting (taken from a representative client account)—are the top 25 companies (out of hundreds) you hold.

Apple Inc
Microsoft Corp Inc
General Electric Co
Wells Fargo & Co
Chevron Corp
JPMorgan Chase & Co
Exxon Mobil Corporation
Alphabet Inc Class A (Google)
Comcast Corp Class A
Home Depot Inc
Citigroup Inc
Facebook Inc Class A
Monsanto Co
Cisco Systems Inc
Oracle Corporation
Berkshire Hathaway Inc Class B
Alphabet Inc Class C Capital Stock
Bank of America Corporation
Medtronic PLC
Visa Inc Class A
Procter & Gamble Co
Intel Corp
Boeing Co


Being in a position to own 25 companies that the world assigns over $2 trillion of its annual spending to is, you must agree, a pretty enviable position to be in—even during those inevitable stretches when their share prices are trading lower. I.e., those visions of destitution your brain conjures up during market selloffs simply do not jibe with the undeniable fact that the institutions you own ain’t going nowhere!

And to close this chapter: If, assuming you’re still awake, you need more convincing that the end of the world stories that certain blokes love to tell via the media should be digested with your proverbial grain of salt, this short one from last month ought to do the trick:
It Ain’t Easy Predicting Bear Markets

My charge as counselor to the folks who entrust their portfolios to our firm is to teach them how to think like long-term investors, which, in today’s media-rich world, can be quite the task. When pundits who—by nature of their media exposure—have to know what they’re talking about tell us that there’s a “99.7% chance we are in a bear market”, that “the S&P may fall further 10-15%”, that we should go “long bonds and short stocks”, that there’s “danger ahead”, that “equities have another 10% to fall” and that “now is not the time to buy”, it can be tough for little old me to convince our clients to buy and/or hold stocks through the inevitable fluctuations that are part and parcel to the business of long-term investing.

In showing this chart (click to enlarge) exposing the recent miscalculations of today’s media darlings, I in no way want to suggest that these chaps are always wrong. I have no doubt that they’ve made some very impressive calls during their careers that have ascended them to their present perches.


When Carl Icahn (arguably one of the world’s best investors) issued his “danger ahead” warning, he said that experts like himself should’ve helped the little guy by sounding the alarm ahead of the 2008 bear market. Problem is, he didn’t see it coming either, the hedge fund he managed took a 35% hit that year.

It’s gotta be tough being a prognosticator, especially when notoriety comes only when you accurately predict a bear market. The visual below (click to enlarge) tells why predicting higher stock prices doesn’t garner much attention, it’s easy. Stocks tend to rise over the long run. Guessing the red, on the other hand, ain't.

bull & bear market chart

I’ll be back soon with more.

Merry Christmas my friends to you and yours!


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