This is Part 2 to the investment newsletter earlier in the month:
Regarding the market, we have had one of the most volatile starts to the year in the market in history. Fareed Zakaria mentioned recently on his CNN show, GPS, that America and the rest of the world look dysfunctional; which is what happens when all the country’s problems are on display 24 hours a day via television, web sites, mobile apps, etc. I believe it’s these type of headlines driving markets today and especially this month. But negative news and warnings about impending economic doom are standard operating procedure for the news. Worries about China’s slowdown on the global economy is the flavor of the month. But fundamental economics are not driving this market, the headlines are. François Sicart of Tocqueville said it correctly in his latest investment newsletter (http://tocqueville.com/insights/why-did-stock-market-tank-yesterday),” Investor psychology trumps business fundamentals in the short term….. The stock market is made up of companies, and very little usually happens to suddenly and fundamentally alter a company’s long-term prospects… But in the shorter or even medium term, the stock market really is a beauty contest, reflecting the moods and preferences of a volatile jury: the investing crowd”
What do I think about this? Am I concerned? How should we react? What changes should we make?
You may be surprised to know I am not concerned and see some opportunities here. First, as some of the clients with me during the 2008 crash will attest, stay calm. The best immediate course is to avoid an overreaction.
To my clients who have been with me for the last 10 years, we have been here before. Different time, but same place. My narrative will not be any different in 2016. Whether it is the credit/mortgage crisis in 2008, the US debt downgrade in 2010, the Greek debt crisis in 2014, and now the China “syndrome” of 2016, stay focused on the next 5 years, not the short term noise and fluctuations driven by the latest headlines.
I know this is difficult. To my newer clients, the clients mentioned above went through an even worse situation back in 2008. These now battle tested stock market veterans saw their most aggressive portfolios drop over 20% in a course of 2 months. Most stayed put and trusted the process. Instead of overreacting they followed a strategy of rebalancing and letting the value funds pick up the discounted stocks, the same portfolio mentioned above produced returns on average of 9% a year over the next five years following this down period. Put simply, a $1M portfolio dropped to $800,000 from Oct to Nov in 2008 but then grew to $1.6M five years later.
How did we react back then? Our value fund managers screened for the cheapest stocks during that time, and mainly home builders and banks popped up. Who was buying home builders and banks back then? Almost no one; but it paid off over the next five years. Let’s fast forward to now; our value funds are buying the very cheap oil related and energy companies. Who is buying oil company stocks right now? Almost no one. This is called value investing. Sounds crazy, but let me remind you of The Great Salad Oil Scandal of 1963 (https://en.wikipedia.org/wiki/Salad_Oil_Scandal). Remember that one? Kidding, most people don’t. The executives at American Express got caught up in a corporate scandal lending to Allied Crude Vegetable Oil which ended up costing the company almost $1billion in today’s dollars. Everyone sold off the stock and it proceeded to lose 50% of its market value. No one wanted to touch American Express’ stock. One unknown brave, young 34 year old value investor saw an opportunity and purchased the stock. By 1974, the stick grew 10 fold and Warren Buffet still owns it today, 50 years later, and is obviously very well-known now. He purchased when there was “blood in the streets”. However, I am not implying we buy specific stocks that are selling cheaply, I am saying a value philosophy pays off in the long run. Our value funds inherently purchase these discounted stocks. Moreover, when we rebalance your portfolio, we will buy what has been down and sell what has been up. On top of this, going forward, I will look to increase allocations to MLPs (down 50% over the past year) and emerging market stocks (down 30% in 2015). Thus, we will take advantage of this opportunity by following Warren Buffet’s philosophy of buying stocks on sale and avoid the loss averse bias ingrained in the psyche of most investors who will try to time the market and sell or increase cash. The market will rebound, as it always does, and returns over the next 5 years should be substantial. The rebound also happens quickly and suddenly, which makes it impossible to time. If you have extra money, now is the time to invest. If you are retired or near retirement, stay calm and patient. Avoid watching the market and focus on having a solid financial plan.