Keep Your Eyes On The Prize!

In an investment letter we penned a little over one year ago, among other things we observed that, “With respect to our investments, unfortunately, we often fail to learn from previous mistakes, such as buying into recent performance, chasing the hottest fad and making wholesale shifts in our asset allocation for one reason or another.” Well, a Presidential election, particularly with a result not anticipated by the masses, can fall within the “one reason or another” reference. As a result, many individuals are feeling extremely despondent and gloomy, while seemingly just as many are quite enthusiastic and gleeful. Irrespective of your views, politics should have nothing to do with your long-term investment plans! Don’t allow your dislike for our next President to result in your bailing out of stocks and jumping entirely into bonds, gold, cash and the like. Likewise, if you are a big fan of our next President you should not permit this joy to result in your abdicating a diversified portfolio and loading up on stocks (and emphasizing those stocks you “think” or “have been told” will outperform).

Although the field of investments can be quite complex, we do our best to adhere to the “KISS” principle (“Keep it simple, stupid!”) as much as possible. This includes, for example, focusing on what is within our control; namely, appropriate asset allocation; adequate diversification; periodic rebalancing; avoiding the temptation to time the markets; etc. “Experts” attempt to make predictions based upon who controls the White House and Congress and the impact on domestic and global markets across various asset classes and sub-asset classes (e.g. which sectors will outperform and underperform over a given period of time; etc.). Unfortunately, the only things certain in life are death, taxes and change throughout time. History is replete with examples supporting the impossibility of predicting with any degree of certainty which asset classes, sectors, companies, etc. will do better (and worse) under a given Administration. Quite simply, this is a fool’s errand.

I have voted in 6 Presidential elections. I’m 3 – 3, batting .500, which would put me in the Hall of Fame in baseball as the greatest hitter ever while failing any course in school. Did I do anything differently the next day and the following 4 (or 8) years in terms of my investments, my life, my work efforts, etc. when the person I voted for became President versus the opposite result having occurred? Absolutely not. While I may have been happy (or glum and moody), I didn’t allow my political views to influence activities within my control, particularly with respect my long-term investment plans. Just like in marriage where you agree to take your spouse “in good times and bad,” (and there will be plenty of both), so, too, should you be cognizant that when you formulate your investment plan you need to stick with what you own through the good and bad because both will occur (and no one knows when and the magnitudes). Unless there is a material reason for making a change (e.g. something in your own personal circumstances; a legitimate reason(s) impacting one of more of your investment holdings; etc.), don’t allow your emotions to get the better of you and your investment portfolio!

As support for the above, below (and attached) I have included relevant information (facts, not my opinions), including some real head scratchers since the election over 3 weeks ago. The sole purpose of including such information is to reiterate the importance of not letting your long-term plans go off course because you didn’t (or did) like an election result. It is important to have a long-term plan, stick to it, modify it as necessary and, at critical times (such as after a Presidential election), do nothing unless warranted!

Market Timing: Worse than the odds of getting rich at the casino – as is relying on projections from the “experts.”

• 10/25/16 thru 11/04/16: S&P 500 Index (large-cap stocks) suffered a 9-day consecutive losing streak (down 3.1% during this time) – its longest in nearly 36 years.

  • 11/07/16: The S&P 500 Index had its biggest gain [2.2%] since March, 2016. The Dow Jones Industrial Avg. (“DJIA”; mega-cap stocks) rose by 371 points [2.1%].

    • The ‘consensus’ reason for the sizable stock market gains was that this was due to The FBI’s announcement on Sunday, 11/06, with favorable news for Hillary Clinton – who, as per most of the media and pundits, was the candidate the stock market favored.

  • 11/08: DJIA up 73 points [0.4%].

  • 11/09: DJIA had been down (867) points overnight – roughly (5%). It was down a considerable amount even before Donald Trump had one a single state – merely because certain states were too close to call at 10:00PM and 11:00PM! Meanwhile, do you think the value of most companies deserved to fall off a cliff that evening absent any new material information regarding their operations, finances, etc.?

    • Remarkably, the DJIA finished 11/09 UP 257 points [1.4%] and traded in a 1,172 point range – one of the biggest single-day reversals in stock market history (even though Hillary Clinton called to concede the election at around 3:30AM on 11/09).

      • “The gains flew in the face of dire warnings from Wall Street strategists of a selloff after a Republican victory.” (Bloomberg article 11/09).

  • 11/10: DJIA finished up 218 points [1.2%].

  • 11/11: DJIA finished up 40 points [0.2%].

• 11/07 – 11/11: DJIA up 5.4% for the week – its best weekly performance since Dec., 2011 despite (a) hardly anyone predicting Donald Trump’s election and (b) most ‘experts’ stating the stock market would fall off a cliff as a result.

  • The DJIA was up 8.2% for the YTD thru 11/11/16 (it’s continued to rise and is up 9.7% for the year-to-date [“YTD”] thru the end of November) – representing 2/3 of the YTD gains in just 1 week! The S&P 500 Index rose by 3.8% the week of the election- its highest weekly gain since 2013. Additionally, the Russell 2000 Index (small-cap stocks) rose by 10.2% - its 6th largest weekly % gain since 1987.

    • Meanwhile, gold, which peaked at $1,337/oz. in the early morning futures market of 11/09 (as the stock market appeared ready for a free-fall) ended at $1,227/oz. on 11/11 (an 8.5% drop in a matter of days – having fallen on Friday, 11/11 by 3.3%, gold’s worst loss in nearly 3 years). At the end of November gold closed at $1,175/oz., having fallen over 7% since the election (closer to 12% to 13% when factoring in its peak in the future market in the early morning of 11/09). Gold had its worst month since June, 2013 (finishing down 7.9% in November); remains up over 10% for all of 2016 yet, as predictable, “Investors Flee Fold ETF At Fastest Pace In Over Three Years After Trump Win” (11/29/16 Financial Advisor). Do you think these investors were allocating to gold as a long-term investment, or merely a short-term trade/bet/gamble over the short-term?

  • Additionally, the Bank of America/Merrill Lynch Global Broad Market Index of bonds experienced over $1 trillion in losses the week of the Presidential election, along with its biggest percentage drop since June, 2015.

    • From 11/01 thru 11/22, the Treasury bond market suffered a (2.52%) loss.

    • Even worse, from early July thru near the end of November, the 10-year U.S. Treasury has lost (7.4%) of its value as the 10-year U.S. Treasdury yield saw its largest one-month increase since December, 2009. The zero coupon U.S. Treasury Index saw nearly (12%) of its value wiped out in November alone! More on the inverse relationship between interest rates and bond prices later.

• “Why Forecasts for a Trump Victory Market Collapse Were So Wrong” (WSJ 11/09/16):

  • “Analysts predicted a collapse in global share prices in the event of a Donald Trump election victory. They were wrong, and now they are asking why.”

  • “Mr. Wolfers, in a piece of research with Eric Zitewitz, professor of economics at Dartmouth College, had predicted a Trump victory would knock 12% off the S&P 500. Others also were bearish. RBC Capital Markets predicted the index would fall 10% to 12% on a Trump win. Citi researchers expected a 5% drop in the index.”

    • Incredulously, the 2-week rally since the November 8th election was the 3rd-largest ever since 1932 (according to Bespoke Investment Group).

    • Additionally, for all of November the DJIA rose by 5.4%, its best performance since March (having set 8 new records in November).

• Citigroup on August 25th: “The election of Donald Trump as President of The United State could lead to chaos in markets and increased political uncertainty that tip the world into recession….”A Trump victory in particular could prolong and perhaps exacerbate policy uncertainty and deliver a shock (though perhaps short-lived) to financial markets.”

  • Citigroup on November 14th: “Citigroup, Inc. views the 72-hour-old rotation into stocks following Donald Trump’s presidential victory as the start of something big…..Strategies led by Jeremy Hale raised the firm’s recommendation on global equities to overweight from underweight.” So much for consistency (and Citigroup is merely one of many who made a 180 degree shift in their ‘forecasts’ pre and post-election)….

• “Trump win prompts optimism, risk-taking among wealthy investors.” (11/28/16 InvestmentNews article). I wonder if this article and the survey results from UBS would have been different had the stock market had an awful November?

• According to The Investment Company Institute, more money was withdrawn from stock mutual funds during the last week of October than any week over the past 5 years. As a result, these individuals undoubtedly missed the rally since the election (due to a lack of discipline and consistency) and are probably now adding to stocks as they attempt to “chase” performance (irrespective of their appropriate asset allocation due to feelings of regret and missing out).

  • In 2012, nearly 40% of respondents to a survey by Phoenix Marketing International said the 2012 Presidential contest caused them to change their investment strategy. Note that the S&P 500 Index nearly doubled during the following 4 years.

  • Remember the Brexit vote in June, 2016, when the S&P 500 Index declined by (5.3%) the following 2 days? Subsequently, in the next 3 days the S&P 500 Index gained back nearly all of what it had lost.

    • Courtesy of the 09/06/16 Financial Advisor Magazine article entitled, “Morgan Stanley Economists Join Goldman Revising Brexit Outlook,” “Morgan Stanley followed Goldman Sachs Group, Inc. in predicting the U.K. economy will prove stronger than economists anticipated in the immediate aftermath of the vote to leave the European Union. Scrapping their previous forecast of a recession…..Previously, we had expected an immediate reaction to the vote to leave, but, in practice the reaction has been muted, or rapidly reversed..” Once again, so much for being consistent, let alone accurate..

• As noted by Ben Carlson in his 10/23/16 article titled, “The Art of Doing Nothing:”

  • “When everyone around you is picking new stocks or funds and churning their portfolios by trying to guess where interest rates or corporates earnings are headed next, it can feel lonely to stick with a more inactive approach.”

  • “There needs to be a good reason for every move you make in your portfolio. Successful long-term investing is about learning to say no over and over again by developing a filter that helps you turn down more investment ideas than you accept.”

• As contained in the 09/02/16 WSJ article entitled, “A Bored Investor Is a Dangerous Thing:”

  • “Fixating on a dull market can leave you restlessly craving excitement that just isn’t there.”

  • “A bored investor is probably more likely to succumb to the whims of other bored investors moving in a herd.”

  • Investing is a continuous process too. It isn’t supposed to be interesting…If you go to the stock market because you want excitement, then sooner or later you will lose.”

• “How to Keep Headlines From Driving Your Portfolio Decisions” by AAII (11/09/16):

  • “Long-term investing success comes in large part from simply sticking to a plan no matter what is going on around you. This is far easier said than done when big events occur. Our desire to do something conflicts directly with what is best for achieving our long-term financial goals.”

  • “Base your allocation decisions on your long-term goals, not the day’s headlines. Just as negative feelings can cause investors to unnecessarily reduce their equity allocations, positive emotions can cause investors to unnecessarily increase their exposure to stocks. Your goal should be to maintain an allocation that’s appropriate for achieving your financial goals, regardless of what the headlines are.”

• The below chart denotes how the risk of losing money investing in stocks declines considerably as one’s time horizon increases. Note the percentage of time the S&P 500 Index returns have been positive from 1926 – 2015

Is it any wonder, then, that those investors who viewed their results more frequently within a given year held a lower percentage in stocks relative to those who look at their results on a less regular basis? Although the value of companies changes in the marketplace every single day, the fundamentals of companies don’t change nearly as quickly.

• Every investment has risk (and often more than one type of risk). For example, in the case of bonds:

  • Prices (market values) and interest rates are inversely correlated.

    • e.g. 10-Year Bond issued for $1,000 1 year ago at 2%. Assume that interest rates are now at 3%. Since an investor may purchase a 3% bond in the open market, why would they ever buy the 2% one issued last year? Only if they pay something less than $1,000 to effectively get at least a 3% yield (rates increased, so the price of the bond issued 1 year ago declined).

    • Accordingly, the 10-Year Bond issued last year will sell at a discount (something less than its face amount) – no different than the price of a used car relative to a new car (all else being equal).

  • e.g. 10-Year Bond issued for $1,000 1 year ago at 3%. Assume that interest rates are now at 2%. Since an investor may purchase the 3% bond in the open market, why would they ever buy the 2% one issued now? However, if they want the 3% bond they will have now to pay more for this (since interest rates declined, the price of the bond issued 1 year ago increased).

    • As such, the 10-Year Bond issued last year will now sell at a premium (something more than its face amount).

• Accordingly, it is possible to lose money in bonds due to an increase in interest rates, decline in credit quality and other reasons (not even factoring in the effects of inflation). Of note:

  • From 11/07 – 11/11, the Bank of America/Merrill Lynch Global Broad Market Index of bonds fell 1.18%. Its U.S. Treasury Index fell by 1.91%, its biggest weekly decline since June, 2009. The 30-year Treasury bond interest rate rose by 0.3% - resulting in a (6.3%) decline in price.

  • Since the election (11/08 – 11/30), the 10-year U.S. Treasury bond has lot over 5% of its value and is over 7% since early September).

• Remember, investing involves an analysis of price and value. Great companies may not be great stocks at various points in time. Every investment needs to be judged on its merits rather than assumed to be ‘good’ or bad’ due to perceived notions. As an example, there is nothing wrong with dividends; in fact, most companies with strong balance sheets, steady cash flow and a thriving business often will reward investors with dividends. Note, however, some article headings over the past few months:

  • “Dividend Stocks Take a Hit” (10/05/16 WSJ) – as utility shares posted their longest losing streak since 2002.

  • “Safest Shares Prove Anything But” (09/12/16 WSJ) – as stocks in sectors with high dividend yields (not necessarily the amount of their dividends per se) had sold off, prompting the end of the article to state, “The real danger is that investors change their minds and flee from what has become a crowded position in long-dated bonds and their alternatives (like dividend stocks), pushing yields up quickly and hammering precisely the shares that are meant to protect you during a selloff.”

  • “The Problem With Dividend Stocks” (09/05/16 WSJ) – given extremely high valuations as investors’ desire for yield bid up the prices of many such stocks.\

  • “Why Investing in Toothpaste Is an Expensive Proposition” (08/09/16 WSJ) – as a number of high profiled companies in the consumer staples sector experienced swelling valuations plus an ever growing percentage of earnings being paid out in dividends (with a number of companies borrowing merely to sustain their dividends).

Attached are the following articles and charts that collectively do a terrific job supporting much of the information contained herein as well as previous correspondence of ours:

1. “A Long-Term Care for Stocks.” In order to obtain the 9.6%/year average annualized return of the S&P 500 Index over 50 years, an investors had to be willing to endure 8 bear markets (20% or more declines), including 2 extreme ones in the 21st century. Not easy to do.

2. “Intra-year dips in the S&P 500 Index happen frequently.” Even in strong years for the S&P 500 Index (e.g. 1997 – 1999; 2009; etc.), the index suffered a considerable drawdown from peak to trough despite finishing the year up. How many investors withstood these declines and demonstrated the necessary patience, temperament and emotional detachment to avoiding selling their stocks at the worst possible times?

3. “U.S. Stocks vs. Foreign Stocks: 2000 – 2015.” Although past performance is no guarantee or predictor of future performance, investors often are beholden to ‘recency’ bias (whatever has already happened we assume will continue to occur). Some investors now want to abandon foreign stocks completely in light of U.S. stocks outperforming them since 2013 (including 2016 to-date). Over the 16 years displayed, ½ the time U.S. stocks outperformed and ½ the time foreign stocks outperformed. Did a bell go off to indicate which would do better the subsequent year? If so, I don’t recall being told.

4. A table from early June displaying the recommended asset allocations from 40 prominent investment firms. How these institutions are able to generate one asset allocation universally acceptable for any investor irrespective of age, risk tolerance, time horizon, financial circumstances, etc. is beyond me. Nevertheless, note considerable disparities in recommended allocations.

5. “What Investors Can Learn From Parents.” Among other lessons are (a) to be patient; (b) expect the unexpected; (c) don’t fall in love with one investment; (d) remain invested through thick and thin and (e) don’t allow emotions to alter your approach.

6. “Afraid of What Comes Next for the Markets and Economy? Read This”. As concluded nicely at the end of the article, “The same punditocracy that predicted that Secretary Clinton would “clearly” win is no more likely, just one day later, to know what will “clearly” happen in the economy. What is indisputably clear is that the responsibility for self-control is in your own hands as an investor.”

7. “Study: Mutual Fund Investors Are Their Own Worst Enemy.” Voluntary investor behavior is the leading cause of diminished returns which includes (a) panic selling, (b) excessively exuberant buying and (c) attempts at market timing.” Sound familiar?

8. 1990 – 2015 chart displaying $10,000 invested in the S&P 500 Index grew to $103,952. If you missed merely the 10 best day (0.17% of the total days), you ended up with 50% less. If you missed the 20 and 30 best days, respectively, you ended up with even considerably less. Who knew which days during this 25-year time frame would be the best (or worst for that matter)?

9. 1926 – July 31, 2016 growth of $1 invested in the S&P 500 Index grew to $5,800. However, missing just the best month (which occurred in 1933) would have resulted in a 30% decline in the value of your investment. Missing the best 10% of months would have resulted in an actual loss of money! Once again, severe consequences exist for those who can’t stay committed to the stock market – which is designed for a long-term time horizon.

10. “A Great Market Rotation” observed how the S&P 500 sectors that led the stock market in the first half of 2016 (including telecommunications, utilities, consumer staples and real estate – with financial services and information technology laggards) completely reversed themselves during the first 3+ months in the 2nd half of 2016, with telecommunications and utilities experiencing corrections (10% or more declines) and information technology and financial services leading the way. Could anyone have predicted that this would occur, and when? Another reason to diversify.

11. “2014: Patience Pays Off.” “Achieving the market rate of return in 2014 required a level of patience and equanimity that eluded many investors – individuals and professionals alike.” “Many investors braced themselves for a continuing slide in stock prices that never occurred.” “The year 2014 was a challenging one in many respects, but perhaps the biggest challenge was to resist the urge to dip and dart in response to the cascade of news events and opinions that suggested action of some sort was imperative for financial success.”

12. “Surprise! No Selloff in 2013.” “To some experts, it wasn’t supposed to look like this. “With so many economic hobgoblins to frighten them, many investors found it easy to dismiss more positive developments as unsustainable or irrelevant.” “But results from this past year tell us we should be skeptical of our ability – or anyone else’s – to do this well enough to outperform a simple buy-and-hold strategy. When investors are studying the long-run record of U.S. stock market returns several years from now, we suspect many of them will find it difficult to recall exactly what it was that they were so worried about and discouraged them from pursuing the capital market rewards that were there for the taking.”

13. “2012: The Year It Didn’t Happen.” “Judging by the headlines in the financial press, investors spent much of the past year anxiously awaiting one calamity after another that failed to occur.” “As is so often the case, earning the rewards offered by the world’s capital markets may have required a combination of discipline and detachment that eluded many investors.”

14. “The Death of Equities, Revisited.” “The notion that risk and return are related is so simple and widely acknowledged that it hardly seems worth arguing about. But these articles (and others of their ilk) offer compelling evidence that applying this principle year-in and year-out is a challenge that few investors can meet, and explains why so many fail to achieve all the returns that markets have to offer.”

One of the most famous investors, Benjamin Graham, said that in the short-run, the stock market is like a voting machine – tallying up which firms are popular and unpopular. In the long-run, however, the market is like a weighing machine – assessing the substance of a company. As such, what matters in the long-term is a company’s actual underlying business performance rather than the investing public’s often fickle opinions about its prospects in the short-term. Keep that long-term in mind despite all the noise taking place which can distract from our mission and veer us off course.

Warm Regards.

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