Year End Roundup
The quarter ending December 31, 2010 was a blowout for stocks and commodities, so it may be difficult to recall that stocks suffered a mid-year bear market – a loss of 16% between April and August. This was spawned by a few factors, fears about a financial collapse of European banks and even nations the most prominent. Sentiment was not helped by the Administration’s coordinated attacks on a prominent Wall Street bank, part of a transparent effort to garner support for sweeping financial regulatory reform struggling in Congress. Then there were the incessant calls for a “double dip” recession from perennially bearish economists, who it seems were dead wrong. Your performance since inception has exceeded that of most asset classes, especially stock, which suffered two mammoth bear markets over the past decade: a decline of about 45% during the Tech Wreck a (2000 to 2002) plus another plunge over 50% during the Banking Crisis of 2007 to 2009.
The quarter ending December 31, 2010 was a blowout for stocks and commodities, so it may be difficult to recall that stocks suffered a mid-year bear market – a loss of 16% between April and August. This was spawned by a few factors, fears about a financial collapse of European banks and even nations the most prominent. Sentiment was not helped by the Administration’s coordinated attacks on a prominent Wall Street bank, part of a transparent effort to garner support for sweeping financial regulatory reform struggling in Congress. Then there were the incessant calls for a “double dip” recession from perennially bearish economists, who it seems were dead wrong. Your performance since inception has exceeded that of most asset classes, especially stock, which suffered two mammoth bear markets over the past decade: a decline of about 45% during the Tech Wreck a (2000 to 2002) plus another plunge over 50% during the Banking Crisis of 2007 to 2009.
The economy in the USA is clearly on the mend, although the current generation of investors, particularly Boomers nearing retirement, are unlikely to ever plunge into equities en masse again. The current mentality is reminiscent of the 1950’s when a generation of Americans, scarred first by the Great Depression, then by World War, refused to trust in the stock market. Similarly, American management, those who dominated the world’s economy in the ‘50’s, hoarded large amounts of cash, fearing a return to Dark Days.
This mentality is actually quite supportive of a prolonged bull market, in my opinion. None-the-less, while today’s market may reflect an earlier era, history does not repeat itself, exactly. Thus informed by the past, I try to stay current with the latest opportunities, and always vigilant against emotionally based investment decisions. If US and world equity markets enjoy another healthy year, there will be a strong temptation to plunge more deeply into the hottest sectors. It’s my intention to remain loyal to companies with high returns on equity, reasonable debt levels and significant management ownership. It’s my intention to avoid owning stocks that are trading above a reasonable estimation of intrinsic value. It’s my intention to keep client portfolios diversified in a meaningful way, not simply owning index funds but owning good bonds and good businesses in a variety of economic sectors.
If we are in the midst of a major bull market, my approach may prove too cautious for some clients. A runaway bull market, if it develops, usually draws away a few people who convince themselves that paying for good advice is a waste of money. I often remark that the only time I saw a significant exodus of clients was during the Technology Bubble of the late 1990’s. One particular client, the plant manager of an aerospace company, was, in 1988, nervous about investing in government guaranteed zero coupon bonds (then yielding over 10%!). He was happy to be with me during the mid 1990’s bear market, grateful for his bond holdings, which rose, as stocks fell in value. Then came the Technology juggernaut of the mid-to-late 1990’s. By 1999 he had metamorphosized into such an investment genius that he moved his account elsewhere, to manage it himself! When an investment “Newbie” get’s infected with the disease of Greed, he reminds one of a teenager who has come to realize what Idiots his parents are. Then, in his ‘30’s or ‘40’s he begins to appreciate and respect his parents for having earned their gray hair the hard way. Having advised people through no fewer than five bull markets, this psychological pattern is familiar and predictable. I suspect it will return toward the end of the current bull market. But to return to present cases, recently, a long time client provided me with an article warning that investors are too enamored of bonds. The scar tissue of the last stock bear market has led them to buy bonds at unacceptably low rates of interest, and the writer opines that a major Bond Bust is in the offing. I might have taken this article more to heart had I not been hearing this same warning for the past two years in a row. Had I believed this, I would have hesitated to lock in yields that had been unobtainable over the previous 15 years. You, as my client, would have missed out on the generous income that has flowed your way from high quality bonds. While I doubt a “Bust” is in the offing, there is no question that interest rates will at some point rise again, and this will cause the secondary market value of bonds and preferred stocks to decline. However, based upon the outlook of such worthies as Bill Gross the Bond Guru of PIMCO Total Return fund fame, the US economy is too fragile to handle a sudden and sustained increase of interest rates. In mid 2010, Gross predicted two more years of low interest rates for the US. I suspect he is correct.
Moreover, so what if rates rise? Should I jettison a bond with a yield to maturity of 7%-8%-9%-10% because the secondary market price of that bond is declining? Consider that today, money market funds yield .01% (AKA “Nothing”), One year bank CD’s yield about .25% , and 5 year US Treasury bonds offer about 2%. For the past ten years, US Common stocks have produced a total return averaging only about 2.9%, with considerable collapses along the way. Should we abandon perfectly good income producing investments for the certain low yields of a money market fund and the uncertain returns of the stock market? No, my predilection is to hold many of these bonds to maturity, thus guaranteeing years of high income for you and perhaps for your heirs. As clients will note, I have committed more money to stocks in the past few months than at any time since mid 2008. In some cases, bond funds have been sold to fuel these stock purchases. Bond funds do not lock in any particular yield to maturity, so they are, in fact, more likely candidates for eventual sale than are the bonds that can be held to maturity. Further, I’ve been closely monitoring our clients’ preferred stock holdings. Why? Preferreds essentially have no maturity date. They are issued, in most cases, in perpetuity, but can be redeemed by the issuer. They are therefore, more vulnerable to a sell off if interest rates begin a sustained trend upward. I’m not unmindful of the potential for rising interest rates, but do not believe we are in imminent danger of a plunge in bond prices or preferred stock prices. Please be assured, however that I’m watching this landscape closely.
