The jury has returned and they have reached a verdict: Anyone who talked themselves out of this market made a big mistake. The Dow rose over 10% in 2012 and rose another 5% in January 2013. The key mistake people make is assuming there is a direct link between how well our government does and how well the stock market does. Our clients, who have followed our advice, avoided this common mistake and fully participated in the bull market. But some investors let the dysfunction in Washington cause them to miss out on the market’s rally.
It’s very easy to go from a successful long-term investor to an unsuccessful short-term speculator without realizing it. It starts by getting caught up in the negative media frenzy that surrounds election politics, Washington’s dysfunction, the budget deficit, the debt ceiling, the fiscal cliff, the U.S. dollar, the U.S. credit rating or whatever the fuel for the fear fire happens to be this month. It is easy to assume that since the issues are unresolved or worrisome, that somehow that must mean that stocks will go down. The fact is that it doesn’t necessarily mean that at all and it probably won’t mean that going forward either.
The reason is simple – the market is made up of resourceful, adaptive, profit-seeking businesses. We are not investing in congress, politics, elections, governments or what the political process can or can’t accomplish. We are investing in well-run companies that exist solely to earn and grow profits for their shareholders. They are going to strive to find ways to profit regardless of any concerns that you or I come up with. There could be violence in Egypt or an earthquake in Japan, yet these companies will continue striving to post record profits. And lately, that is exactly what they have been doing. This is not a market you want to try to outsmart or over think. We don’t need to ignore the potential negatives – we just need to resist the temptation to act on them when it comes to investing.
The score board does not lie. The market is up over 120% since the March 2009 low. During much of that span we read the news about how awful it was and how much worse and different the recession was this time. Yet the market, as measured by the 500 largest companies in America (S&P 500 index) just hit its highest level since October of 2007 and the Dow is approaching 14,000. After 4 years and $400 billion in outflows from stock funds into bond funds, stocks just received a record $14 billion of inflows during the first week of January. Investors may be late to the party, but hopefully they are determined not to miss it. The market is very close to posting 4 straight up years, the longest bull market since 2004. Successful long-term investing requires a long-term mindset, one that looks at the market in terms of years and full market cycles (typically 3-5 years), not months, weeks or days.
We believe this market still has legs. For one thing, stocks ultimately follow the direction of earnings (profits). U.S. companies are posting near-record profits right now and they have been doing so for several quarters, so it is not surprising that stocks are doing well. The fact is that U.S. companies are lean and mean, with more cash, less debt and higher profits than ever. And they are cheap, 40% cheaper than they were at the peak of the last bull market based on the price-to-sales ratio. Individuals and corporations have record amounts of cash sitting on the sidelines with no good place to go because interest rates are so low.
But it gets better. U.S. companies are taking market share worldwide in many industries. And because the U.S. also has some of the world’s cheapest and most abundant energy supplies, we are becoming a preferred manufacturing destination for companies all around the globe. The U.S. is in a better energy situation than most of the developed world right now. We are on the verge of becoming a major exporter of cheap natural gas (U.S. $3.55 BTU, other countries $12 -$16 BTU). This bodes well for many U.S. companies. Unemployment has been falling for the last 4 years and just hit a 5-year low, people are getting jobs and going back to work. Housing starts are at a 5–year high, home prices are rising faster than they have in 5 years, auto sales just posted a 12% gain year over year and hit their highest level in 5 years. The consumer is in better shape now than they have been in decades, household debt payments are at their lowest level in decades, since 1983 according to recently released federal reserve data. Inflation has been and should be a non-issue for the foreseeable future. Why? Because globally there is a glut of cheap labor and manufacturing capacity. The world is simply able to produce significantly more goods than we can possibly consume efficiently, therefore, prices stay low. The rate of saving is high which keeps demand for loans low, which in turn keeps interest rates low. Most of these conditions are not unique to the U.S. and are not likely to change significantly for several years. Deflation is more of a threat than inflation right now. The U.S. has many positives right now that you simply don’t read or hear about much in the midst of fear-based headlines and news stories.
As registered investment advisors, we are in the business of advising our clients on all aspects of investing. Obviously, a key to the process is how accurately we can evaluate and predict the future direction of the markets (stocks, bonds, real estate, commodities) and the trends for interest rates and the economy. These factors greatly influence how we choose to allocate our investments, so getting them correct is of paramount importance. No firm is ever right all the time, however, as long as we are correct on the long-term trends and market cycles (3-5 years) we can add significant value over time.
After studying our advice and predictions over the past 2 years in this newsletter, it is clear that we have been very correct. While the media and Washington D.C. would have had you panic selling several different times over the past 4 years, the correct course of action was to stay invested and profit, as we advised. We never took a bearish position. When I got into this business and started writing this newsletter in 1988, the Dow was around 2,000 – now it is pushing 14,000 – and I can tell you that there has been no shortage of disasters, fears, wars, bank failures and government bailouts over the years. Worry, fear and pessimism won’t ever subside. Markets have always had to climb the walls of worry, its just what markets do.
So, what if you are still not convinced and you just want to avoid stocks for the most part? We would suggest that instead of missing the boat entirely, consider our strategic income approach. It represents our most conservative approach as it focuses primarily on bonds. This strategy is normally 65% to 90% invested in bonds, and has had less than half the volatility of the stock market (S&P 500 index) over the last decade. While we don’t favor bonds in general, due to their lower, long-term total returns vs. stocks, they do serve a purpose for the risk-averse and those seeking a smoother ride. We do not recommend owning the types of bonds that most people own (long-term, U.S. investment-grade bonds) in the current, historically low interest rate environment, because they tend to get crushed once interest rates start to go up. We focus on high-yield bonds that trade primarily on the performance of the underlying companies rather than on interest rate movements. We also focus on international bonds and investment-grade bonds with shorter maturities as they too are less sensitive to U.S. interest rates going up. In addition, we mix in some reverse convertible bonds, preferred stocks, dividend stocks, real estate investment trusts, business development companies and master limited partnerships that generate steady income.
We welcome the opportunity to sit down with you and review your portfolio to insure that it fits with your unique circumstances. We offer comprehensive financial planning to help you determine where you are and where you need to be. Please do not hesitate to call us and schedule an appointment. Thank you for the trust and confidence that you have placed with us as we continue Building Wealth Wisely.
Carl W. Marker
Founder, Chairman and Chief Investment Officer