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WWBD?

Bear markets push our buttons. They shake our commitments, our conviction and our investment compass. They lead us emotionally to that dark place where we ask, is investing just a sucker's game? Let this update serve as a reaffirmation for why we invest in the stock or bond markets and how to do it the right way. What Would Buffett Do? 

 

Investment Realities

 

Most of the world stock indices including those in the US are now showing negative results over the last 24 months (two years). If you're feeling like you haven't made money in the last two years, it's probably the truth. Yes, there are lengthy periods of time without gains or even losses. When we go through these cycles, we are often reminded that we should invest for the long term. What does that really mean? We don't interpret that to mean 'stay with the same holdings or even fully invested through all markets'. That means stick with your discipline, your risk tolerance and your process for the long term, through all markets. If you're a buy and hold, passive investor, then you hold and hope in periods like these. If you're an active manager (us), you adjust as conditions warrant. Both have risks and pitfalls. In times like these we have that voice in the back of our minds saying, 'just sell everything.' Selling everything in a fit of emotional despair regularly proves to be an act of financial suicide, especially when it happens at the bottom. Furthermore, your portfolio will never recover sitting in cash and you will have the added difficult decision of when to get back in.

 

At the same time, the financial services industry does a great job convincing the masses that "the markets" generate a 7-8% return. Here's the reality check. That 7-8% number is valid only when looking at long, long, long term averages, typically longer than the investing careers of most participants. It includes runaway bull markets like the 90’s, which did generate 15-18% average gains for a decade. It also includes generational bear market cycles like we have seen twice in the last 15 years when average returns get very close to zero. Here's another reality check; there is no guarantee of success with investing. Your experience and success are purely a function of the many decisions you (we) make along the way rather than the false promise of gains just because the industry says it is so.

 

Add Money on Market Discounts (if possible)

 

If I could change one thing about the client investment experience, it would be this. I would create a system that only allows new investments into the markets at times when the market is attractive and selling at a discount. The markets are currently working their way toward that moment. In 22 years of managing money professionally, I've never seen it happen. Money always arrives at our door (consistent with net inflows to equities among the masses) within 12-18 months of every bull market peak. Investors of all kinds would do themselves an incredible favor if they could be more disciplined and patient in their decisions of when to add new money to investments. Forget the sell high bit, your success, as an investor is so much more dependent on buying low. We can handle the piece of buying securities for our clients at market lows, but we can't force or entice "new investment" at those same times. We try very hard to make it clear to our clients via our Calling All Cars emails alerting them when to add new money. This is the time to queue up your cash now that the market is finally developing some upside opportunity. I suspect, sometime in the first quarter of 2016, we'll be sending out another alert but it's too early to make that call.  Of course not everyone has the capacity to add money at their discretion, especially those in retirement. But doing so provides an incredible boost to your portfolio for the ride back up.

 

What Would Buffett Do?

 

Some people don’t like Buffett. That’s fine, but you have to respect his value based discipline especially in the face of terrifying conditions. He and his team at Berkshire Hathaway truly have ice in their veins, regularly buying stocks and entire companies aggressively while the masses are selling in fear. Buffett would be the first to tell you that investment returns come from smart buying. He waits, and waits and waits and waits until the thing he wants becomes attractive. Then he buys a huge position with 20 year goggles firmly in place. He is not perfect, no one is. Berkshire Hathaway (B) lost 12.06% last year. BRK/B is the 4th largest security in the US stock market by market cap so we're talking about some very real loss of capital and wealth destruction associated with that negative performance. But Berkshire investors remain steadfast and trust that Buffett is not thinking about changing his 50 year old strategy or selling companies just to stop the pain. No doubt, he's on the hunt, looking for deals, sitting with a pile of cash that he has patiently accumulated through much of the last couple years. Warren Buffett has his process for investing that remains rigid through all markets. That is his discipline. Ours is different to a degree in that we do work to cut exposure during bear markets and raise exposure during bull markets in an attempt to smooth our investor's returns. Our process remains rigid in all markets. As we have said many times, attractive long term results are the residue of excellent process. Like Berkshire Hathaway, sometimes those results are not so attractive in the short term. We remain unwavering in our commitment to our process.

 

The Magic is in the Mix

 

Every one of our profiles has a prescriptive allocation for our clients meaning some percentage recommendation to tactical equity, blended asset, and income strategies. Importantly, we structure each profile to have some exposure to our income models, which are our best performers over the last 12-18 months now. Even the youngest investor profile, our "Plant" investors, has a 10% recommended allocation to either of our Income strategies just for balance and diversification when stocks are falling as they are. On the other end of the spectrum our "Harvest" clients, those in retirement, have a recommended Income allocation of 40% of total portfolio values. Sticking with the right mix of diversified strategies is critical to your peace of mind during deep corrections or bear markets. After years of a rising stock market, it's very easy to let your portfolio slight toward a larger stock allocation without managing the mix as well as we should. Feel free to check in with us regarding your current mix of strategies and we can make quick adjustments if you're not in the prescribed allocations.

 

What Are Your Options?

 

As I said earlier, bear markets can shake our base conviction of why we invest in stocks, bonds and commodities. There must be better options out there right? Well a lot depends on your level of expertise and the landscape for alternative ways to build wealth. Real estate is a big one and perceptively THE alternative to traditional investment securities. But with only three regional markets pushing out to new price highs beyond those set in 2005, we have to respect the fact that timing also matters a great deal with real estate. Is real estate a good deal? That's a tough question and a complex answer. Arguably, I think there will be a better time to buy real estate following the standard 18 month cycle of rising interest rates but there are a lot of other variables that go into price. I do know two things; The first is that is real estate is an illiquid asset, meaning it cannot be sold quickly if necessary and transaction costs are prohibitive. A losing "investment" in real estate that can't be sold at your discretion carries a special kind of anxiety and financial stress. Second, we know that any form of hard asset like real estate can have some very high carrying costs (utilities, landscaping, window coverings, furniture, paint, plumbing, replacing dead appliances, etc). My investment in my home came with a notice a year later from my HOA notifying me a $10,000 assessment to replace old water pipes in the community. So far, the only notices I receive regarding our stock holdings are for dividend payments received!

 

We might also look at various forms of fixed income including CD's or buying individual bonds held to maturity as a "safe" investment. The well known problem here is that the current interest rates offered for such investments are so small that they aren't even covering the meager 2% inflation cost of living increase; most pay less than 2%/ yr. CDs and money markets pay virtually zero. For those interested in owning higher yielding income securities on a tactical basis, we have our two Income models, which are performing very well.

 

In a nutshell, the landscape outside of the financial markets is, and has been, pretty bleak for almost a decade. We are empathetic to this conundrum as we feel it ourselves, almost trapped into parking our money in the financial markets. As such, we do the best we can for our clients to make the experience tolerable while focusing on real wealth accumulation over time.

 

A discussion of your options wouldn't be complete if we didn't include the option to manage your own money without paying someone like us to do it. That is always an option. You might have the skills, time, energy, economic background, financial knowledge and real time experience to do it well and save 1-2%/ year in management fees. Personally, I know that we work hard to add value in managing assets with expertise and integrity for our clients. But we also provide financial planning advice, tax strategy and filing preparation, estate planning and keep your financial world orderly with our excellent service team often for the same low fee.

 

2008 All Over Again?

 

It's almost comic how many times I've heard this in the last 48 hours. Why do so many look at the 2008 bear market and assume we are just going to do it all over again now? Well first the media isn't helping with entertaining reminders like the HBO film "Too Big to Fail" followed by the big screen debut of "The Big Short". But mostly, it's all just human psychology. When we are afraid, we want to put our finger on the thing that makes us afraid. That's why traffic slows down to see a traffic accident. 2008 and events surrounding that 58% drop in stocks and the Great Recession are the modern day boogie men. As the most recent and close "accident", we turn our gaze to see it again and extrapolate that outcome to today.

 

We see very little in today's economic or financial landscape that resembles anything close to the conditions present in 2008. Margin debt is perhaps the only metric that is similar. Housing starts, non farm payrolls, industrial production, leading economic indicators, the shape of the yield curve, available supply of personal and corporate cash, household debt are all in very distinctly different positions and trends than they were in 2007. That was a credit and banking liquidity crisis with an associated real estate bubble. Where's the bubble today? Where's the liquidity crisis? Of course anything can happen, but we would say with strong conviction that if a bear market were to occur now, it would not be for the same reasons as our last bear market. Since 2014, we have spoken at length of the high likelihood of a "Garden variety" (15-20%) bear market that resets values, creates some real doubt and sets us up for the next bull market leg higher. So far, that's all we see.

 

We're empathetic to all investors including our clients. We know this is an emotionally tough time and one that requires a great deal of trust on your part. Any loss, even something small and recoverable isn't desirable. As managers, we get it as our personal money is right in their with yours feeling each day's gain and loss just the same. But, these are the very days that will define your success or failure looking forward. Be disciplined and strong now. Be objective in your decision-making and let fear come and go without reaction.

 

Very sincerely,

 

Sam Jones