This letter is in two parts – part one – Our General Principles, a slightly more expanded review of our investment and planning approach which I encourage you to read as all our actions and recommendations are based on this. Part two will review my current observations regarding the economy and investment climate.
PART ONE: GENERAL PRINCIPLES
It will be worth restating, even in the context of a letter primarily focused on the year just past, my overall principle of investment advice. It is goal-focused and planning-driven, as distinguished from an approach that is market-focused and current-events-driven. Long-term investment success comes from continuously acting on a plan. Investment failure proceeds from continually reacting to current events in the economy and the markets.
• You and I are long-term equity investors, working steadily toward the achievement of our most cherished lifetime goals. We make no attempt to forecast, much less time, the equity market; indeed we believe these to be fool’s errands. \
• Since we accept that the equity market cannot be consistently timed by us or anyone, we believe that the only way to be sure of capturing the full premium return of equities is to ride out their frequent but ultimately temporary declines.
• By my count, there have been 15 “bear markets” in equities since the end of World War II—an average of one every five years or so. The average depth of these declines was something on the order of 30%. But in September 1945 the forerunner of the US S&P 500-Stock Index was about 161; the Index ended this past year at 3230. Thus, at least historically, the permanent advance has triumphed over the temporary declines.
• My essential principles of goal-focused portfolio management remain unchanged. (a) The performance of a portfolio relative to a benchmark is largely irrelevant to long-term financial success. (b) The only benchmark we should care about is the one that indicates whether we are on track to accomplish our financial goals. (c) Risk should be measured as the probability that we won’t achieve our goals. (d) Investing should have the exclusive goal of minimizing that risk.
PART TWO: CURRENT OBSERVATIONS
• Global Stock Markets performed well in 2019 with most markets posting double digit returns. Bonds also provided above average returns. 2019 was one of the very few years where all investment sectors had positive returns.
-• Two thousand nineteen (2019) was, for the US economy, the mirror image of the previous year. Two thousand eighteen (2018) was a dramatically outstanding one for the US economy—and for corporate earnings and dividends—despite that, the equity market ended with a significant decline – a19.8% peak-to-trough decline through Christmas Eve. This past year (2019) was the exact opposite: an exceptionally good year for the US market—up 35.2% (S& P 500), plus a couple of more percentage points for dividends—even though the economy slowed somewhat, manufacturing went into decline, and the earnings of the S&P 500 almost certainly ended 2019 down slightly year-over-year.
• 2018 and 2019 demonstrate once again – the stock market and the economy tell us little of the other over the short term.
• Global economic growth has been muted for some time. While Germany has been Europe’s economic engine for decades, it is now on the verge of recession, having avoided one last year.
• China, the world’s second-largest economy, continues to grow at a health rate but expanding at the slowest pace since the early 1990’s.
• U.S. growth and profit projections are lower than last year and a potentially tumultuous year given the upcoming election.
• Many stock valuations in the US are stretched relative to history. At some point, earnings growth will be required to justify these levels. If earnings don’t increase, a correction (either dramatic or not) in these stock prices is likely.
• It is once again critical that portfolio’s remain in a diversified mix of quality investments – we simply cannot tell what the year will bring.
• It’s interesting to note how investors reacted to a relatively mild (7%) equity market decline experienced in the US in May of 2019.
• Simply stated, during this short one month decline of the S&P market index, net sales of U.S. equity mutual funds and ETFs—absolutely, and especially contrasted with bond fund inflows—soared to levels not seen since the Great Panic of 2008. I repeat: a one-month, 7% drawdown of equity indexes set off a sale of equities and a purchase of bonds similar to the great financial crisis of 2008-2009!
• Given how equity markets have recovered from the 2008-2009 financial crisis, it’s interesting to note that investors continue to be pessimistic and panic easily when it comes to day to day equity market prices.
• Considering what the world has experienced recently, and the markets response in spite of it, suggests to me that the patient long term investor will continue to be rewarded.
• This is not to be taken as any sort of market forecast. (As I’ve always said to you, I’m a planner, not a forecaster) It is simply an observation, as we look into the new year, of the constant fear present, even after a decade and more of positive returns. There will be plenty of time to begin worrying when the stock market once again becomes cocktail party conversation, and everyone around us is excitedly bullish. I will make note when that begins to happen.
• Over the coming year we will ensure portfolios’ are appropriately diversified and positioned for individual needs.
Thank you, most sincerely, for being my clients. It is an honor and a pleasure to serve you.