September 15, 2017

There are great quotations about many areas of human affairs, and the field of investing is no exception. Let’s take a look at a few of them and see how they might apply to today’s investing environment.

“Markets do not go up and down on good or bad, they go up and down on better or worse.” 
— Richard Bernstein, longtime Wall Street strategist

We have been asked quite a bit about the 15% rise in the U.S. stock market since November’s election and its implication on future market returns. We are not attempting to make any political or value judgments here, so please bear with us. The late Professor Allan Meltzer once observed that U.S. economic policy has generally alternated between periods of growth and periods of redistribution. The U.S. Gross Domestic Product has averaged a real, or after-inflation, annual rate of growth of 3% since 1950, but has exceeded that average level only twice in any calendar year after 2000, in 2004 and 2005. This post-2000 period encompasses each of the last two Presidential administrations with both political parties occupying the White House for two consecutive terms.

So we have been a little short in growth of late—16 years is a long time for the world’s largest economy to experience subpar growth. The recent upturn implies that investors are expecting an improvement, where the positives of the proposed policy mix of  tax reform and decreased regulation outweigh the negative potential of trade becoming less free. International economies and stock markets, which have experienced even less growth and lower stock market returns than the United States in recent years (except for having risen more than the S&P 500 Index this year from their depressed levels), will hypothetically be forced to compete with a more growth-oriented United States.

“Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.”
— John Templeton, founder and former manager, Templeton Growth Fund

So where does that put us today? For the stock market, it is hard to say that there is general pessimism with valuation metrics residing at above-average levels. It is also hard to claim that the sentiment around the current stock market is euphoric as professional investors seem just as baffled by the upturn as the average CNBC viewer. It seems that the market as a whole is residing in its typical area, somewhere between skepticism and optimism. It is important to remember that it is a “market of stocks, and not a stock market.” Many economically cyclical companies have risen quite nicely of late and will require a stronger economy going forward to justify today’s prices in the short-term, while more “defensive” stocks have not returned as much this year, but could perform better if the economic growth is not as strong as the market projects.

"It seems that the market as a whole is residing in its typical area, somewhere between skepticism and optimism."

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
— Peter Lynch, former manager, Fidelity Magellan Fund

We are often asked if we think a stock market correction is imminent. So let’s be honest and say three of the most underused words on Wall Street—we don’t know! We can say with absolute certainty that one will occur, but we frankly have no idea when or from what stock market level. Here is what we do know—stock markets have risen over 8% per year from 1805 through the present, and 9.5% from 1925 through today. Since 1925, we have experienced a depression, a World War, the Korean and Vietnam Wars, the stagflation of the late 70s and early 80s, the Crash of 1987, the internet boom and bust, and the financial crisis of 2008-9. Yet the stock market provided handsome returns that were triple the rate of inflation. This is why Warren Buffett says that the U.S. stock market is the most rigged game in town for the equity investor. Going back even further, whatever one thinks about today’s volatile political climate, we can probably agree that Abraham Lincoln faced an even more difficult environment.

All this talk about corrections implies that all investors should react in the same manner should one occur; nothing can be further from the truth. Investors are not all alike. Each one has a different ability and willingness to take risk along with different investment time frames and tax situations. To imply that all should be treated the same would ensure a suboptimal result for everyone.

“Time is the friend of the wonderful company, the enemy of the mediocre.”
— Warren Buffett, Chairman, Berkshire Hathaway

The ideal stock to purchase is one that is able to compound its earnings over a long period of time at a high rate. The investor can hold the company’s stock for long periods of time as those earnings compound and the stock’s value appreciates without selling the stock and paying capital gains taxes. A mediocre company that cannot reliably compound earnings must be both bought and sold judiciously with capital gains and the associated taxes being realized on every profitable trade, thus lowering the investor’s after-tax return.

"The ideal stock to purchase is one that is able to compound its earnings over a long period of time at a high rate."

“It’s waiting that helps you as an investor, and a lot of people can’t stand to wait.”
—Charlie Munger, Vice-Chairman, Berkshire Hathaway

Without patience, one cannot reap the benefits of the wonderful long-term investment, and long-term returns are hampered. Studies of large numbers of brokerage statements have shown that less frequent trading actually helps returns. The same studies show that women trade less frequently than men and earn higher returns. 

“The world is messed up and it always will be—now go figure out how to make some money.”
— Philip V. Swan, Founder, Philip V. Swan Associates

Mr. Swan, who founded one of the firms that became Clifford Swan Investment Counselors, accumulated a lot of wisdom in his 60-year career and was always willing to share it in a most enjoyable manner with his colleagues and clients. This quote is a personal favorite of this author because of how quickly it resonates with almost everyone who hears it. Let’s face it—there are always some dangerous actors on the geopolitical scene, as well as many potential negatives looming in the economy and in specific companies that might prove troublesome to one’s portfolio. A portfolio manager’s job is to make the best decisions they can under ambiguous circumstances, and separating actionable news from inessential noise is a large part of that.

 "A portfolio manager’s job is to make the best decisions they can under ambiguous circumstances, and separating actionable news from inessential noise is a large part of that."

The author had the pleasure of hearing longtime investment consultant and author Charley Ellis speak some years ago. Mr. Ellis mentioned that he had recently gone to see someone run a marathon. As he stood at the finish line, he saw the winner of the marathon raise his arms in exultation—but so did the majority of other finishers, who were just as excited to complete the race as the winner was to have won. Then it hit him—they had all won “their race,” and that was what was important to them! He then equated that to the investment industry by saying that it is possible, with proper discipline and coaching, for everyone to win his or her individual race and accomplish what is important. 

And that is what is important to us at Clifford Swan! Working with our clients and helping you with your own investment marathon is extremely rewarding for all of us, and we appreciate the opportunity to be of service to you.

Download Article: Words from the Wise and Today's Stock Market

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