I recently read John Mauldin’s Little Book of Bull’s Eye Investing: Finding Value, Generating Absolute Returns and Controlling Risks in Turbulent Markets.
Mauldin also writes a weekly e-newsletter that provides outstanding perspective on risk management, global markets and the economy. I read it regularly so I had an understanding of his positioning. The book does a nice job of clarifying realities of investing that don’t often get communicated to the general public.
Mauldin thinks we are in for several more years of lackluster stock market returns as the world deleverages from burdensome debt.
“Investing is about seeking value and controlling risk and working with the trends rather than against them,” Mauldin writes. As simple as it seems to find value, manage risk and ride trends during rising markets, it can be very difficult to do the same when markets behave like they have over the past 12 years.
Some of Mauldin’s key points:
Bear markets can be very long-lasting despite the regular appearance of bull market rallies within the longer-term downtrend.
- If you invested in the S&P 500 in 1966, it was 16 years before you saw a gain and 26 years before you had an inflation-adjusted gain
- It is clear that there have been long periods of history when the market did not grow at all, let alone the 10 percent per year reported by Ibbotson.
Markets overreact in both directions:
- In the 17 years from the end of 1964 to the end of 1981, the Dow gained exactly one-tenth of 1 percent. That’s 0.1 percent. In the bull market that followed, from 1982 to the peak of March of 2000, the Dow rose from 875 to 11,723—a spectacular gain of 1,239 percent, nearly a 13-fold increase.
- An overvalued market doesn’t just return to normal value; it keeps falling and goes far below normal.
There is not a strong correlation between a strong economy and exceptional stock returns.
- From 1964 through 1981, while the stock market was piling up its 0.1 percent gain, gross domestic product (GDP) actually grew 374 percent. During the bull market period from 1981 until the beginning of 2000, the economy grew only 197 percent, or about half of the earlier period. If you take out the effects of inflation, you find the economy grew exactly 76 percent in both periods
- The experience from 1964 to 1981 is bald proof that the stock market and the economy can go their separate ways for long periods. And that experience wasn’t an anomaly. The economy more than doubled in real terms from the end of 1930 through 1950. Yet in 1950, stock prices were roughly the same after 20 years.
Emotion and perceptions drive the stock market as much, or perhaps more so, than earnings of publicly traded companies.
- Citing research from Dreman and Lufkin: “investor perceptions are more important than the fundamentals (statistical measures of a stock’s value) … the cause of the major price reversals is psychological, or more specifically, investor overreaction.”
On finding mutual fund managers who can repeat market-beating performance:
- Some managers have what appears to be a very good track record, but when you look into their actual performance, it turns out to be based on a very few big-payoff trades. The rest of the portfolio simply moved with the market. If you invest with such a manager, you are hoping he can keep hitting more than his share of home runs. This is very hard to do year after year. (While Mauldin questions the ability of mutual fund managers to outperform consistently, he does not alternatively prefer index funds that simply buy the market. Reduced expenses are one thing but full exposure to a lot of unattractive investments is not worth the lower cost according to Mauldin.)
On gold
- I divide gold into two piles: “insurance” gold and “investment” gold. I feel strongly about insurance gold. I think everyone should have some. I continue to by physical gold every month. In February 2002, I turned bullish on gold as an investment, and I still am. I expect to remain so for some time. There is significant chance that the U.S. Congress will fail to get the federal government’s deficit under control. That would mean an even bigger rise in the price of gold.
On commodities
- Commodity funds add true diversification to your portfolio because their returns do no correlate with returns on stocks or returns on bonds. They are part of what I consider to be a core part of a diversified portfolio.
On the future
- I am not certain about much, but I am certain about this: the future will be different from what we think it will be today. The changes are coming at an ever-accelerating pace. We can plan and dream. But more than ever we need to think about Plans B and C and D. The odds are your personal world is going to change dramatically in the next 10 years. How you cope with the change will be the measure of how well you live. Change is like a train. Either it can run over you, or you can catch it to the future.
~ Gary Brooks – Brooks, Hughes & Jones, Partners in Wealth Management, Tacoma, WA
Forward to a friend
Sovereign Debt Crises Are Nothing New
Government debt problems in Greece and some of its European neighbors have generated a lot of news over the past several weeks. Viewed with the long lens of history, this problem could generate a sarcastic, “So what’s new?”
Greece has spent 50% of the time since 1800 in default on its debt.
This is one of many startling thoughts in This Time is Different – Eight Centuries of Financial Folly by Carmen Reinhart and Kenneth Rogoff.
I recently read this book. It highlights how, “throughout history, rich and poor countries alike have been lending, borrowing, crashing—and recovering—their way through an extraordinary range of financial crises.”
“This time is different” is a misnomer usually explained as “We’re smarter now. We learned from the past. We have better data.” It’s rarely true.
Here are some notes and quotes I thought were worth sharing:
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What is new this time is that an increasingly global economy means that trouble in one area can have greater impact on another.
Mohamed El-Erian, the Chief Investment Officer of PIMCO, the largest bond fund manager in the world expanded on this thought and compared the Greek situation to the subprime mortgage crisis in the U.S. that kicked off the global recession in 2007.
“At the beginning of ‘07, the general view was subprime was containable. It’s isolated. We heard those same words being applied to Greece. However, what we are learning is that we live in a very connected world and a major disruption somewhere in the world has to be taken seriously because of this connectivity.”
With the European Union and International Monetary Fund acting Monday with a package that pleased global investors, fear has been reduced. It doesn’t mean that problems are solved. Greece could still default on its debt and many nations—including the U.S.—have a lot of fiscal belt tightening to do as the world de-leverages from the great debt bubble.
Ultimately, though, we view these challenges like a series of potholes showing up in the road over the winter. They test the suspension of your car if you drive right into them but either they will get paved over or you’ll learn to drive around them.
For investors who have smartly diversified portfolios, damage will be reduced through exposure to holdings and markets that aren’t as sensitive to the solvency of companies or nations.
While each market correction creates risk aversion and a rush to “quality” investments (mostly perceived to be gold and U.S. Treasuries at the moment), we do not foresee a significant tactical adjustment to the personalized investment strategies we currently apply. If anything, the relative strengthening of the dollar leads us to tilt slightly in the favor of stocks of large U.S. companies that pay dividends.
~ Gary Brooks
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Posted in Commentary, Financial planning, Investments
Tagged debt, diversified portfolio, global economy, gold, greece, investments, markets, reinhart, rogoff, this time is different