As an update to the newsletter content below, it should be noted that in 2009, US stocks declined over 20% during the first two months of the year, only to rally over 50% the remainder of the year and finish up approximately 26%. This 26% gain after the worst first two months in US stock market history represents over six times the average annual gains achieved by US stocks since 2000. Simply put, it is impossible – and potentially dangerous for your long-term financial health – to attempt to time short-term market movements. If you are thinking of taking action in your portfolio (other than adding to high quality dividend paying stocks) I would strongly encourage you to ask the following questions:
1) What specifically is it that I fear? (E.g. a slowdown in China? If so, why does a 6.9% Chinese GDP scare you?) A Fed Reserve move? A market decline tomorrow? If you think about it clearly, your ‘fear’ probably (or should) comes down to something like this: “Not having enough money when I need it.”
2) Is the fear based in fact? Is it true?
3) Can I possibly know it is true? (E.g. not having enough money when I retire, etc.).
4) How do I react when I have that thought? (Feel the need to do ‘something’).
5) Do I have a long-term history of accurately predicting and timing short-term market movements? Many investors, professional and otherwise, will state for years that they think a market correction is coming, then when one finally does they say, “I told you so” when in reality they got it wrong 99% of the time and right 1% of the time, not to mention you still need to ‘get it right’ when it comes to getting back into stocks. On that point, most investors get back in after stocks have gone up, not when they are down further and things look worse, therefore they end up being worse off than if they had just stayed the course for their long-term money.
6) Is the action I am considering taking for certain going to fix my fear? Or is it possible that it will actually make a false fear (one not based in facts) come true. Specifically, if I sell stocks while they are down materially and put my money into cash which has a guaranteed negative 2% - 3% real return per year, might this action actually cause the thing I fear to come true – the opposite of what I am trying to achieve?
7) What is my true time horizon for my investments, e.g. if I am retiring in 5 years, is my time horizon actually 5 years, or really 15–20+ years given that the money has to work for me long into retirement, not just upon retirement?
8) Based on the answers to these question, am I willing to reconsider the facts about long-term stock returns and markets’ historical recovery from declines (see below) before I take action?
As always, we are here to listen, answer questions, and provide objective input about your specific circumstances.
As a tribute to the late David Bowie who wrote many songs including “Five Years” that inspired me as a youth, I’m going to be a rebel and dedicate this newsletter to forecasting beyond the near term. I’m not trying to be a hero here, and despite the fact that I’m anything but an absolute beginner, I certainly don’t profess to be able to predict day to day changes like all the young dudes on Wall Street. With all that said, let’s dance.
The New Year brings its usual slew of market forecasts, but how useful are they? According to a recent NYT article, the average annual expected gain by analysts since 2000 was 9.5%, yet the actual gain was less than half that at around 4%. In 2001, the consensus was for a gain of 20.7% while the market actually dropped 13%. Off by over 30%. Whoops. What did the prognosticators as a group anticipate would happen to US stocks in 2008? A gain of 11.1%. Result? A loss of 38.5%. In fact, not once in the last 16 years have stock forecasters predicted a down year, yet that has occurred five times.
Predicting stock market returns is the opposite of forecasting the weather. I can tell you with a high degree of certainty that it will rain in a few hours, but predicting the weather for five days from now is very uncertain and five years from today? No idea. For stock returns, near-term outcomes are impossible to predict accurately. Anyone who tells you they can know with consistent certainty where the market will be in a day, a week, or even a year, is fooling himself (and you). Where will the DOW be 10 years from today? That is fairly predictable.
With that said, here are my ‘forecasts’ for the next 5+ years, a reasonable time frame for such predictions in the world of stock ownership, and even for someone in his early 70s let alone mid-40s, a time horizon to seriously consider for stock ownership.
· US Stocks will experience several corrections (10%+ drop peak to trough) and at least one bear market (20%+ decline). They will arrive at unexpected times, for unexpected reasons, and end fairly quickly. Patient and prudent investors will add to their holdings (via putting more money to work and/or reinvesting dividends) and many investors will sell, not based on rational thought or a long-term plan, but on near-term fear. Here are recent examples of the length of major market declines:
As you can see, for those who held their positions, it took a short four years to recover from one of the most brutal bear markets in history, and that assumes you were 100% invested in US stocks and didn’t reinvest dividends. If instead you were well-diversified with some bonds, commodities, international stocks and the like – and reinvested your income to buy more shares at lower prices - your time to recovery was even shorter. For someone approaching retirement it often seems like you need the money ‘soon’ but in reality you need it to last for decades. To be sure, you may withdraw a certain percentage each year, but often the income produced from dividend paying stocks and a well thought out bond portfolio can cover withdrawal needs while principal continues to grow long into retirement.
· Value/dividend paying stocks will outperform growth/non-dividend paying stocks. From 1928 to 2014, dividend paying stocks within the S&P 500 returned 10.4% annually on average versus around 8.5% for non-dividend payers. Dividend payers experienced these superior returns despite being less volatile with a standard deviation of 18.3% v 30.1% for non-dividend payers. For the last 10 years, however, non-dividend stocks outpaced dividend payers by over 1% per year. In 2015 growth stocks outperformed value stocks by nearly 9%. I believe the trend of value/dividend stocks out performance will re-emerge in the decade ahead, perhaps dramatically (a seemingly small 2% advantage compounded over 10 years is dramatic).
· Investors will have stop loss orders on high quality stocks. There will be a day when stocks drop significantly and the stop loss orders will be triggered. Within a short period of time those investors will regret that they sold at much lower prices. One of many examples, last August during a few hour market storm GE traded under $20 a share. Within about 60 trading days it was up over 50% to the low $30s. This is one of the largest companies in the world moving over 50% in a couple months. Emotional-based money will panic and sell during these times; rational-based money will hold or add.
· Many companies exposed to oil/commodities will go under. The strong ones will survive and thrive in the years to come. This is no different than during the tech crisis of 2000-2003 and the financial crisis of 2008–2011. Second and third-tier companies with weak financials and high leverage got crushed, while the strong made it through the storm to come out the other side even stronger. Companies like XOM and CVX - both of which are projected to maintain if not increase their dividends this year - have the financial and operational strength and flexibility to delay capital expenditures, reduce headcounts, and employ other means to withstand low oil prices. CVX has a 5%+ dividend yield and a debt-to-capital ratio of under 20%. XOM’s yield is nearly 4% (almost twice the 10 year treasury yield) and debt-to-capital ratio of 17%. Industries go through cycles, some more severe than others, but the strong tend to survive while the weak disappear. Companies like INTC, MSFT and other industry leaders saw their stocks decrease dramatically in the early part of the last decade. Their leading position within their respective sector and strong financials allowed them to not only survive the bursting tech bubble, but they continued to pay an ever increasing dividend while their business and stock price recovered. In the case of financial companies, the very best of bread like GS, JPM and WFC – while in part for financial but mostly for political reasons cut their dividends - recovered relatively quickly from the worst financial crisis in nearly 100 years and are now paying strong and growing dividends. I forecast that five years from now we will look back and see this is a the same kind of buying opportunity for strong energy companies as 2002 was for great tech companies and 2009 was for strong but temporarily down financial companies. What happens in the next five days, weeks or months is anyone’s guess.
· International stocks, in particular emerging markets, will outperform US stocks over the next 10 years. Dividend yields are higher for blue chip international stocks versus US Stocks, and P/E ratios are near historical lows for emerging markets which are trading at a deep discount to US stocks despite faster growing economies. The weakness in commodities and strength of the dollar have been huge headwinds for foreign stocks the last several years. At some point these trends will reverse and there will likely be big gains for stock prices of companies based outside the US. For the last several years being diversified into international stocks has been a drag on performance vis-a-vis US stocks; the opposite will be true in the years ahead.
· Those who allocate capital consistent with their investment time horizon (cash for near term, certain bonds for medium term, and stocks for long term) and stick to a disciplined, well-diversified investment program will do well over time. Those who panic and sell into market weakness when their cash needs are not for years to come will regret the decision years hence.