The Patient and Disciplined Investor…
Ruminations on long-term wealth building and retirement- income strategies
written by Todd M. Kirsch
Volume 8/Issue 1 January 2017
“Permanent loss in a well –diversified equity (or stock) portfolio is always a human achievement, of which the market itself is incapable.” – Nick Murray, author and speaker
The Year 2016 Provided a Tutorial on Investing
The year 2016 certainly brought surprises that rattled investment markets. But there are some valuable lessons to be gleaned that might help you going forward. Consider how we started 2016 a year ago. The S&P 500 closed at 2044 on December 31st, 2015. It closed on February 11th, 2016 at 1829 – a 10.5% drop. Headlines from early last year seem rather amusing now. CNN Money’s headlines included: “The crash in oil prices continues to ruin your portfolio.” Ruin? Business insider: “Chaos on Wall Street: Here’s what you need to know” Chaos? “Recession watch, 2016” Recession watch? “Investors are nervous” Nervous? It was a buying opportunity. Bloomberg was still running hyperbolic headlines into May: “Bank of America Strategist Warns of Imminent ‘Vortex of Negative Headlines’ to Send U.S. Stocks Plummeting.” So was CNBC: “This bank thinks the S&P could fall 15% this summer.” Do these people actually get paid to write these things?
Whenever stock prices drop like this, the media trots out the usual suspects who make a living peddling fear. There is wringing of hands and gnashing of teeth. Bad news sells, and some market “experts” have figured out that they can make more money selling fear than reminding readers that the capitalist system, though imperfect, has historically been, and continues to be, a juggernaut of wealth creation.
But 2016 wasn’t finished – another buying opportunity arrived in late June. The Brexit vote caused the S&P 500 to drop 5.3%. Then the overnight futures the evening of the election were also off about 6% when it started to become clear that Donald Trump would be elected president.
So what have we learned? Well, it’s essential to realize that basing your investment decisions on headlines is a mistake. And I don’t think I would take politics into consideration, either. Headlines and political issues tend to be fugacious – i.e., sensational and here today, gone tomorrow. Principles, on the other hand, tend to endure. Speculators (i.e.. gamblers) might be basing decisions on headlines. But you, my dear reader, are an investor. As such, you should be basing your investment decisions on a financial plan whereby you (and your spouse) have set a variety of very important personal and family goals, most of which are long-term.
With these thoughts in mind – and 2016 presenting an obvious learning example – we turn our thoughts as to some general principles:
Principle #1 – Most clients are working on a financial plan that covers multiple decades, if not multiple generations. For this reason, investment decisions are based on client goals – and what gives them the best chance of reaching those goals….not on the transitory, hyperbolic media headlines of today.
Principle #2 – I do not and cannot forecast the economy – much less what stock prices will do if and when people get emotional around buying or selling stocks. I don’t believe anyone can consistently predict these things. My greatest value to clients is to be the calm, steady voice that tells you everything will be okay in the midst of uncertainty. Clients hire me to help them separate their emotions from their investment decisions. Consider this: the GDP of the U.S. contracted 4.1% in the 2007-2009 so-called Great Recession – yet the S&P 500 plunged a whopping 57% from October 2007 to March 2009. Yes, you read that correctly – 4.1% vs. 57%! Think of the regret you would have if you had sold out in March of 2009 when the S&P bottomed around 670. I have personally heard some of these stories, and it’s near impossible to recover from those mistakes. In a nutshell, I am a planner, not a fortune teller. You will want me on your side – and in your ear – when the spaghetti hits the fan the next time.
Principle #3 – My approach to portfolio management consists of essentially three objectives (1) what type of investment portfolio gives you the best chance of reaching your goals, (2) benchmarks, such as the S&P 500, are mostly irrelevant – the only benchmark we should be measuring is your progress towards your financial goals (one can “beat” the S&P 500 over a given time period and still run out of money in retirement), and (3) volatility of stock prices isn’t risk (the media tells you otherwise) – risk is that you, based on fear or panic, will sell part – or heaven forbid – all of your portfolio at exactly the wrong time thereby permanently impairing your capital and your ability to reach your financial goals.
Principle #4 – Once we have painstakingly developed a comprehensive financial plan for clients, I rarely suggest that we make changes to the investment portfolio unless client goals have changed. The media is constantly urging, nudging even begging you to “do something!” My rather unscientific sense – though verified in various ways by a number of scholarly sources – is that investment performance is negatively correlated to activity within the portfolio. In other words, the more you “tinker” with your investments, the worse it generally does. Or think of investments as soap – the more you handle them, the smaller they get. There have been plenty of studies suggesting that women are better investors than men because of this. Sorry fellas, tinkering is in our DNA, but it doesn’t help us as investors.
Principle #5 – Going back to 1980, the average intra-year decline in the S&P 500 is 14.1% – that’s average! This means that, at some point during the year, stock prices – on average – have dropped 14.2% from a previous high. Many years – like 2008 – it’s been much more. Yet, the S&P 500 ended positive 27 of those 36 years. The S&P 500 has gone from 106 in 1980 to about 2250 as of the date of this writing – and that doesn’t include dividends. The lesson is simply this: leave….your…. portfolio…..alone. Let it do the heavy-lifting and go live your life without pretending that you’re smarter than the market. I like the quote from Warren Buffet: “Our favorite holding period [for stocks] is forever.” That might be overstating it a bit, but you get the point. Finally, consider that stock prices since 1926 have, on average, hit a new high a mere 3.3 years after a bear market begins. I have no way of predicting that the future 37 years will be as good as the last 37, but I certainly favor the idea of placing stocks in portfolios for long-term goals – and then let the money managers and stocks do their job.
Principle #6 – We can never, ever, EVER be certain of a rate of return by owning stocks (or bonds). The only thing asked of us is to be rational in a relentlessly uncertain world. The world can be an ugly place. You might have noticed the name of this newsletter – the Patient and Disciplined Investor. I could have named it the “Irrational, Reactive, Time-the-Market, Cutting-Edge, Psychotic Investor” – but that doesn’t fit my practice. Patience, discipline – and faith in capital markets is, by definition, RATIONAL. And it is based on the last 225 years of market returns since a collection of 24 men began trading stocks under a buttonwood tree in New York City that eventually became the New York Stock Exchange. Acting rationally under generally uncertain and sometimes completely irrational conditions is the hallmark of truly successful investors. We’re not here for a quick kill – or the right to brag to your neighbors at the block party how you got out of the way of the 2007-09 crash (only to, uh-um, still be in cash). We are investing to reach real life, tangible, family-oriented goals that we can look back on and say: We did it! It was tough to maintain the faith during those difficult times, but look at what we have now – and what our kids, our grandchildren, and perhaps a charity have as a result of our hard work, prudence, and rational approach to investing.
Rationality will continue to be the building block that I will base my practice on going forward.
Observations for 2017
“Looking ahead to 2017, with U.S. markets appearing to be reasonably undervalued (in our view from an accelerating earnings, free cash flow and dividend perspective-three of the most important measures) on most fronts.” – David Schaffer, Managing Director, Institutional Equity Sales, Raymond James (12-29-30)
Observation #1 – As mentioned above, investment markets put on a tutorial for investors last year. After the initial 10.5% drop, we ended 2016 around 2,250 – that’s about a 23% increase from mid-February and about a 10% gain on the year. Throw in about a 2% gain due to dividends, and those numbers increase to 25% and 12%. Not bad for such an allegedly slow-growth economy. The lesson is don’t invest based on politics, headlines, or – as much as I would like to – the Chicago Cubs. Though, wait just a second, the Cubs won the World Series on November 2nd when the S&P closed at 2097 – and markets have really done well since the Cubbies won the World Series, so doesn’t that mean that…..nope, don’t go there. There is no correlation between the two, but heaven knows – somewhere, somehow, someone is making a case for such an “investment strategy”.
Observation #2 – Participants in the trading of common stocks – aka “the market” – don’t like uncertainty. Bad news – which can be digested and accounted for – is better than uncertainty. The uncertainty surrounding the presidential election is over and voila, stock prices increased. My sense is that stocks would have also bounced up had Hillary won the election – though perhaps the bounce would have looked different. There will always be uncertainty, but don’t let “bad news” dictate your investment decisions. It could be good news for stock prices.
Observation #3 – It is almost comical how the financial media is constantly classifying the market as “overvalued”. But then again, if it wasn’t overvalued, then it wouldn’t be at imminent risk of “crashing” – and well, not as much nonsense journalism could be vomited out to the public. A common approach to measuring the value of stocks is to compare the prices of stocks to the earnings for that company – otherwise known as the Price/Earnings (P/E) multiple. But remember that there is a past P/E and a future or anticipated P/E. Based on past (12 months) earnings, I agree that an argument could be made that perhaps stock prices are a bit high, at least historically. But included in the last 12 months are some very poor earnings from a now relevant and significant energy sector. If we look to future, anticipated earnings, stock prices are quite consistent with historical averages. This is especially true considering that the 10-year U.S. Treasury bond is only yielding about 2.45%…not exactly stout competition for stocks.
Observation #4 – It’s possible that we are only at the beginning to mid-stage of an epic bull market run. That might sound naïve and trite to a pessimist – and I understand that. But when you carefully consider how bull markets in stocks have ended historically, you might reconsider. Bull markets generally end when there is a general feeling of euphoria around stock prices. People lose sight of investment risk, and unsophisticated investors are lured into the market thinking they can make easy profits. Demand overwhelms supply – it’s good until it isn’t and then bam! – the market begs for – and sometimes gets in brutal fashion – a correction that knocks some “sense” back into the market. Stocks are then returned to their rightful owners – the long-term accumulators of ownership in America’s companies. The media shrieks about the end of the world and how much money “investors” lost, and well, the process starts over. Consider the euphoria before the housing bust in 2007 – consider the dot.com bust in 2000 – and consider the Granddaddy of them all – the bust of 1929 that didn’t end until 1932 (for an outstanding review of the euphoria during the 1920s, pick up Rainbow’s End, the Crash of 1929 by Maury Klein.)
History certainly does not have to repeat itself – and this bull market, since March of 2009, could certainly end in different fashion. There could be a significant terrorist act or some other major act of aggression by another nation that changes things quickly. But I sure don’t sense any euphoria going on in investment markets. Company earnings are beginning to accelerate on a sound base of financial stability within corporate America. We might be transitioning from an interest-rate driven bull market to an earnings-driven bull market. It could be good for some time, yet.
Observations #5 – The U.S. still has the world’s most vibrant, resilient, innovative economy in the world. Stock returns in other parts of the world for 2016 were not near as good as the U.S. Once again, it appears that the U.S. is going to have to lead the way out of a relatively sluggish world economy going forward.
Observation #6 – All things being equal, rising interest rates cause bond prices to fall. With rates most likely on the rise going forward, a reasonable investor might reevaluate how much money to commit to bonds – which have, for over 35 years, been considered a relatively “safe” asset class. This could be good for stocks – or at least be an underpinning of strength for stock prices. Another source of strength could be a lower tax rate on U.S. corporations and tax-relief for funds held overseas by U.S. corporations.
Observation #7 – Let’s hope our newly elected leaders do not engage in tariff legislation that causes other nations to retaliate with substantial tariffs on our products. Trade wars don’t end well – consider the 1930s.
Bottom Line: There are many reasons to be hopeful for 2017 and beyond. Don’t sell your investments based on politics, headlines, or rising interest rates, – and certainly don’t sell on the “news”. Stay invested, my friends.
We transitioned to Raymond James over 3 years ago – but it seems like yesterday. We would not be enjoying our success without the hard, diligent work of the ladies in my office. I am very appreciative of their efforts. Let’s hear it for Kelly, who has been here nearly 11 years, Crystal 3.5 years, and Jericha 5 years. Thank you, ladies! We make a great team, and I am very thankful for your efforts.
On a Personal Note…
My son Ryan is now a junior at CSU studying civil engineering. I’m glad someone in the family understands those topics – too hard for me! My two daughters, Zoe and Julia, are 16 and 14 and are both attending Mountain Vista High School. Zoe has become an extremely skilled violin player (I’ve always liked those string musicians!), and Julia is playing volleyball for both the high school and club. They all make Papa Bear very proud. 🙂
For those of you who have trusted me with your money, thank you – I am deeply moved and grateful for the confidence you have shown in me and Raymond James. While money is important, it doesn’t mean much without our health and relationships. I have gotten to know many of you and your family members over the years, and that is one of the greatest joys of my work. I probably have the best “job” in the world! Happy New Year for 2017, and as the French say, “à votre santé!” – to your health!
Todd M. Kirsch, CFP®, JD, CHFC®, CLU®
Kirsch Wealth Advisors, an independent firm
8191 Southpark Lane, Suite 110
Littleton, CO 80120
Securities offered through Raymond James Financial Services, Inc.
Member FINRA & SIPC
Todd has been serving clients since 1993. Prior to that time, he attended Boston University School of Law and obtained his law degree in 1989. He practiced law with a large international law firm in the areas of taxation, securities, and corporations. He graduated from Kansas State University in 1986. He obtained the prestigious Certified Financial Planner® (CFP®) designation in 2002 and also holds the well-respected Chartered Life Underwriter and Chartered Financial Consultant designations from the American College.
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Inclusion of these indexes is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Past performance does not guarantee future results.
The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material and does not constitute a recommendation. Any opinions are those of Todd M. Kirsch and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice. Investing involves risk. You can lose your principal. There is no assurance any strategy will be successful. Please consult your financial advisor before implementing any investment strategy. Past performance is not a guarantee of future results.
 And these are not insignificant events. Consider that the U.S. has a total stock market capitalization of about $25 trillion. And we’re only talking about the U.S. here. That’s a loss of $125 billion – with a B – that was lost in the emotional knee-jerk reaction to headlines.
 I am also the calm, steady voice that will tell you to be careful when the “next, big thing” captures the imagination of the investing public. We haven’t seen this in some time, but most of you remember the dot-com craze of the late 90’s. Many investors lost sight of their goals paid the price in the recession of 2000-02.
 Please keep in mind that the money managers we hire are making many of these decisions as to when to buy/hold/sell various securities – and in what percentages.
 The study measured returns after inflation and dividends – which is the correct way to conduct the study. Ned Davis Research, Robert Shiller; Eugene Fama & Kenneth French; Hulbert Financial Digest; The Wall Street Journal, March 7, 2014, Mark Hulbert, Don’t Fear the Bear.
 To be sure, international markets are not doing near as well, but market leadership has a funny way of rotating around.