Todd Gray, Portfolio Manager
Wise men speak because they have something to say; Fools because they have to say something. ~ Plato
Well, it is that time of the year once again. No, I am not referring to Black Friday or holiday parties. I am referring to that time of the year when Wall Street strategists fill the airwaves with predictions concerning where the stock market will end up next year. Television and radio programs are filled with investment guru’s confidently making such predictions. Each year I eagerly await for that brave soul who, in front of a national audience, responds to the question of where the market will end the following year with these three simple words, “I don’t know.”
Why is it that these well-educated people are so eager each year to publicly share their market prophecies when they are so frequently proven to be wrong? Well, for some it is undoubtedly a matter of self-promotion and ego. However, for most of the investment profession it is a matter of not being able to say those three difficult words, “I don’t know”, especially when it is the client who is asking the question. As paid professionals we feel compelled to act as if we have some secret fore-sight that allows us to know where the market will move in the short run. While such predictions may make for an interesting topic of discussion over a morning cup of coffee, I question their value in making successful investment decisions. If you listen to, or read, enough of these predictions you will find convincing arguments put forth for the market going both up and down over the next year. There is always evidence that can be found to sup-port both cases. However, the stock market often enjoys being a contrarian and doing the opposite of what these so called “experts” believe will happen.
We believe it is important to keep in mind that bull markets begin and end with little warning and often when least expected.
Not only do I not know with any certainty where the stock market will end 2015, I actually don’t care and would urge you to not care either. Why? Because you should not be focusing on where the stock market will be trading in one year but where it will be trading five and ten years from now. Stocks should be purchased with long-term money, not with money that you are likely to need in the next year or two.
Successful investing is more a byproduct of time than timing.
Although I would be uncomfortable telling you whether the stock market will be up or down in 2015, I do feel comfortable telling you that I believe the market will be higher five years from now and would be highly confident predicting that the stock market will be higher ten years from today. This is not wishful thinking but a statement supported by history. Over consecutive five and ten year periods of time the stock market has produced positive results during the vast majority of these periods.
The portfolio managers here at the trust company manage portfolios based on the belief that while the stock market is one of the great vehicles for building wealth over the long-term, a bear market could begin tomorrow. So when and how do we prepare for down markets? We are constantly preparing for a downturn in the market starting with the moment we initially develop your portfolio. There are a number of strategies that can help reduce the impact of stock market declines. In the brief space this newsletter allows, I want to touch on three that I think have the biggest impact being:
- Investing in companies with substantial com-competitive advantages
Diversifying your stock portfolio amongst different companies representing a wide variety of industries significantly reduces the impact of declines affecting an entire sector of the economy or specific industry groups. For instance, in recent weeks the price of stocks within the Energy sector has fallen as the price of oil dropped dramatically. If energy related stocks represented a major portion of your portfolio then you would have suffered a significant decline in value. By also owning stocks within the Consumer sector of the economy that are benefitting from falling oil prices, the impact on your stock portfolio of declining oil stock prices would be substantially reduced.
“I try to buy stocks in businesses that are so wonderful that an idiot can run them because sooner or later, one will.” – Warren Buffett
Investing in companies with substantial competitive advantages, or what Warren Buffett refers to as wide “economic moats,” can significantly reduce the impact resulting from economic downturns. Stocks with substantial economic moat generally are less volatile than stocks with little or no-moat over the course of an economic cycle because their competitive advantages result in more predictable and consistent earnings growth, higher returns on investment capital and higher cash flows. When economic conditions are weakening, stock investors tend to move their money into wide moat companies because of their ability to make money through both good times and bad. Now this does not mean that such companies are immune from declines in their stock price but they typically decline in value substantially less and the possibility of these companies going out of business is far less than companies with little or no competitive advantages.
“In finance, everything that is agreeable is unsound and everything that is sound is disagreeable.” – Winston Churchill
“Rebalancing” is based on the old recipe for successful investing being “Buy Low and Sell High.” It is a principle that most investors readily accept but have difficulty put-ting into practice. It involves reducing exposure to stocks when they reach a level within your portfolio that exceeds your long-term target allocation, and increasing your expo-sure to stocks when they fall below the target allocation. Why is this so hard for investors to implement? Because it requires selling when the stock market is moving up and buying when stock prices are falling, which likely runs counter to what your instincts are telling you. Allowing your stock allocation to substantially exceed your long-term target will magnify your potential losses when the market inevitably falls. On the other hand, letting stock allocations fall well below your target allocation will result in diminished returns over time, threatening the achievement of your long-term financial goals.
In our last quarterly newsletter Jack Davidson wrote about the time tested business model of the Brooks Brothers with their focus on providing quality clothing at reasonable prices. Like Brooks Brothers, the portfolio man-agers of the Trust Company of Vermont seek to buy the stocks of companies with great business practices that we believe can stand the test of time. We want the stocks we buy to wear well and provide you with great value over time.
We wish all of you a New Year full of joy, good health and, hopefully, a rising stock market (disclaimer: this is not a prediction.)