Stocks fell sharply in the first six weeks of the year amid rising concerns about the global economy, the fallout from lower oil prices, and divergent central bank policy. But a rapid rebound in commodities prices, coupled with easy monetary policy and better-than-expected U.S. economic data spurred a month-long rebound, bringing major U.S. indexes back to where they started the year. Not unexpectedly, we were whipsawed and today, in better shape than when I wrote you in February.
Consider this travel-themed analogy:
Suppose your lifelong dream was to go overseas, but you were deathly afraid of experiencing turbulence on an airplane? So, you decided to forego any travel until a new plane was invented, one that could guarantee with absolute certainty that passengers would never feel turbulence. Your travel agent would say, “With that strategy; you will surely remain permanently grounded (and so will my business)!”
Yet, investors who view bear markets as something to be avoided at all costs are falling into exactly the same type of limited thinking. The best way to make it through market volatility is to actually “befriend the bear.”
A core concept of basic economics is that risk and expected return are related. The most common benchmark in the U.S. for a “riskless” investment is the one-month Treasury bill. Because stocks are considered riskier than one-month T-bills, the only reason a rational person would ever take on that extra risk is to receive higher returns than what they would earn in the riskless investment. However–and this is key–if the expected always occurred, there would be no risk. For example, if stocks always generated a higher return than T-bills, then stocks would be a sure thing. Thus, they would warrant the same lower long-run return as T-bills.
Let’s look at the year-by-year returns of the S&P 500 from 1926 through year-end 2015. During that 90-year period, the S&P 500 index generated an annual negative return 24 times. That means 27% of the years, or more than one in four, have been negative ones for the S&P 500 index. Looking at rolling, multi-year periods within that time frame, we find several in which the S&P 500 index generated very significant losses:
• January 1929 – December 1932: The S&P 500 index lost 64%.
• January 1973 – September 1974: The S&P 500 index lost 43%.
• April 2000 – September 2002: The S&P 500 index lost 44%.
It is the very existence of these kinds of losses that allow investors to expect significantly higher returns from stocks than from the one-month T-bill.
So, yes-if you want your portfolio to do well over the long run, you’ll likely have to experience some amount of turbulence. If you insist on a guaranteed smooth ride, you will never get off the ground. I’ve found the better way to protect yourself is to make sure you always listen to the flight attendant and have your seat belt buckled. By this, I’m referring to your long-term investment plan. A proper plan will already have incorporated the inevitability of financial turbulence and will have made provisions for how your day-to-day cash flow needs will continue to be met during such a period.
This is a period of excessive volatility. It creates tremendous opportunities to capitalize on inefficiencies in the marketplace. But, since change does not happen overnight, you need patience and liquidity to let it unfold. This is a market of stocks, not a stock market. Unfortunately, electronic/technical/systematic trading takes no prisoners and can override fundamentals over the short-term. Stop thinking as a trader and start thinking as an investor! GCM does not buy for next quarter’s earnings but focuses instead on the next few years’ revenue growth, competitive position, the mix of business, operating margins and returns, cash flow, especially free cash flow, and valuations. We want multiple ways to win on each investment while protecting our downside, too. We are global investors with a global perspective!
Also, remember that as an equity owner you are buying part of a business, not a stock price.
In the long run, fundamentals win and will be priced accordingly.
The bottom line is that I see value everywhere and no recession. The reality is that the outlook for global growth is not all that bleak although it may not reach historical rates of gain.
Volatility, confusion and fear create opportunity. We love it! There is more to say but that is enough for now. Look at the facts and take out all of the emotion before making any decisions. Invest, don’t trade.
Here’s to safe and turbulent-free investing (and travels),
Goldberg Capital Management is an investment adviser registered with the State of CT Department of Banking. This Newsletter and its contents are for informational and educational purposes only. You alone will need to evaluate the merits and risks associated with the use of the information provided herein. Although this Newsletter may provide information relating to approaches to investing or types of securities and other investments you might wish to buy or sell, no information provided in this Newsletter is intended or should be construed as an investment recommendation or endorsement from Goldberg Capital Management. Please remember that past performance is no guarantee of future results.