Letter to Our Clients - October 2010
Dear Clients and Friends:
For the financial markets, 2010 so far has been a year of more bark than bite. Something no one expected is that mortgage rates are now lower than they were at the beginning of the year, making 15 and 30 year mortgages the cheapest in history. Otherwise, though, bond yields and values are relatively close to where they were at the end of December, 2009. Not much excitement for a strategic and patient investor.
The stock markets moved up steadily from January to April, and then dropped over 10% from their highs, with June’s performance the worst June results in several decades. Bearish investors outnumbered bullish investors almost 3 to 1 in early July. Many of you were reading in the papers that noted experts had consulted their charts and determined that the stock market averages would drop by 50% or more before the markets and the economy would recover. (I received a few phone calls from clients who read about the highly-regarded economist who predicted the stock market would drop by 90% before it would be safe to invest again!) And then... Then the market had its best July in decades. Bearish/bullish sentiment changed and “investors” were confident. Then August had another very large drop, again, one of the worst in decades. This caused these same “investors” to get bearish coming into what has traditionally been the worst investment month of the year – September. And then... September has had the best stock market performance since 1939, and at the end of all this drama, the markets were up slightly from the beginning of the year. All this noise, and so little change – on the surface.
However, there have been some developments that are dramatic and which might influence your investment decisions.
The first pertains to the corporations that make up the major stock markets. For the last several quarters they have been remarkably profitable. They have amassed record amounts of cash and their balance sheets are in outstanding shape – again, perhaps the best in history.
The second relates to interest rates. The “spread” between bond yields (interest rates) and stock dividends is an important technical indicator. As of October 12, 2010, the interest rate (yield) for a 10-year US Treasury Bond was 2.44%, as quoted on various internet sources. Using Google to search for the dividend yield of the Dow Jones Industrial Average (an unmanaged index which cannot be owned directly) shows a dividend yield of 2.79%. For some high-quality companies, the interest on their long-term bonds is less than their dividend yield. It is my understanding that this is a situation not seen since the early 1950’s.
A third is that many commentators believe an entire generation will never again have faith that the stock market can create investment profits, as happened with people who lived through the Depression. The influence of hedge funds and programmed trading to create rapid and dramatic fluctuation reinforces this distaste for equity investing.
This means that, by historical standards, stocks might offer the potential for significantly greater cash-flow and growth than bonds or cash. But, remember, these are observations – not predictions!
All this works in favor of prudent, disciplined investors. Why? Historically the stock market has rewarded those companies that are well-run and profitable. In my industry there is a lot of complaining that investing according to the fundamentals no longer works, mostly for the reasons I mentioned above about hedge funds and programmed trading. Very few institutional managers are concerned about exercising the patience and discipline required to create long-term value to their investors. Instead, there is undue focus on quarterly performance, since that is what drives their compensation. Follow the money!
If you review your account statements, you are likely to see that we had very little turnover, that is, selling and re-buying, on an annual basis. You will remember that we did not encourage you to bulk up on equities when the markets were rocketing upward, and we urged you not to sell when the markets were dropping. We have stressed the importance of three things: 1) creating an investment strategy designed to help you meet your objectives, 2) maintaining balance and diversification so that your risk and growth potential were not dependent on a few securities, and 3) helping you remain disciplined so that you could tolerate fluctuation and uncertainty along the way. For many clients, investment performance has been in-line with market averages. If you do not feel you fit this description, please call. If you are one who has been receiving market returns, you will be dramatically ahead of the average investor. Why? On-going studies consistently demonstrate that the average investor buys too late and sells at the wrong times, so that “investor returns” are significantly less, on average, than “investment returns.”
I believe everything I have written above indicates that this is a great time to be invested in the stock market – but only with the percentage ratios that permit you to remain comfortable when the news is bad. It is an even better time to be adding to equity-based securities, especially for people participating in 401(k) and 403(b) plans, or for those who can save and invest on their own.
HOWEVER, this opinion goes with the warning that it is uncertainty which creates opportunity, and there is no way to know if or when risk-based investing will be profitable. (Of course, lower-risk investing may avoid principal fluctuation but has many other kinds of risks!) I doubt we will see another long-term bull market like 1982 to 2000 for several more years. Instead, I think we will bounce up and down, 10% to 20% or more, over the next few years. There could be some higher highs than this, or some lower lows, but I think we are stuck in a trading range for a while longer. However, I also firmly believe two more things: 1) There will be another long-term bull market in our investment lifetime, and 2) we cannot predict when it will begin, how high it will go, and how long it will last.
The drivers for these beliefs are very long-term trends, which some writers call “secular” bull or bear markets. I had hoped to discuss these trends in this letter, but it will have to wait until next time.
For now, I hope you can enjoy the upcoming holiday season. We are honored and grateful for the opportunity to work with you. Please be sure to contact us whenever we can be of assistance.
Robert K. Haley, JD, CFP®, AIF®