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Welcome to Low Rates, High Returns.

Welcome to Low Rates, High Returns

“Rule #1: Don’t lose money.

Rule #2: See rule #1”.

———

Warren Buffett, Berkshire Hathaway.

Net worth: A$125 billion.

This is the first post on our new blog; stay tuned for many more.

Please note the information on this blog and in the book is general in nature, and it can’t take into account your personal situation.

Always seek professional financial advice before making financial or investment decisions.

Our new book is due to be released in 2020, and it explains clearly & succinctly the benefits of managing your own money…and exactly how it can be done safely more profitably than you think.

These benefits are what we know as the ‘3 Cs’ of investing yourself:

Cost, choice, and control.

Thanks to the wonders of the internet it’s now quite well known that it’s possible to get average results, simply by doing what everyone else is doing.

But what if you don’t want to be an average person with average results?

What if you want to consistently generate wealth-creating rates of return without the ever-present spectre of significant loss?

To do better than average, by definition you need to think differently from the herd.

For about the past decade, it’s been relatively plain sailing for investors.

Markets recovered from the last crash and went into a secular bull market where real returns have been consistently strong for more than 10 years.

But the price you pay for an investment matters – as Buffett said, what is smart at one price is stupid at other.

Markets move in cycles, so you need to be aware of how to invest accordingly…and safely.

In 2019 we’re now into the rampant speculation phase of the cycle, with the general public piling into the market at its peak, and it will likely end the same way that it always does.

Which is to say, not well, and probably in tears.

It’s a big world out there, but sometimes an irrational ‘home bias’ limits investors from seeking out stronger (& often safer) returns in international markets.

Why limit yourself?

The good news, as we always say, is:

‘It’s not that hard, honestly!’

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We look forward to sharing your journey to abundant money management.

Short of time? Jump straight to our 8 timeless investment principles here.

Read about how to maximise your long-term wealth guided by the Kelly Criterion here.

You can download a FREE CHAPTER of the new book here (or by clicking on the image below):

FREE Chapter download.,

Please note the information on this blog and in the book is general in nature, and it can’t take into account your personal situation.

Always seek professional financial advice before making financial or investment decisions.

To see more about our coaching programs see here.

How to be patient, grasshopper

(with Stephen Moriarty)

Periodic bursts of excitement

It’s been terrific to be able to watch a bit of Test Match cricket on television again over the past week or two, albeit with no assembled crowds to cheer the matches on.

It’s always fascinating when our American friends from over the drink come across cricket for the first time.

The brilliant US writer Bill Bryson once wryly observed how while there might be the occasional burst of activity and excitement, for most of the time very little appeared to be actually happening.

For us cricketing tragics, part of the beauty of the elongated Test Match series is that you can dip in and out of it over the summer, sometimes in a detached manner, yet other times gripped to the action.

While some periods of the game can seemingly require an awful lot of spectator patience, the good parts become all the more rewarding for it.  

Punctuated equilibrium

Investing can be a little like punctuated equilibrium, a theory which states that evolution occurs primarily through ‘short bursts of intense speciation’ followed by lengthy periods of stasis, or equilibrium.

In the markets, as they say, there are days when months happen, and months when days happen.

It can be difficult to maintain a constant rhythm when the drumbeat is ever changing.

Sometimes nothing seems to happen for long periods of time.

But this ‘nothingness’ is not useless (as was commonly believed in early evolutionary theory) but provides important information.

And that information is that we know low volatility begets high volatility, and stability creates instability.

The market is our servant not our master, so we need to ensure that we remain vigilant…yet at the same time detached.

Busy doing other stuff

How do you do nothing when there’s nothing to be done?

The simple answer is that you do nothing by doing something else!

Let us explain.

Whether we are doing ‘nothing’ or not depends upon what we believe to be important in our lives.

Sometimes people work for years in a job and think that they’re ‘doing nothing, going nowhere’.

This is obviously not the case, as they still turn up to work every day, but it may feel like it is nothing because it’s not important or valuable to them.

The desired end game is that as you become a systematic investor you may approach the Zen state.

That is, you simply implement our 8 timeless principles in a perpetual manner, without fuss or undue concern.

The outcome is that our desire to make money is somehow reduced (if that is the right word) and the process of evolution takes over.

When you get to this point in your investing journey, there’s comparatively little emotional attachment to it.

Why?

Because you will have experience, and some faith, that the world cycles.

The cycles are somewhat unpredictable – like punctuated equilibrium – but you know that they will come around again.

Patience and process

Sometimes you just have to be patient.

Remember, the market determines the returns on offer.

It’s a metaphor for how much of our life we can control.

We have seemingly gotten used to the idea of control, self-determination, and personal empowerment.

Yet you can clearly see through randomness of the past year how little control of the environment we often actually have. 

You can order a copy of our new book here.

To download a FREE chapter from the book, see here.

CAPE crusaders: what’s too hot…and what’s not?

(With Stephen Moriarty)

CAPE ratio & expected returns

We’ve spoken at some length previously about the CAPE ratio, what it measures, and why it’s important.

As noted, the US CAPE ratio is presently high in historic terms, levitating at around 30, despite the troubling outlook for the US economy.

This points to only modest expected returns for the decade ahead, even before accounting for the downside risk for earnings, and inflation.

Such a historically high CAPE ratio has always ultimately been followed by a sharp decline in stock valuations too.

We spend so much time considering the US because it is the largest and most influential equities market in global terms.

And, as we have shown, given the interconnected nature of markets these days, if the US comes down then it will most likely bring other markets around the world down with it.

US exuberance

The US market has been more expensive than has been the case lately, as measured by CAPE, but only during the dotcom boom of the late 1990s through to 2000.

The market then crashed, which tells you much of what you need to know.

There may not be much sustainable upside from here, but potentially there’s a good deal of downside.

The so-termed ‘FANGMAN’ stocks have topped a valuation of US$7.1 trillion this week, an outlandish increase of nearly two-thirds since March, in spite of the obvious economic malaise.

US$7 trillion is apparently roughly equal to the combined GDP of Germany, Italy, and Indonesia, for whatever that’s worth!

Amazon, Google, Walmart and many of the highest-profile tech stocks ballooned to record highs this week.

Yet more than a fifth of America’s small businesses have been forced into closure this year due to the Coronavirus and recession.

Around the traps

Not every market around the world is nearly so expensive as the US, of course.

Britain has faced plenty of well-documented challenges across the past decade, and of the developed markets the UK’s FTSE index is reasonably attractively priced, with a CAPE ratio running at around 15.

Australia appears to be neither particularly cheap nor expensive at today’s levels.

A fair number of the emerging markets countries have been battered in recent times, and as such are cheaper still by comparison.

A flavour of emerging markets ‘value’ is represented by Turkey in our colour-coded chart below, but you might just as easily look variously at Russia or Korea, Spain or Poland, Chile or Pakistan, all of which have become cheap.

Emerging markets can be more volatile, of course, but this is a risk that can be managed using sensible asset allocation.

Alternatively, these days you can easily find ETFs or other ways to effectively cover a basket of emerging markets stocks.

Of the sectors, Energy was demonstrating reasonably attractive value this year, while some other sectors such as IT look to be very expensive.

Overall, there are still plenty of places you can find ‘value’ at the moment.

But our view is still that we need to be careful overall, given the heightened risk of a US correction.

You can order a copy of our new book here.

To download a FREE chapter from the book, see here.

Narratives versus numbers (echoes of the Nifty Fifty)

Statistics over stories – with Stephen Moriarty

We all love stories.

Words that describe emotions can teleport us into the world depicted in the tale, and this can lead to a form of ‘neural coupling’ with the storyteller.

Investors are also naturally drawn to narratives or stories:

The current frothy environment appears to have a particular accord with the dotcom boom/bubble of the late 1990s.

The patterns repeat.

Even before the internet craze there was the famous ‘Nifty Fifty’:

The problem with piling into what’s popular is that even the greatest companies in history can turn out to be rotten investments if you pay too much for them:

The ‘Nifty Five

Recently the so-called ‘FAANG’ stocks have soared and together are valued at around US$6 trillion:

Here’s another look at the recent explosive performance of these ‘Nifty Five’:

In May the US employment-to-population collapsed to the lowest level since 1948, with more than 47% of the population not working.

Overall stock market earnings have been battered even more than we feared they might at the beginning of the year, and with new COVID-19 cases in the US hitting fresh daily highs a full recovery is likely to be years away.

Current narratives

The current narrative is that earnings don’t matter too much for stock markets due to low interest rates and the size of the policy response.

In an echo of the tech wreck, thousands of new retail investors (in truth speculators) have come pouring into the market, many of whom have been buying shares in bankrupt companies, hoping to buy for $1 and sell for $2 (known as the ‘greater fool’ theory).

Here are a few of the other current narratives:

In the short term narratives drive market sentiment, but over the longer term statistics will tend to serve you better.

Update: a basket of 90 internet stocks is now valued at an outlandish 160x earnings.

Unfortunately, the numbers tell us that this won’t end well.

To find out more about our coaching programs see here.

Sticking to the principles (and avoiding recency bias)

Recency bias

One bias we are all prone to is recency bias – a situation where we think (feel, really) that things will pretty much be the same and there will be no shocks or unwelcome surprises. 

But markets aren’t known as the Great Humiliator for nothing.

It’s usually when we least expect it that markets rise or fall steeply on unexpected news.

Markets are traditionally forward-looking, and if we generally think the future is rosy there’s no reason to adjust our allocation or views.

The problem, as we also remind people, is that it’s the truck you don’t see that runs you over. 

We’ve said for some time that we didn’t know what the exact issue would be, but given our experience in market cycles and our use of macro valuation tools such as the CAPE ratio, we said that markets were far too expensive and would most likely plunge at some stage. 

And indeed they have.

We don’t take any joy in this, but simply point out that you need to incorporate a view of the future which canvasses as many realistic scenarios as possible.

As we’ve also pointed out when the markets collapse like they have, then cash, which we’ve been holding for some time, suddenly becomes extremely valuable.

A dollar, which a few months ago would buy, say, one share of a company, can now buy perhaps one-and-a-half…and in many cases, two.

This where you get to add value, so to speak.

A bit of patience and looking ‘wrong’ for 12 months while markets climb is all part of the cycle.

8 timeless principles

And so we refer at these times to our 8 timeless principles

When markets do what they do, we understand that you need to have a systematic approach, meaning one based on a sensible set of rules that you always adhere to .

We often get tempted to let winning stocks run, even though a logical and prudent approach would be to recognise that real risks have risen, and potential rewards have fallen. 

That leads us to understand how important market cycles are, and since we’ve been in the rampant speculation phase of the cycle for some time, we’ve been holding plenty of cash.

We still are.

And by plenty we mean a greater than 50% allocation to cash.

We realise the importance of the CAPE ratio and other macro valuation tools in giving us some valuable information about where we are in the cycle, and how we should be positioning ourselves for the future.

It’s important that you try to be one step ahead not one step behind.

It’s when markets crash (or rise exponentially) that an understanding of our own personality becomes so important, as the markets swing from greed to fear in an instant.

And along with that, our emotions change, we become much more conservative, and we may even impact other areas of our lives as we realise we should’ve been selling when others were buying.

We see risk where others focus on rewards.

We use our risk hierarchy principle to determine whether the level of funds we should have in the market and where they should be. 

In the 4 action principles, we see the importance of asset allocation both at a macro level in determining the division between stocks, bonds, property, and cash…and at the micro level in terms of how much each investment or stock should be, and how much cash to hold against it.

We see the benefits of diversification, knowing that while there are cheap markets they may still become cheaper, making them even more attractive than they were previously.

Having a systematic approach with a developed investment plan allows us to methodically buy low and sell high at the times when others are doing the opposite. 

And, of course, throughout the market cycle we ensure that we avoid being too greedy or too fearful by maintaining our rebalancing strategy. 

The 3 Cs: cost, choice, and control

We often say that these principles aren’t perfect.

But over an investing lifetime, for folks who want to take control and manage their own money – what we call the ‘3 Cs’ of cost, choice, and control – these principles are a simple and effective roadmap for building wealth in whichever markets you choose to operate in. 

It’s times like now when these principles become invaluable.

To find out more about our coaching programs see here.

Scout’s honour (value versus growth)

The information in this blog post is general market commentary in nature only. It cannot take into account individual circumstances and does not constitute financial advice.

Value versus growth

We’ve discussed value versus growth previously, and we believe that ‘value’ will outperform growth over the coming cycle.

Recall that growth has had a spectacular run for much of the past 10 years, while value has struggled.

But, as we know, all things cycle, and we believe that it’s time for value to dominate, with its long held advantage over growth.

Mean reversion, anyone?

Buying the dip?

Many finance folks are predicting great times ahead for those that ‘buy the dip’ especially after a 35% decline in the market (and a subsequent bounce).

Now they may roll out the old ‘average returns of 8%!’ (or whatever the latest catchphrase is) but then fail to disclose that the 8% is made up and periods like 1982-2000 (where a starting CAPE of about 8 saw US stocks return approximately 16% per annum), but also 1966 to 1982 (when those very same markets delivered nothing).

Of course, we’ve also previously discussed the importance of market cycles, and from 2000-2020 returns have been close to negative – after accounting for fees, taxes and inflation – simply because the starting valuation had risen to 44.

Now the standard response is ‘well, yes, but if you invest over the long term you’ll do just fine’.

This may be partly true.

The advisor will certainly do just fine, with a regular income from fees that you pay to hold through long periods of flat or negative returns.

You, on the other hand, could end up with distinctly underwhelming results if you pay too much for stocks.

Be prepared!

Markets cycle, then, and if we have some indicators (like the CAPE ratio) which can inform our asset allocation, then we should be investing a lot when and where CAPE ratios are low, and less when and where they’re high.

The other point is that advisors and finance industry folks fail to state that the 15% or so on offer in 1982 is not the same as the negative return on offer in 2000.

Your start and end dates matter.

Buy low, and sell high!

With that philosophy in mind how should we approach the future?

Alas, we have no personal magic in predicting the future and so we don’t throw out X% or 15% because we know it’s not that straightforward.

However, what we do know from a reading of market history and from simple maths is that the lower the price you pay, the better the return.

Let’s take a look at how we can use this knowledge with reference to out 8 timeless principles of investing. 

As Howard Marks said:

‘I can’t predict, but I can prepare’.

Surveying the wreckage

In a bear market we should be ready with our heavy weighting to cash, and beginning to look for ‘value’ amidst the carnage.

One idea that we do promote is the risk hierarchy: the preference for most investors to stick to ETFs, or well-established companies that are in some way part of a country’s infrastructure (systemic type companies).

This typically means stocks large cap stocks at the bigger end of town, which also have strong balance sheets (i.e. manageable debt through a recession, or under a stress scenario), a competitive advantage, and a long history of trading profitably and delivering dividend payments.

It’s the dividends that we want to discuss here today. 

Given what we know about valuations (they’re still fairly high) and what we know of the outlook for the next 12 months, we can foresee plenty of companies cutting their dividends, whether by choice or through necessity.

The latter case will probably be more prevalent given the parlous state of the global economy.

Even in a low interest rate environment we need to be conservative and judicious in selecting investments if we want to hold them for a reasonable period of time.

We also need to think about what the future looks like.

And while we won’t go into too much detail here today, we can probably expect to see less globalisation, more home country based production, and a greater role for governments in providing jobs and stability.

This is probably applicable to countries like Australia where there are significant levels of private debt, and investors will need some time to deleverage if the economy slows and unemployment rises (which looks certain at this stage).

Thus we don’t think this stock market decline will be a short-lived one.

We think it may persist for some time (we don’t know for sure, of course, but we’re remaining conservative in our views at this stage, since being hairy-chested may result in a large capital loss, through buying too hard and too early).

Generally speaking we think investments of interest will generally speaking be found in those sectors that are more value-oriented than the sectors which tend to do well in growth environments.

In other words, we’re saying telcos over technology companies.

Tech is fine on the way up, but an absence of growth and dividend payments may see them become exposed in a short while.

Opposed to that, companies such as AT&T, to pick just one such example, are currently paying a solid dividend.

Dividend cuts coming

Now as we mentioned these dividends may be cut with the expected decline in earnings.

At other stress points in history companies have cut their dividend payments – and sometimes by a substantial amount – but while this may temporarily make them look like a ‘bad’ investment, we believe over time these solid, systemic companies will outperform and deliver consistently strong dividends if you buy at the right price.

Armed with our 8 timeless principles, as covered in our book, we think there are some sectors that will be strong performers over the years ahead.

We can use the CAPE ratio to determine which countries, sectors, and companies within those sectors are worthy of further research with a view to buying cheap when we think the bear has stopped growling.

We think the bear will be with us for some time yet, and there’s no need to rush in at this stage, but as Howard Marks and Baden Powell have both said…be prepared!

To find out more about our coaching programs, see here.

The elusive search for certainty

Reversion to the mean

It’s been what can only be described as a great 10 years for stock market investors.

From 2009 to 2019 the US markets returned approximately 350%.

It was the 4th best decade in terms of returns.

But we know that the good decades are usually followed by below-average decades and we’ve started this decade in a distinctly ominous fashion. 

After 10 years of solid returns there are plenty of investors who think the show will just continue and markets will be fine.

Cautious talk of mean reversion and market cycles is dismissed with the wave of a hand.

All the same old reasons are dragged out again.

The market will apparently stay high because of ‘new’ tech like Netflix and Uber, or due to different accounting methods.

Value investing is dead, and the old industries will fade away, they’ll say, and growth will continue forever.

And the creme de la crème:

’Buffett is underperforming because he’s an old fogey and out of touch…’.

You get the picture, it’s the same old story repeated over and over again, with but with different protagonists and new characters….

Wake-up call

The recent steep fall and high volatility has provided a wake-up call for many investors: young and old, beginner and experienced.

Suddenly, we’re talking about bear markets again.

But these warnings are countered by the ongoing sales pitches of the finance industry, including the old favourite that now presents a ‘once in a generation’ buying opportunity.

If you ask the finance industry there’s almost never a time to sell, and it’s nearly always a time to buy.

Prices are low? Buy lots!

Prices are high? Buy anyway!

Whatever you do, just buy and hold and you will be fine in the long term, goes the patter.

If you invested funds near the market top of 2000 (as you tend to when you have a superannuation account) then the returns have been less than impressive since we’ve now experienced two periods of steep losses. 

Now you can quite rightly argue that it’s all well and good cherry-picking dates.

Point duly taken.

But when do you start buying again?

After all, you can’t sit idly by on the sidelines forever.

Well, no, you can’t, but a read of market history can give us some valuable clues.

History leaves clues

Most bull markets end in a two-phase process as we’ve discussed previously.

That is, an initial steep fall, then followed by a slow and agonising decline (we call it being sandpapered to death).

What you may not know is that secular bear markets can last for a long time.

As in, a very long time.

From early 1966 to the latter half of 1982, for example, the Dow Jones Index in the US went nowhere, and tailed away sharply in real terms.

That’s right, the market meandered across 17 excruciating years. 

First and foremost, bear this timeline in mind when the finance industry tells you it must always be a great time to buy.

We believe that it’s still early days, and that there will be plenty of time to buy, rather than feeling the need to rush back in.

Policy stimulus

Because 2009 rebounded quickly, many folks think this time around will be the same.

But history shows that bear markets usually take longer to stop than we think than they will.

Things may be somewhat different this time because policymakers have learnt that they can’t just sit idly by and wait for free markets to function again.

Governments and central banks were quicker to respond in 2009 than they were in 1929, and they’ll be quicker again this time around.

7 lessons from previous grizzly bears

Can we learn anything useful from previous bear markets?

Given that history doesn’t repeat but it does rhyme, we think we can. 

Firstly, bear markets can last for a long time.

OK, you’ve got that one down pat.

Here are 7 other lessons on bear markets:

1. They end on pessimism, not optimism – with many financial folks advising others to rush in and buy stocks, this seems to indicate that we’re not at the bottom yet.

The bear market has more likely ended when you tell your friends that you’re buying stocks and then find yourself blocked from their Facebook or Twitter page!

2. Research shows that equity valuations are mean-reverting and that the bear market may not be finished until some equities trade at a 70% discount to the replacement value of their assets.

Macro valuations indicators such the US CAPE ratio also indicate that, if history is a useful guide, we’re still a considerable way from the cycle low and the start of a new secular bull market.

The long-term CAPE average is roughly 17 and we’re still – even after the declines to date – tracking at around 24.

And if earnings collapse as we expect then there will be no imminent recovery.

3. Sentiment is still somewhat positive in the sense that many folks are still saying everything will be fine in markets within a relatively short period of time (say, 6 months).

The industry is naturally and persistently optimistic in talking up markets, but a more considered and realistic view would tell you that there’s likely to be considerable carnage in the global economy resulting from the Coronavirus.

Bear markets usually end when folks simply refuse to believe positive economic news, having been burned too hard and often previously (a bit like a discrepancy between company performance and share price performance where the company is growing its retained earnings).

We’re not nearly at that point yet.

4. Bear markets usually do not last only one month.

Bear markets tend to go for longer than you expect, and so we don’t think we are there yet given it’s been only one month. 

5.  The auto industry starts to increase sales due to reduced prices.

We suspect this might be a while away, too, since Aussie households carry considerable debt, while we also recently went through a prolonged boom period for new motor vehicle sales.

Only relatively recently did Aussie consumers start to ease their collective foot off the pedal, so to speak.

6. One leading indicator is that copper prices start to improve, and that commodities more broadly begin to pick up.

This is not happening yet, but it could be argued that at some time in the future oil will bounce and demand will improve in a bid to catch up for lost time.

We also believe that governments will spend up big over the coming years in order to build, repair, and replace our ailing infrastructure assets, which have been allowed to run down due to constrained government budgets.

These projects will also be great job generators thereby increasing demand for a range of products and services. 

7. One important flag is the market in general stops falling on negative news.

The idea here being that only bad news becomes the norm and to be expected, and by that point there are few who believe things might be improving (even when they actually are).

It’s only at this point that the stock markets start to awaken. 

End of the bear

Here, then, are a few ways to think about how bear markets end, and you can begin to watch yourself for the signals.

Overall, we believe that there’s plenty of time to build a solid portfolio that will perform over the long term.

We think that when the secular bear market ends, a new secular bull market will begin, in part thanks to the global stimulus being delivered.

Perhaps that’s the most important lesson of all from history: nothing stays the same forever. 

There’s no need to rush in now, but on the other hand (and it’s always annoying when folks say that) you also can’t simply wait around on the sidelines until the good news is flowing again.  

If you want to catch equities somewhere near the bottom, then you need to start buying at some stage.

Remember that if you have a systematic approach with a well-thought-out plan using asset allocation, diversification, and our other timeless investment principles, you will be able to prosper in the coming bull market. 

The benefit of having market experience is the ability to understand that trees don’t grow to the sky, and that markets will always cycle and mean revert.

Markets become cheap, and then expensive, and then cheap again.

Often there’s a considerable amount of time between these points, but if you’re prudent and neither too greedy nor too fearful, then you should do just fine. 

To find out more about or coaching programs, see here.

Value investing through a crisis

Disclaimer: the information in this post represents general market commentary only, and does not constitute advice in any way.

Too early…or too late?

As we’ve been saying for a long while global stock markets have been a somewhat difficult place for investors like us who adopt a systematic approach and remain steadfast to our investment philosophy and principles.

As markets rise, we rebalance to take profits – only to see the market climb further – this becomes a common emotional pain point, when you’re an investor using market cycles to determine your asset allocation. 

Invariably you appear to sell ‘too early’, and while everyone else enjoys the party and bragging rights you’re sitting in more and more cash. 

Well, we have periodically looked somewhat silly over the past 12 months as the 2019 stock markets returns were very strong, in the range of 20-25%.

Alas, we missed out on the bulk of those gains.

But in saying that, did we miss out? 

Well, not really, because markets since crumbled back to 2009 prices, so far, in the space of about 5 weeks (the Aussie index was also at the same level as today in 2006).

So the stock market is now considerably lower than where it was before it started its 2019 run, with a decade of price gains erased in about five weeks.

So much for buy and hold in all markets.

But whether markets are high or low, of course that doesn’t mean there are no opportunities, and this is what we want to discuss here today.

Seeking value

We know the US market has been expensive, and it has fallen sharply, but still it remains well above its long-term CAPE ratio of 17.

Even if you account for low interest rates, it’s hard to get interested or excited at these levels.

Europe has wandered about all over the place over the past 15 years but is generally cheaper than it was, and there appears to be some value in European countries and companies.

And the emerging markets take the prize for the lowest average CAPE ratio at about 13.

Amongst those we know that a few countries (Russia, Korea, Chile, Turkey, Pakistan, and a few others) are worthy of consideration for a portion of your hard-earned capital. 

Investing when emerging markets are cheap can still be challenging because they can still go lower, especially while there’s a global decline underway driven by COVID-19.

But, as Templeton said, to outperform you must do something different from the crowd.

At some stage we need to begin building a portfolio of investments including country ETFs, sectors, and individual companies. 

We believe there are some appealing countries, sectors, and individual companies that are worthy of further investigation or a small starting position.

Remember your asset allocation plan, as this is where you will be able to ensure that you don’t over-bet.

Not all or nothing

Investing does not mean piling into the markets all at once.

It means taking a disciplined and patient approach to building a portfolio. 

Over the coming weeks and months we’ll be searching markets far and wide for opportunities.

We’ll be in no rush as markets can stay low for many years. 

But, as a taster, we’ll be focusing on a global approach with an emphasis on those areas that are ‘cheap’.

At this stage this we may begin to look at commodities such as oil, sectors such as energy, and potentially a weighting towards emerging markets since some are becoming very cheap indeed.

While the US remains expensive, this doesn’t mean we avoid purchasing companies or sectors in the US market entirely, because there will eventually be opportunities to invest in great companies with long and proven histories, low debt, and a solid track record of paying dividends. 

To begin with your journey, check out some emerging markets and determine if they fit your systematic investment plan.

Read widely, check out other sources, and follow business news to see if there are any ETFs or companies that warrant further investigation. 

We encourage you to begin the search for yourself, and start with asking questions about value (which is what people have consistently failed to do in recent years).

We’re only a call away if you’re interested in learning about our 8 timeless principles for investing. 

No, you haven’t missed out on the opportunities (avoiding FOMO)

FOMO rears its head

We’ve just had a couple of years of investors and speculators becoming increasingly fearful of missing out on late cycle stock market gains.

But that third or rampant speculation phase of the market cycle has now passed.

Prudent investors prepared for the crash by reducing their market exposure.

But some are now facing a different dilemma, involving the fear of missing out on the arising opportunities.

Firstly, breathe…take a chill pill, and relax.

We aren’t yet half a dozen weeks into this downturn, and we haven’t even had the first unemployment rate reports, let alone the cascade of floundering company earnings releases.

Let’s just recap on a few slides before moving on to the key point of this post.

Firstly, the recent extreme level of daily volatility is not the sign of a healthy market.

In fact, it’s an indicator of precisely the opposite.

The best and worst days in markets tend to cluster into those periods wherein investors experience large drawdowns.

Secondly, we only tend to see these repeated daily moves of more than 5% (in either direction) during times of great market distress or turmoil.

This isn’t a great signal either.

Thirdly, remember that drops are almost invariably followed by pops, even through the worst stock market downturns in living memory.

Intermittent rallies are part and parcel of market crunches.

And fourthly, note that the trend may continue to be your friend, since even the most brutal bear markets will always intermittently feature rallies.

It’s just the nature of the grizzly beast.

Realistically the pain of this recession is only just beginning for many listed companies, and we’re nowhere near the end of the opportunities for prudent investors with cash available to deploy.

The Kelly Criterion

Now, on to the key point.

Let’s tie this back to our overall investment philosophy, particularly with reference to the Kelly Criterion.

One of the reasons the Kelly optimisation model holds that we should never be 100% invested in stocks is simply because there will always be great opportunities to buy low in the future.

The goal of the value investor is to buy a dollar of value for 50 cents (or ‘step over one foot hurdles’ depending upon your preferred analogy).

To protect your capital you must always buy low and sell high, to survive and be around for the all those wonderful opportunities in the future.

We might be able to better understand the fear of missing out if there was only one stock market or basket of securities to choose from in the world.

But today this is not nearly the case.

It’s a big world out there, and by irrationally focusing only on one market (the home bias) then so many wonderful opportunities may pass investors by.

So far, some sectors (e.g. energy) and some commodities (e.g. copper) are beginning to look interesting, but US stocks are still too expensive given the dire outlook, and there will be no shortage of ETFs on sale over the coming year or two.

You can think of your investing as a series of repeated similar bets, patiently picking off the great buying opportunities as they arise.

The simple knowledge that there are many stock markets and sectors around the world, and that they each have their own market cycles, can be your informational edge.

One thing that we do know is that a global recession will throw up countless opportunities to scoop up bargains in a low risk fashion.

The great benefit of the Kelly Criterion is to maximise your long-term wealth and geometric returns, buying more units when stocks are on sale and earnings yields are attractive.

By being patient you get to buy more units, at a better price, with higher yields.

You won’t achieve this by continually reacting to daily market moves and snatching at every 5% dip.

Of course, if global markets panic and fall to extremely low valuations, then it makes sense to ramp up your exposure to equities capitalise on the opportunities, in accordance with Fortune’s Formula.

But at this stage there’s no logical need to rush or fear missing out.

Show me the money (dividends)

‘Show me the money!’

Yes, most of us would know that line from the Tom Cruise movie.

When it comes to investing we think dividends are the equivalent of ‘showing us the money’.

Those doing our coaching programs know that we are devotees of what we call the risk hierarchy.

In short we normally prefer to buy market indexes from both developed and developing markets, from sectors (such as e.g. energy, or consumer discretionary), or regions, such as emerging markets.

We don’t have an aversion to buying individual stocks, but we believe that for most investors using the risk hierarchy (as one of our 8 timeless principles) is a prudent way to manage risk.

Now we also know that some folks just can’t resist a bit of a dabble in individual companies. 

We get that!

It’s clearly not going to be that cool when you hit the dinner party and say, ‘I just bought Russia!’.

We know that’s not exactly a great opening line to a conversation and, yes, it’s usually better to say that you’ve just bought Woolies or BHP…or indeed any other big-name company.

Now if you look at the following diagram it shows a distribution of returns from US companies.

That long column way out there on the right represents the big winners of the market such as the Apples, Amazons etc.

Unfortunately, by definition most of us end up with companies that are nowhere near as successful as Apple or Amazon. 

For our Australian readers here’s some information about the success or otherwise of Australian publicly listed companies.

I don’t think you need us to tell you that a large portion fail over time (around 70%).

Many others don’t fail outright, but lose 75% or more of their value (meaning you’d subsequently need to hope for a 400% return to be ‘made whole’).

Roughly 60% of companies never beat the index.

And finally there’s a small batch of winners – approximately 20% of the total – which succeed and pay dividends. 

To summarise, then, for the would-be stock pickers out there:

Still not convinced?

We also notice that many folks (and much of the finance industry) spend an inordinate amount of time talking about and searching for the next Amazon or Google or Apple.

Of course the trick is to buy them when they small or micro cap stocks with prices under a dollar.

However the big problem here is that you must pick be able to pick them early!

Pick one of these babies early in the piece and it’s easy street. Cool! 

You often see this type of line:

‘If only you’d invested $10,000 in Berkshire Hathaway/Apple/Amazon back then you’d be a billionaire today!’

This may well be true!

Alas, firstly $10,000 ‘back then’ may well be the equivalent of a huge sum today, so you’d have had to be wealthy to slip a lazy $10,000 of spare cash into Apple or Berkshire.

Secondly, you must’ve been able to hold through Amazon’s 95% decline (no, that’s not a typo) in the dotcom crash.

Or when Apple nearly went bust, but thanks to Bill Gates stayed alive.

Or held any of them through the subprime crash or the 2000 dotcom crash where the overall market fell 50% or the tech-heavy NASDAQ fell approximately 80%. 

OK, but still…

Let’s say you are 30 years of age and you’re still keen to invest in individual companies for the next 30 years.

Let’s also assume you pick 5 to 10 companies each year and hold that as a portfolio (the reality is that most folks and fund managers have more than 10 companies in their portfolio).

Now that may mean picking as many as 200-300 stocks over your 30-year horizon.

In order to be successful, you’ll first need to pick more than 50% as winners, and then have these 50% outperform so well that they cover for your inevitable losers.

If you glance again at the capitalist distribution diagram above you should be starting to think that picking stocks might prove to be a mug’s game… 

The dividend component of returns

Right, I get it, but I still want to pick individual company stocks.

OK, so let’s see what has worked for us most of the time. 

We prefer to invest in large, long-established, profitable, and systemic companies that pay dividends.

Why?

Because they’re a far more reliable source of income, and they’re much easier to select than trying to pick the next 100-bagger.

And dividends are a very important component of overall returns.

Market prices of individual stocks fluctuate with the short-term rises and falls of the market, but the dividends in the long run may become the bulk of your returns.

The reinvestment of dividends (or good, solid compounding) is often neglected because investors focus on trying to buy growth companies (a subject for a later post) for the short term, rather than focusing on sustainable long-term results.

Notice how many pundits talk about the price of stocks or the market rather than the earnings yield or dividend yield. 

Studies show that dividends are a very valuable source of returns for investors (and largely account for the fact that overall returns are strong).

Capturing these returns will most likely come from investing in reliable dividend payers, being incumbents that have established themselves in their market or sector, and thus have a strong level of security and continuity.  

Therefore if you want to start investing in companies when markets are low, look for the large, mature, dividend payers, with a stable market share and not too much debt.

As a rule, you will do better with these types of stocks over time than with trying to pick the next Apple. 

Finally, check out some simple strategies such as the ‘Dogs of the Dow’ concept.

No, these don’t outperform every year, and even Buffett doesn’t beat the market every year.

But having a systematic approach (one of our 8 timeless principles) will increase your probability of investing success.   

Remember, show me the money dividends!

To find out more about our coaching programs see here.