Dec 312015
 

The market is at a crossroads here at the beginning of 2016. As we celebrate a new year, emotions are running high as the Federal Reserve moves rates higher, the Chinese economy slows, the dollar strengthens, the United States is in the third quarter of an industrial recession, potentially dipping into a full blown recession during 2016, and we still face what seems to be significant, albeit largely ignored, geopolitical risk.

Another issue is that weak energy prices and weak oil and gas earnings are hurting the overall earnings power of the energy sector – giving the energy sector its first earnings loss in 42 years. Companies tied to metals and mining or other commodities, and companies reliant on high exports struggled heavily as well.

When emotions run high, investors tend to make emotional decisions. Long-term investors become induced to become more short-term oriented in their thinking, buying stocks on a single day’s rally or selling after a swift 11% percent decline.

Based on the historical performance of the S&P500, it’s that second decision – the fear-based move to sell – that is the more dangerous one. In fact, even if one was the world’s worst market timer over the past several decades, one still made money on stocks, according to an analysis done by institutional portfolio manager and financial writer Ben Carlson.

Ben names his awful (or perhaps unlucky) investor “Justin.” Justin made his first investment in the beginning of 1973, right before a 48 percent crash for the S&P 500. Justin then held onto stocks after the drop, saving a total of $46,000, and not getting up the gumption to commit more savings until September 1987—right before a 34 percent crash. Justin then continued to hold tight, making only two more investments before retirement, which came right before the 2000 crash and then the 2007 crash!

So how did “Justin” do after these 42 years of epic market misfortune? Actually, he made money. As the market successively made record highs, he turned the $184,000 he invested over the years ($6,000 in 1973, $46,000 in 1987, $68,000 in 2000 and $64,000 in 2007) into $1.16 million—for a total profit of $980,000. That represents an annualized return of roughly 9 percent, on a money-weighted basis. Even after accounting for inflation, Justin has increased his wealth substantially by investing in stocks. The key is that Justin never sold; he never tried to outsmart the market—instead riding the stock market’s long-term trend higher.

I pride myself in knowing my clients very well so as I sit here I can almost hear a few clients comment, “I don’t have a 40 year time horizon.” Or, “It’s different this time.”

Don’t have a 40 year investment horizon? How about 15 years? Most would agree the past 15 years in the market have felt pretty awful. So bad, I’m not going to pain you further by reciting the examples. But, an investor who invested in the market at the beginning of the year 2000 (the top of the tech bubble) and suffered two breathtaking losses within the next 8 years would have still enjoyed a 100% total return over the 15 year time period of 2000-2015. If that client were in the two largest mutual fund holdings the Harding Financial Group holds for our clients, James and Parnassus, that investor would be up 170% and 217% respectively. (Data provided by Morningstar)

This time is different you say? I say, not only is this time different, every time is different. There are so many variables to consider that make each cycle unique: the level of the market, interest rates, inflation, demographics, trends, sentiment, economic activity, growth rates, industry leadership, fiscal & monetary policy, innovation, technology and a plethora of other factors that keep markets moving.

The variable that is by far the most important: Human nature. When it comes to human nature, however, this time is never different when it comes to the reality investors will continue to act irrational, making emotion based decisions. A ‘this time is different’ mindset is costly if you believe that getting caught up in the collective fear and greed of market participants will work out this time. Our irrational impulses lead to overconfidence, herd mentality, overreactions to short-term events, loss aversion and extrapolating the recent past into the future.  It’s why we’ve always had manias and panics and we always will.

Investment success will always involve some combination of patience, long-term thinking, risk control through diversification, understanding the importance of asset allocation, keeping your wits about you at market extremes, a focus on your time horizon, and an understanding of your own behavioral biases.

My career began in 1998, just prior to a 19.43% drop in the market over a two month period. Some of my closest friends are also Investment Advisors and we often joke that we couldn’t have started our careers at a worse time. But one thing I’ve learned over the years is that if you are going to make investment mistakes, make sure you are biased towards optimism and not pessimism. Long-term thinking has been rewarded in the past and unless you think the world or innovation is coming to an end it should be rewarded in the future. As Winston Churchill once said, “I am an optimist. It does not seem too much use being anything else.”

I’m optimistic about the United States and our economy over the longer term but near term, the economic numbers indicate 2016 will likely be one of the more difficult years in recent history. That’s not to say I expect a broad market 2008 style decline but I do expect tremendous volatility and it’s likely a couple sectors will experience 2008 style declines, as the oil sector did in 2015. Fear will be an increasing component to market movement. We will remain cautious but involved in the market establishing positions that have a strong 3-5 year outlook due to various factors. Because of my expectations, clients can expect a significant amount of trading early in 2016 as we reallocate for the year and acknowledge the changing market dynamics. Our repositioning is in keeping with my expectation of an improving a 3-5 year time horizon for the companies and sectors to which we have exposure. I will not catch the bottom nor am I attempting to do so. I’m interested in paying reasonable prices for good companies. We are planting seeds. While in the short term the market weather may be cloudy and not appear conducive to growing a nice portfolio, I believe the positions we plant during the coming market volatility will be strong healthy components of your portfolio several years from now.

I wish you and your family all the best in 2016.

Sincerely,

NewHardingSignature
Michael R. Harding, CFP
President / Portfolio Manager

P.S. During 2015, the Harding Financial Group celebrated our 10 year anniversary and was named as one of the “Top 25 Fee Based Financial Planners” by Columbus Business First. I am so proud of the relationships we have developed and the work we have done for our clients. Thank you for giving us the privilege of serving you.