A Crisis of Faith?

Crisis of faith

Doubt is not a pleasant condition, but certainty is absurd.  – Voltaire


Dow 20,000 is upon us.  If not today, then tomorrow perhaps?  If not then surely soon.  Who was certain of this a quarter ago?  Meet any who claim to have been with a degree of skepticism as we find ourselves on what was an unlikely path.  That is not to say our present path is devoid of promise and potential.  It has that.  It’s just that the further we stray from the expected the wider the possibilities become; both good and bad.

How then as investors should we best position ourselves?  Rather than simply answer (way too easy) perhaps a moment to consider the opinions of several well-known market thought leaders.

  • “The markets are assuming that he [President-elect Trump] is going to create three to four percent growth on a sustainable basis…It is demographically impossible…. When the markets figure this out, they are going to crash….I think it [Dow] is going to end up between 3000 and 5000 a couple years from now.” – Economist Harry Dent, Saturday December 10, 2016. 
  • “As we get into the governing of the next administration, it’s probably a good opportunity to continue to trim the U.S., which is overvalued relative to the rest of the world,”   Mark Eibel, Russel Investments, Friday December 9, 2016. 
  • “If I was an investor and I was in cash, I wouldn’t try to time the market to make the best return in the next 12 months.  It wouldn’t be a surprise if we had a 10 percent pullback next year.” – Tom Lee, Fundstrat, Wednesday December 14, 2016
  • “2017 could be a binary year when the market [S&P 500, currently at 2,258] falls to 1,600 in the bear case and rises to 2,700 in the bull case.” Savita Subramanian, Bank of America/Merrill Lynch, December 19, 2016
  • “Our expectations are for tailwinds (meaning a good environment) for the equity market stateside as elements of the simulative fiscal agenda broadly outlined by President-elect Donald Trump are implemented.” John Stolzfus, Oppenheimer, December 19, 2016.

These diverse views don’t come as any surprise.  It’s only really worrisome when everyone anticipates the same future outcome.  For now some firms advise moving canned goods into bunkers while others are sipping muddled blackberry bramble cocktails poolside.  That’s the beauty of free and open capital markets!  People disagreeing about the prices of assets based upon future forecasts is what provides us the liquidity we require to comfortably invest in financial instruments such as stocks.

So how should we position ourselves moving forward in the new Trump-led dynamic?  Asked another way how should we change our current allocations if at all?  In order to answer this we must of course understand our current allocations.  We’ve been overweight cash, market weight bonds and underweight small cap, emerging markets and international stocks all year.  A little less cash and a little more of those more volatile asset classes since the election.  That means we’re at the party, but we arrived late.  Has our very conservative approach been working well for us in 2016?  Not really.  Don’t misunderstand, stocks are up!  Market values are up!  Then what’s the problem?

The problem is risk (as defined by exposure to what are historically more volatile asset classes) in 2016 has been rewarded spectacularly.  We are highly risk conscious investors slow to embrace the more volatile asset classes and quick to sell them.  As such, 2016 will be a year where on the whole our portfolios under performed versus our benchmarks.

Why even bring it up?  Because Monarch beating passively managed portfolios (blended benchmarks) is the norm.  We take periods of under-performance, inevitable as they are, very seriously.

Has a year of failing to beat our benchmarks as we have in years past caused us to question our worth as managers?  Maybe we’re not that good, after all.  Is it time to reconsider our decades-old approach to investing and embrace a more passive “park it and forget it” strategy?  Owning less cash and more small caps sure would have been a bumpy road but by year end it would have been worth it.

Simply stated, no we will not abandon our approach to investing because we were not up as much as our benchmarks this year.  Our clients value the comfort of consistency and an understanding that we’re not out chasing whatever asset class tends to be hot for a time.  While it’s healthy to question our outlook for an individual stock, a sector or a market we remain steadfast in our approach to prudent portfolio management.  Owning individual high quality, attractively priced, blue-chip equities and investment grade bonds with low portfolio turnover while limiting exposure to riskier asset classes is in our view the best long term path towards attractive real (net of inflation) returns.

We acknowledge that we won’t out-perform every year.  Doing so most years is good enough for us.  In a year when stocks were already down around 11% by February, Brexit, the anticipation that the Federal Reserve would raise interest rates combined with the nuttiest Presidential election in memory we can easily imagine the shoe on the other foot had the market performed poorly.  “Why were you [Monarch] so heavily invested in the riskiest assets when the market was screaming at you to sell with all that was going on…”  Better to invest prudently and occasionally under-perform in years with surprising upside than to sit on hands and risk large losses when things turn sour.

In 2014 Berkshire Hathaway, Warren Buffet’s investment company, had under performed the market for five consecutive years.  What was the smart move if you owned Berkshire Hathaway then?  Our view is the smart move was to buy more because from a twenty year perspective he was still killing it.  Sure enough he’s done well since.

Management styles go in and out of favor.  Some styles tend to outperform in good markets while other outperform in bad.  The worst thing a manager or investor can do, in our opinion, is to try and skip to whatever style is in fashion.  We are happy our clients enjoyed another year of positive returns.  We’re delighted that over longer terms we’ve performed very well relative to our benchmarks.  We’re ready to add even more value in 2017 and here’s how we’re going to position our portfolios early in the year.

First, we will over-weight stocks relative to bonds.  Long term, some of the policies hinted by the Trump administration (if enacted) give us cause for concern from a market perspective.  We’ll save an analysis of proposed policies, their accompanying risks and potential payoffs until after inauguration when we have a better sense of which will top his administration’s agenda.  However, short term we anticipate the stock market is going to continue to celebrate.

Within domestic markets we will continue to add to Energy and Technology sectors.  We will under-weight Telecom and Consumer Staples.  We will adjust to market-weight exposure for international developed, emerging markets and small caps while avoiding REITs, MLPs, preferred stocks, and precious metals.

We wish all of you a wonderful holiday season and a New Year full of good health and prosperity.

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