It has been quite some time since the phrase “cash is king” has been uttered. In general, the idiom has been used to make the case for investing in cash securities, despite the unremarkable growth potential of the asset class. The benefits of investing in an asset that is likely to preserve its value in a broad stock market downturn can be underappreciated until that downturn actually occurs. In a market environment where stock market valuations are largely higher than average and bond prices are also exceptionally high, cash should be considered as an appropriate investment allocation in a balanced portfolio. The problem has been that the yield on cash securities has been nearly non-existent for almost a decade. But that’s beginning to change.
I’m sorry that my letter happens to be delayed this quarter. While finishing a first draft, the stock market reminded us all of its unpredictability and potential for sudden course corrections. Instead of sending this letter out in its original and dated form, we felt it obviously imperative to address the current market correction. At the same time, last year was such an uncommon year in the capital markets that I decided to retain much of the original letter’s content for your edification. Despite the understanding that market corrections may occur at anytime and for unpredictable reasons, they can still be unnerving. When market volatility increases it is important to remain disciplined and stick to your long-term investment strategy. Thank you for your continued interest in these periodic letters. The intent is to provide you with our interpretation of the current capital markets in the context of investing for the long-term and to regularly communicate our investment philosophy in managing your wealth.
Investing is and has always been a balancing act of contradictions. President Harry Truman complained that he wanted someone to “give me a one-handed economist. All my economists say, ‘on the one hand…on the other’”. In today’s environment, we have elevated asset values in nearly all types of assets on one hand. But on the other hand, we have loose global monetary policy. Likewise, we have historically low levels of asset price volatility on one hand. But on the other hand, we have a geopolitical landscape that is disruptive and uncertain. So what can we do to weigh these factors and arrive at a decision on how to invest our assets?
The first three months of the year have proven to be very agreeable for investors, perpetuating the antithesis of Murphy’s law. If you recall, Murphy’s law states that “anything that can go wrong, will go wrong”. The adage has always struck me as a sort of seasoned pessimist’s guideline for properly setting expectations. Don’t get your hopes up and you’ll find that disappointment comes infrequently. The present state of the markets has us considering what happens to markets when everyone seems to be assuming that Murphy’s law will be enacted by executive order at any moment.
Everybody loves an underdog, right? In August, 2015, before the season began, the Leicester City Football Club in England faced seemingly insurmountable odds to win the Premier League title. Odds-makers chanced the club’s prospects for the title at an astonishing 5,000-to-1. To give you an idea of how ridiculously absurd those odds are here are some other odds that lend perspective. The U.S. Men’s Hockey Team was given 1,000-to-1 odds of winning the gold medal in the 1980 Olympics. The Minnesota Twins faced 500-to-1 odds of winning the World Series in 1987. The Cleveland Browns were given 200-to-1 odds of winning the Super Bowl this season (they finished the season with one win)1.
With considerably less animosity or entertainment value, there is another major debate raging at the moment that doesn’t involve our choices for the next U.S. president. It is one that is perennial, has been analyzed exhaustively by scholars and has staunch advocates at opposite sides of the debate. The conflicting wisdom of Warren Buffett illustrates why investors can’t seem to make a clear determination on whether passive or active investing is the superior methodology.
I’ve always had a fascination with the night sky, watching the stars and learning to identify planets and constellations. I remember “camping” in a friend’s backyard when I was young and watching the northern lights, back when they were still visible from Minnetonka. Last fall, I got a rare treat on my way in to the office as I caught a glimpse of a spectacular green meteor streaking through the early dawn sky. It’s difficult to not be in awe of the rarity of what we have on Earth when gazing into the infinite darkness of the night sky. Still yet, to realize that the earliest civilizations of humans have been staring up at the same scattering of brightly twinkling stars for over 5,000 years allows us to briefly relate to our ancient ancestors.
I was recently invited to speak to a class of students at Mound-Westonka High School about the stock market. Nothing spells excitement to high school students like a guest speaker about the stock market! These kids were different though, in that they were very good at hiding their boredom as I spoke--only kidding, of course, they were very attentive and asked excellent questions. After all, they were in the middle of playing The Stock Market GameTM (“SMG”)1 and competing against dozens of other teams around the state to invest a virtual $100,000 for about three months. In all honesty, I have mixed feelings about the SMG since it does a wonderful job of introducing young people to investing and provides the opportunity for teachers to instill important lessons about being responsible and prudent with your finances. At the same time though, over such a short period it’s difficult for students to see the value of truly investing rather than just trading or speculating. Graph 1 illustrates how the value of the S&P 500 Index changed during the first quarter.
In keeping a review of 2015 brief, I’m attempting to live by the wise words of Bambi’s bushy-tailed friend Thumper, “if you can’t say somethin’ nice, don’t say nothin’ at all”. While Birchwood enjoyed celebrating its 25th year in business, last year will go down as a disappointing one for investors. With stock and bond indexes ending the year roughly where they started, growth of invested capital was a struggle. Marked by a tepid first half of the year, markets sold off sharply during the third quarter only to recover much of the lost ground over the final two months of the year. Perhaps most memorable about 2015 from an investment standpoint was the wide anticipation that the Federal Reserve would raise the Fed Funds interest rate for the first time in nearly ten years. Since announcing the increase in the short-term interest rate, the S&P 500 Index of U.S. stock prices has lost over 12 percent of its value1 and long-term U.S. interest rates have actually fallen2.