Confidence or Prozac
In his most recent article, Jeremy Grantham describes seemingly reasonable people, armed with terrifyingly accurate data, foretelling of the end of the world. Investors with lots of cash become inert objects, mired in cement, and too terrified to invest. Those investors who are fully invested move from fear to denial and finally to panic, at the end becoming catatonic.
Grantham encourages all investors, before rigor mortis sets in, to evaluate where they currently are, where they want to be, and how they can get there. A clear “battle plan”, developed by taking motivation from both your head and your stomach, he says, should clear the way for investors to overcome “investment paralysis”.
Elaine Garzarelli, formerly a Prudential analyst, called the market correctly in 1987, when shortly before the market crashed in October she put her clients into cash, where they stayed until the mid 1990’s, ultimately missing out on much of the rally in the stock market during the Clinton administration. She was only half right. In other words, you have to be right twice about something that no one knows with any certainty.
For those who are waiting for the tide to turn before they purchase stocks, remember that human nature is hard to overcome. For instance, you decide to invest when the market moves up 10 percent. That day comes, but you may decide, “is this rally groundless?” Therefore, you wait until the market moves up another 10 percent – just to be certain. At that point, you decide to wait for the market to pull back a bit and then buy because you’ve already missed 20 percent. As you wait for a better day the market advances another 20 percent and now with current investor psychology very bullish (a condition usually evidenced somewhere near the top of the market) you decide to jump back in having missed 40 percent of the market’s appreciation. Unfortunately, at every signpost, the future is no more predictable than it was at the last one.
What goes down must go up
“Though the path has not been smooth, our economic system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it will continue to do so. America’s best days lie ahead.” This quote by Warren Buffett from his letter to Berkshire Shareholders sums it up quite well. It is worth noting that since market records have been kept, stocks have outperformed every other investment category – including the period of the Great Depression, when they lost nearly 90 percent of their value!
If you have substantial cash you will need to (re)invest at some point. There is motivation to start now (confidence), as long as you are willing to risk the possibility of short-term declines in return for long-term profits. Remember, the future is not foreseeable and the fundamental goal of equity investing is to buy lower and sell higher. RKM has long advocated a strategy of buying into market declines, given that the biggest risk for many investors is to over-allocate to cash, missing upward movements in the market, which normally happens rapidly and abruptly.
Year of the Ox (aka Bull!) –coincidence?
We don’t know when the market will bottom. But whether it’s this month or December of this year, we are confident it will. It the meantime there is a strategy for the large cap equity portion of a portfolio that offers high current income with the potential for long-term appreciation. We suggest adding high quality equity/income funds or “dividend aristocrat stocks” to the portfolio, as this likely increases current income with appreciation potential. The S&P 500 dividend “aristocrats” are the 52 companies in the S&P 500 index that have followed a policy of consistently increasing dividends every year for at least 25 consecutive years. The current yield on several equity/income funds averages about 5 percent. That’s comparable to starting a 100 yard dash on the 50 yard mark, given that large cap stocks returned on average about 10 percent annually over the last 70 years. Investment income, whether from dividends or interest provides a cushion in down markets and many top-quality stocks have higher yields than the 30-year Treasury and better appreciation potential.
Grantham calculates the “fair value” of the S&P500 at 900, approximately 30% above where the index sits now. Although he believes that the index has a 50/50% chance of dropping below 600, many stocks and funds will have posted a double digit return per year above inflation for the next seven years. This might not be the absolute bottom of the market, but it is so close to a bottom, prudent investors are now investing.
Christopher Blakely 03/2009
Sources: The Wall Street Journal; Bloomberg LP, GMO North America
