For the past three years our insistence on maintaining a globally diversified portfolio has not been especially helpful in outperforming our blended benchmark on a consistent basis. If we use the EAFE Index (the MSCI Europe Australasia Far East Index) as a proxy for international markets, the returns versus the S&P 500 Index (the stock index in our benchmark) look unattractive:
The investment team members at Pinnacle are connoisseurs of investment research. We read a vast variety of analysts and money managers, each having their own opinion about the economic cycle or their particular area of expertise. We have spent a decade finding those analysts who are clear in presenting their point of view, are well-known in the buy-side investment community, and are (hopefully) smarter than we are. However, as we have opined on many occasions, it is simply not possible to be in the business of venturing opinions about the financial markets without being wrong at one time or another. For that reason, most analysts make certain they caveat their thoughts about financial issues and at least make an effort to present the opposing view, if for no other reason that they don’t want to make a devastating mistake that could upset their reputation and their business. Everyone involved knows how to play this game. For Pinnacle, as the consumer who is willing to pay for the privilege of reading an analyst opinion, we subscribe to analysts and research firms that give the clearest possible forecast. We know how to sift through all of these opinions and add them to our own internal research as part of the “weight of the evidence” we use to formulate Pinnacle’s own investment view. If the analyst or research house we follow is too vague they inevitably get dropped from our research. And if they are clear and concise we applaud them, but also require that they are right more than they are wrong.
We’re three weeks into the football season so it’s time to break out the tired sports metaphors. Today’s column is titled, “Blocking and Tackling,” which I’m using as a new and interesting way to announce that this is a good time to review the fundamentals of Pinnacle’s investment philosophy. With luck, we’ll soon have an opportunity to write about how to invest without being “blind-sided,” how avoiding a bear market allows us to not have to “drop back ten yards and punt,” and how looking at trailing returns is an exercise in “Monday morning quarterbacking.” But for now, let’s concentrate on blocking and tackling.
Every Pinnacle client signs an Investment Policy Statement that spells out the long-term targets for risk and reward for each Pinnacle strategy. Risk is presented in absolute terms as a fixed range of returns based on back-testing a five asset-class portfolio from 1972 to the present. The range of expected annual returns (risk or volatility) in the IPS is based on the standard deviation, or the dispersion of returns, from the very long-term average return presented to clients in our now famous (or infamous) Red and Gray charts.
Behind closed doors U.S. politicians on both sides of the aisle acknowledge that something needs to be done about the future cost of entitlement programs and our growing national debt. The secular bear market view holds that the U.S. will not be able to fix these issues politically and the problem will eventually be resolved by a riot in the financial markets. In this view, stocks will not be able to mount a sustained multi-year rally until the structural risks posed by the U.S. debt mountain are resolved. But as we head into the election season, it is also worth considering the secular bull market view. If the U.S. election helps lay the groundwork for an acceptable long-term solution to our debt problems, then there is plenty of room for stock market multiples to be supported going forward.
Two articles by the Wall Street Journal’s Tom Lauricella, one of my favorite writers, came across my desk last week. With titles like “’Go Anywhere’ Goes Awry” and “Macro Funds Show Micro Returns,” the message was clear: Go Anywhere mutual funds and global macro hedge funds are having a tough time earning positive returns in the current market environment.
Recently I was interviewed by Money Magazine on the topic of Exchange Traded Funds (ETFs). I pointed out that ETFs are an excellent investment tool to implement a sector rotation strategy, and that sector rotation was completely different from the Morningstar Style-Box approach to equity selection. Morningstar is perhaps the best-known research firm specializing in independent mutual fund analysis and its star-rating system is widely used in the investment industry. In 1992 Morningstar introduced a system for categorizing mutual funds by investment style. The Morningstar Style Box (on the right) divides the equity mutual fund universe by two major characteristics: market capitalization (or the market value of the companies in a fund) and the valuation of the stocks in a fund based on the P/E and P/B ratios. So a mutual fund that owns large cap stocks with high P/E and P/B ratios is likely to be found in the large growth, or upper right hand quadrant of the box.
I just returned from a trip to Canada that took me from Niagara Falls to Toronto to Montreal to Old Quebec, and then back to the U.S. Our final stop before getting on the plane home was the Norman Rockwell museum in Brockton, Massachusetts. The museum owns hundreds of Rockwell’s original paintings, many of which are iconic images that once graced the cover of the Saturday Evening Post. In the mid-1980s, the artist’s last studio was moved to the museum grounds, and curators have faithfully recreated it as it was when he was at his busiest.
A journalist once asked me what advice I’d give a 60-year old, about to retire. To be honest, I might as well have been asked to list the causes of the Civil War. From the perspective of a trained financial planner and the Chief Investment Officer of a private wealth management firm, the question is, well… difficult. The journalist was writing for the Wall Street Journal and looking for sound investment advice for folks who have been buy and hold investors for their entire investing lives, and now faced the dawning realization that buying and holding is actually a high risk strategy in expensive markets.
Two of the most destructive forces for the economy are the words “let’s suppose” and the use of the = sign. When we put the two together, they form a combustible combination that gives seemingly well-intentioned and rational investors the power to disintegrate assets at will. This is because investors have a desperate need for quantitative models that will justify or ‘prove’ their investment theses, if for no other reason than it provides much better job security than having an investment thesis based on their good judgment and common sense. Unfortunately, this state of affairs gives rise to some of the most egregious misuses of the scientific method that one could imagine.