SPECIAL INVESTMENT UPDATE
May 11, 2016
Dear Clients and Friends,
The purpose of this Special Investment Update is to address the issue of whether or not this is a good time to invest in the stock market. A top-tier presidential candidate, a billionaire, says that this is a “terrible time” to invest in the stock market. Even if you do not accept the GOP front runner’s view that “we’re sitting on a massive bubble”, there are reasons to be concerned about the current level of stock prices. Is there anything we should be doing differently to protect ourselves against the risk that a big decline in equities may be just around the corner? Any prudent financial battle plan must reckon with this reality. However, when political candidates start lecturing about the stock market, it is important for us as investors, to be somewhat skeptical of Donald Trump’s political comments. Even the experts in the field barely understand the market. How can an outsider pretend to know better?
First of all, it is important to note that whether or not we are headed for the “very massive recession” he is predicting, Trump has raised an important issue for investors. Stocks, on the whole, are not cheap. In fact they are quite expensive by historical standards. Not as expensive as they were at the height of the Internet mania in 2000, but as expensive as or more expensive than they were at such prominent market tops of the past in 2007, 1987, 1961 and 1929. When valuations reach the upper end of their historical ranges, accidents frequently happen. If, for some reason, the U.S. economy were to stumble into a recession sometime during the next year, it would be perfectly normal for the headline stock indexes to tumble 20% or more.
How, then, do we deal with the possibilities of a sharp market decline in the not too distant future and the likelihood of sub par returns on a broad basket of U.S. stocks over the next decade? Some folks will try to outsmart the market by darting in and out, buying and selling, constantly tearing their portfolios apart and rebuilding them according to a pre market-timing scheme. Unfortunately, the record suggests that most investors who pursue this tactic will end up lagging a simple buy-and-hold program over the long-term. We, at Farmand Investment Services believe there is a better way.
As many of you already know, we advocate maintaining a well-diversified “balanced” portfolio made up of stocks and fixed-income instruments. The firm’s basic investment philosophy is conservative in nature and emphasizes preservation of capital, diversification, and a sensible level of risk. We use a top-down approach in our investment process, utilizing macroeconomic analysis to construct the mix of our targeted asset allocation (equity, fixed income, and cash). We then select individual securities, mutual funds, or exchange-traded funds from those asset classes based on each client’s investment policy statement, as well as the potential long term value inherent in the particular security. The firm identifies a set of securities, across our three asset classes, from which we select for investment. Our firm emphasizes high quality growth and value-oriented stocks and mutual funds.
Initially, unless precluded by the client’s investment objectives and risk tolerance, most of our portfolios maintain a formulation of our targeted asset allocation mix of approximately 45%-50% fixed, 45%-50% equity, and 0%-10% cash.
We have shifted the asset weightings in our portfolios from time to time as market conditions change. But any allocation shifts have been incremental and within a narrow range. We are never 100% out of stocks, because we are convinced that we can always find stocks and funds that will beat the returns on cash by a comfortable margin over the long run. Likewise, we are never 100% out of bonds, because we are confident that we can always find some bonds or bond funds that will produce a higher long-term payoff than cash.
As long as interest rates stay this low, which has been the case over the last seven years, cash and its equivalents are typically used only to take advantage of opportunities to buy undervalued stocks and bonds. The level of cash that we allocate to most of our portfolios ranges between 0% and 10%. However, during periods of caution, we have increased the level of cash and correspondingly, when opportunities for further again arise, we have decreased the level of cash.
Overall, we have serious long-term concerns about the current level of stock valuations but we do not feel the fundamental and technical conditions are in place yet for a major decline. To the contrary, it appears that the upswing since February has enough momentum to keep the market on an uptrend, with occasional dips, through the seasonally weak period from May through October.
We truly value our business relationship with our Wealth Management clients and we will always strive to provide you with the best level of service. Thank you again for your time and we look forward to speaking with you soon.
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