Lessons Learned

Beginning of the year letters are always hard to write because there is a tendency to talk about the year gone by, or worse, attempt to predict the year ahead. Therefore, we are titling this year’s letter in an attempt to share some of the lessons that should have been learned over the past few years. We begin with this quote from an Allstate commercial featuring Dennis Haysbert:

“Over the past year, we’ve learned a lot. We’ve learned that meatloaf and Jenga can actually be more fun than reservations and box seats. That who’s around your TV is more important than how big it is. That the most memorable vacations can happen ten feet from your front door. That cars aren’t for showing how far we’ve come, but for taking us where we want to go. We’ve learned that the best things in life don’t cost much at all.”

Charles Dickens’ classic novel begins with the quote, “It was the best of times, and it was the worst of times.” That quote is certainly reflective of the stock market in the year gone by as 2012 went down in the books with that moniker. To be sure, from the October 2011 “low” into the April 2012 “high” it was the best of times with the S&P 500 gaining some 32%, and we were bullish. From there, however, the equity markets got much harder; and is it any wonder? Indeed, it’s been said that the stock market anticipates events six months in advance. If that’s true, around the April peak the SPX started worrying about the Presidential election and then the “fiscal cliff.” Subsequently, the SPX declined 10.9% from the April “high” (1422) into the June “low” (1267). From there the rally resumed and peaked in September at 1475 before spending the rest of the year in a “struggle” (see chart on page 3). On the surface the nominal numbers portrayed a great year with the SPX sporting a total return of 13%+. Yet for most investors it was a pretty difficult year with roughly 90% of professional money managers underperforming the SPX as they worried about waning earnings momentum, softening economic statistics, Euroquake, a China debacle, a dysfunctional U.S. government, etc. Of course I personally don’t mind the underperformance because many of the folks who underperformed did so because they were managing “risk,” which is at the centerpiece of my investment philosophy. As often referenced in these missives, investors need to manage the risk, for as Benjamin Graham espoused in his book The Intelligent Investor, “The essence of investment management is the management of RISKS, not the management of RETURNS. Well-managed portfolios start with this precept.”

Investors should keep that quote on their walls so they don’t forget the major lessons learned since the 2008 Financial Fiasco. Yet, there are other lessons to be remembered. To that point, Merrill Lynch lost two of its best and brightest back in 2009 as Richard Bernstein and David Rosenberg left for less constrained environments. During their final weeks at Merrill they wrote about lessons they have learned over the decades. To wit:

Richard Bernstein’s Lessons

  1. Income is important, as are capital gains. Because most investors ignore income opportunities, income may be more important than capital gains.
  2. Most stock market indicators have never actually been tested. Most don’t work.
  3. Most investors’ time horizons are much too short. Statistics indicate that day trading is largely based on luck.
  4. Bull markets are made of risk aversion and undervalued assets. They are not made of cheering and a rush to buy.
  5. Diversification doesn’t depend on the number of asset classes in a portfolio. Rather, it depends on the correlations between the asset classes in a portfolio.
  6. Balance sheets are generally more important than are income or cash flow statements.
  7. Investors should focus strongly on GAAP accounting, and should pay little attention to “pro forma” or “unaudited” financial statements.
  8. Investors should be providers of scarce capital. Return on capital is typically highest where capital is scarce.
  9. Investors should research financial history as much as possible.
  10. Leverage gives the illusion of wealth. Saving is wealth.

David Rosenberg’s Lessons

  1. In order for an economic forecast to be relevant, it must be combined with a market call.
  2. Never be a slave to the data – they are no substitutes for astute observation of the big picture.
  3. The consensus rarely gets it right and almost always errs on the side of optimism – except at the bottom.
  4. Fall in love with your partner, not your forecast.
  5. No two cycles are ever the same.
  6. Never hide behind your model.
  7. Always seek out corroborating evidence
  8. Have respect for what the markets are telling you.

There was another savvy seer that left Merrill Lynch, but that was 21 years ago. At the time Bob Farrell was considered the best strategist on Wall Street, and while he still pens a stock market letter, his “lessons learned” are as timeless today as they were when written in 1992.

  1. Markets tend to return to the mean over time.
  2. Excesses in one direction will lead to an opposite excess in the other direction.
  3. There are no new eras – excesses are never permanent.
  4. Exponential rising and falling markets usually go further than you think.
  5. The public buys the most at the top and the least at the bottom.
  6. Fear and greed are stronger than long-term resolve.
  7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chips.
  8. Bear markets have three stages.
  9. When all the experts and forecasts agree – something else is going to happen.
  10. Bull markets are more fun than bear markets.

With these lessons in mind, we wish you good investing in the New Year.

P.S. – After weeks of being on the road I am actually on campus for the next few weeks, so call me …

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© Raymond James


© Raymond James

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