VOL. 130 | NO. 240 | Thursday, December 10, 2015
The Worldly Investor
DAVID S. WADDELL | Special to The Daily News
Over the last 13 months, or 262 trading days, the S&P 500 has produced a 0% return while the Barclays total bond market index has produced an enviable 1%. Over the last several weeks I have received several calls and emails from clients, fatigued by sideways markets that want to “do something” about it.
This emotion, while understandable, can often lead to mistakes. One of our roles as investment advisors is to help clients widen their field of view and mitigate the risk of trading mistakes. Over the past twelve months the markets have produced some distinct winners and losers. US stocks +.91% vs. international stocks -7%. US internet and biotech stocks +20% vs. US energy stocks -20%. US growth stocks + 7%, US value stocks -4%. Which would you buy if you were craving returns? Clearly large cap US growth themes like biotech and technology make money while US value themes like Europe, emerging markets and commodities do not.
Human beings have an inherent bias to extrapolate forward recent performance. This tendency seduces investors into buying high and selling low. Over a long period of time, these emotional adjustments detract about 4% annually from average investor performance as measured by DALBAR.
Extending the Field of View. I recently reviewed a study from the well regarded investment team at William Blair. They project 8-year forward returns for various asset classes by summing up return components. For instance, they project that large cap US growth stocks will produce annual returns of 2.3% by adding a 2.1% dividend yield to earnings growth of 4.4% then deducting 4.1% for a contraction the P/E multiple. Essentially, they expect contracting valuations to deduct 60% from expected growth in dividends and earnings over the next eight years. Not particularly encouraging, but somewhat expected after an uninterrupted seven year rally in large cap US growth. Fortunately, there are other market areas better positioned mathematically for returns. William Blair projects the following 8-year forward annual returns: US Small Cap -3.9%, US Healthcare 1.4%, US Technology 2.1%, US Value 7.1%, US Financials 6.7%, Europe 7.8%, US Energy 12.2%, and Emerging Markets 13.8%. Therefore, by extending their field of view, investors should overweight financials, energy, emerging markets and US value…the polar opposite of what is working now!
Bottom Line: On December 16th, the US Federal Reserve will fundamentally alter the investment landscape by raising interest rates. While the escalation may be gradual, higher rates historically lead to lower P/E multiples. Overextended areas of the market like consumer discretionary (Amazon) and biotech (Valeant) that have enjoyed near vertical appreciation over the last seven years appear particularly vulnerable. Other areas that have failed to fully participate like the emerging markets, Europe and energy seem better suited for the next seven years mathematically. Of course, returns get calculated based upon end-points and the projections do not reveal the timing of rotation…only that it will happen within the eight year window. In today’s frenetic environment eight years feels like a lifetime, which brings us to the first rule of investing…discipline and patience required!
David Waddell is president and CEO of Memphis-based Waddell & Associates.