Market Worries

June 2, 2016

Market Worries
By Michael K. Farr

In our May 11 Market Commentary, we wrote about how the most successful investors are able to drown out all the noise and focus on their long-term goals. We said that some of the strongest bull markets in history have taken root in the face of significant and widespread concerns about the investing backdrop - a phenomenon generally referred to as "climbing a wall of worry." And finally, we said that missing just a small number of the best-performing days in the market can have dramatically negative implications on your long-term portfolio returns. The conclusion? Stick to your discipline, maintain your dispassionate composure, and, most important of all, avoid trying to "time the markets" by constantly trading in and out of positions based on your daily whims.

Throughout the course of the current bull market, which admittedly began from very low levels in early 2009, there has been an overriding sense among individual investors that the second shoe is about to drop. And despite gains of over 200% since those market lows, we can still sense an uneasiness permeating some of our clients' minds. Whether it be the impending presidential election, the threat of higher interest rates, terrorism, Europe, China, or whatever else, it seems as though many investors see far too many obstacles to higher stocks prices anytime soon. About the best scenario many see is a continuation of the flat markets we've experience over the past 18 months. But more importantly, many investors continue to distrust the stock market as a mechanism for retirement savings and wealth accumulation. Are they right?

In short, the answer is no. The investor reaction to the financial crisis and Great Recession is a natural response to a very traumatic event. In a sense, many investors are experiencing collective Post Traumatic Stress Disorder (aka, PTSD). It took many years for Depression-era investors to regain their trust in the stock market and their willingness to accept some risk in the pursuit of better investment returns. Though our recent economic troubles were less severe and shorter in duration, many investors did see the lion's share of their retirement savings disappear in a short period of time. To make matters worse, many homeowners lost their homes and/or home equity as housing prices experienced their first meaningful downturn. So this is not the type of experience that is easy to expunge from one's memory.

Which brings me to an article I saw in The Washington Post this past weekend by Barry Ritholtz. After I read Barry's article I knew I had to revisit the subject of emotional investing. Barry's article, entitled " Say 'Yes' to the Financial Advisor Who Will Tell You 'No'," did a great job at describing some of the common pitfalls that individual investors face in the process of managing their own money. Covering a wide variety of psychological compulsions, Barry's list of fourteen common investing mistakes rings true now more than ever. In theory and in practice, an effective investment manager is able to help individuals avoid these mistakes and therefore earn better long-term returns.

* Taking on more risk than is prudent.

* Buying the hot new thing.

* Participating in an expensive, underperforming private investment (e.g., hedge funds, venture capital).

* Using excess leverage.

* Following the advice of pundits or talking heads.

* Overtrading.

* Pursuing the latest media fixation.

* Speculating in commodities.

* Allowing emotions to steer investments.

* Buying low-quality, high-yield "junk" fixed income paper.

* Buying non-liquid investments (private equity, gated private investments).

* Market timing.

* Buying IPOs.

* Cherry-picking portfolio allocations.

It is important to note that the investment mistakes listed above apply regardless of your risk profile. Erring too far on the side of caution is just as common as investing too aggressively in the hopes of outsized returns. Those who got out of the stock market completely during the throes of the financial crisis in favor of capital security incurred huge opportunity costs. The damage from this decision has compounded as stocks (using the S&P 500 as a proxy) have produced positive returns in every year since 2008. The reality is that most of us need to earn a return on our savings to be able to someday retire with financial security. Throughout our history as a country, there simply hasn't been a better investment class than stocks for those seeking to generate superior long-term investment returns. Given the current level of interest rates, we believe it is highly likely that stocks will continue to be a very important tool for achieving retirement goals.

So, in summary, leave the worrying to us. That's what we're here for. Determining the possible implications of changing economic trends and other market influences is our job, and we take it very seriously. The highly tenured and credentialed analysts and portfolio managers at Farr, Miller & Washington spend their days analyzing your portfolio's composition and the tradeoffs between higher returns in good markets and capital preservation in down markets. As has been the case for a while, we remain defensively positioned and hope to be able to withstand many different market scenarios. Our defensiveness is achieved in a number of different ways, including investing in companies with broad company and industry-sector diversification; limited financial leverage; strong cash flows and limited dependence on capital markets; experienced and successful management teams; solid track records; reasonable valuations; and dividend support, among other attributes. Having said all that, we should also say that neither we, nor any other investment manager, get it right all the time. We think our approach to investing provides investors an opportunity to outperform the overall market (as measured by the S&P 500) over long periods of time without taking on more risk than the overall market. But all active managers, by definition, are at some risk of failing to beat their benchmarks over time. In other words, past performance is not an indicator of future results.

Finally, as an Registered Investment Advisor (RIA), FMW is required to operate under the fiduciary standard. This means that we must always put our clients' interests first when making investment decisions. So, as Barry says, "If you want to make an expensive gamble, enjoy a lovely vacation to Monte Carlo, but please leave your retirement plans out of it." We agree whole-heartedly.

Peace,

Michael