Happy New Year everyone!
Time Magazine’s
cover story, in their November 26, 2012, issue proclaimed, in huge, bold-faced
type: “WHY STOCKS ARE DEAD (And Bonds
Are Deader)”. Headlines like that scare
a lot of people, especially when they are being bombarded from all sides with
doomsday articles on the so-called “fiscal cliff” and all the dire things that
were going to happen when we were supposedly going over it.
If, as Time
proclaimed, bonds are even deader than stocks, how are we supposed to invest
our money? Are we to leave it in cash
with money market yields at essentially zero? Well, you had to read all the way to the fourth-page ending
of the article to learn that the protagonists of the story, Bill Gross and
Mohamed El-Erian of PIMCO Investments, are buying blue-chip stocks rather than
bonds (their primary business).
According to El-Erian and Gross: “Blue chips have become the new
bonds. Multinational franchise firms…
can spread risk around the world while delivering a 3% inflation-beating
dividend…. Well-capitalized growing firms that are undervalued because they are
in beleaguered markets are also smart plays.”
So, the conclusion of the Time article is the exact opposite of the
bold-faced headline.
When all is said and done, the shares of strong, undervalued
companies are perennially the best investments.
And that’s exactly what we have said and done for years. We look for companies that create economic
value by perennially producing returns on invested capital that exceed their
costs of capital and look to buy them when they are undervalued. Buying and holding stocks has been difficult,
at times, in the last 10-12 years but, during that long and sometimes unsettled
period, it has been, and continues to be, the right way to invest.
In the context of the daily news cycle, it is good to step
back and remember where we are economically at the moment. In their 2009 book “This Time is Different”,
Reinhart and Rogoff demonstrated statistically that financial-panic induced
recessions historically have a long tail of approximately seven years. Beginning in late 2007, we have just been
through the worst financial panic since the great depression, so statistically
we should not expect our difficult economic conditions to fully abate until
sometime in 2014 or 2015. And that’s
about how it feels. Unemployment is
gradually improving, but it looks like it will remain high for several years to
come. The housing market, while a bit
better, is still soft. Automotive and
retail sales remain slow and inflation is non-existent, at times bordering on
deflation. Households continue to
relentlessly pay down their debt, which is theoretically a good thing but, when
you’re paying down debt, you put off major purchases, such as cars and houses for
several years (perhaps to 2014 or 2015).
So, while corporate profits are gradually improving, it is unlikely that
they will become really robust for several years to come. In the meantime, shares of good companies can
be expected to remain reasonably stable and dividends should generally be
secure, as the economy continues to slowly improve.
Finally, as we have expected for several months, the United
States did not go over the fiscal cliff, despite the horrid prognostications of
the national (and international) press. Of
course, much more remains to be done in cutting spending to reduce the deficit,
so we can expect a lot of political posturing and nay-saying throughout the
coming year. Nonetheless, everyone
should keep in mind that the United States of America is not having any problem
funding its debt obligations at historically low interest rates. That is primarily because
the debt of the United States is safer by far than the sovereign debt of any
other country in the world. So, we are
not Greece (or Italy or Spain) and debt Armageddon is not upon us just yet,
despite the cries of the far right during our recently concluded presidential
campaign.
In conclusion, here is the last paragraph of our blog two
years ago, at the end of December 2010:
We are avoiding market-timing, looking instead to “draw
our own line” that wavers less than the markets. We do this by investing only
where we see value and value-creation for the long-term, sometimes regardless
of the level of the stock market. As frustrating as the past decade has been,
that strategy has worked for us and resulted in better returns than the market
over time. Making predictions about future stock market values can be eternally
futile. We will stick with what we know and pursue our strategy of creating
wealth and preserving capital by investing in companies that consistently
create value for shareholders.
Ditto!
Happy New Year,
Jack and Peter Falker
January 4, 2013
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