Earlier this week a reader left a comment asking what I do when financials go up a lot and everything else just sort of muddles. From the question it seemed like he knew that I am light on financials and so would lag on that type of day. With regard to the question, I'm going to add one plus one and get eleven in exploring how to think about performance.
Anyone who is active in the markets and mediocre in their ability to construct a portfolio and navigate the market is going to have years where they beat the market and years where they lag the market. There is no avoiding the occasional lag, or the more than occasional lag. The sooner people realize this the better their experience with investing will be.
At any point in time, an actively constructed portfolio will be tilted to some sort of outcome (intended or not) and away from some other outcome. When the market favors the biases built into a portfolio (again, intended or not) the portfolio will do relatively well, but if the market does not favor these biases for some period of time the portfolio should be expected to lag. If you can understand that no one can be right all the time and that a portfolio will be subject to both sides of this coin--that is just how it is--investing should be less emotional. So, if you lag for a year that just means that the biases in your portfolio were probably not in favor.
All of that notwithstanding, the thing that matters more than anything else in investing is having enough money when you need it or, perhaps more correctly, giving yourself the best shot at having enough. An easy way to do this, although the comment is somewhat glib, is to avoid or minimize doing truly stupid things like selling out after a massive decline or putting way too much into a lottery ticket biotech stock.
This has lead me to focusing on the result achieved over a longer period of time like a complete stock market cycle. In looking at the entire cycle a path of minimal resistance is to think in terms of going along for the ride when the market is going up a lot, going up a little or going down a little and trying to sidestep when it is going down a lot. Obviously, I view the S&P 500 going below its 200 DMA as a good warning for when down a lot might be likely.
A few days ago I posted a made up example of a portfolio that lagged the market in every up year but got defensive at the right time and so, for the length of the entire cycle, came out ahead. I asked rhetorically whether the portfolio beat or lagged the market and, of course, the answer depends on the time frame.
One reason I focus so much on foreign markets is that I believe they make the task of going along for the ride easier and actually offer the opportunity for doing better than just going along for the ride; again, over longer periods of time and not quarter to quarter.
I've made a couple of references to Bespoke's report on results for that just ended decade for various foreign markets. As the US was dropping 24%, countries like Chile were up 194%, Norway up 121%, Brazil 301%, Australia up 51% and China up 136%. I believe I've written about those countries more often than any other countries and obviously I own them for clients. I did not start buying them (and writing about them) to chase alpha but because they have different fundamental, economic attributes than the US (less so with China than the others). This will be a repeat for long time readers but countries with different types of economies are likely to be at different points in their economic cycles and so different points in their stock market cycles thus offering the chance at equity diversification.
Understanding that those countries are different than the US is easy. Looking at the most basic of economic data like GDP, unemployment, deficits (or surpluses as the case may be) inflation and debt is also easy. This can lead you to some very simple conclusions about the economic footing these places are on versus the US. From there picking how to invest in these countries is more difficult but not as difficult as some would have you believe.
As Bespoke's numbers show, getting the country right can have a meaningful impact longer term for a portfolio. To be clear, shorter term anything goes. Two stocks I have mentioned frequently as owning are Statoil (STO) and Vale (VALE). From the beginning of the last bull cycle (actually Jan. 1, 2003) STO is up 200% and VALE is up 1200% versus 23% for the S&P 500.
Over the whole cycle they have added a lot of value for any US based investor who owned them. However, during the worst of the bear market they dropped a lot. From their respective peaks, both about eight months after the US market peaked, STO dropped 68% and VALE dropped 79%. Both have since come back a lot but are still well below their highs. To the extent that buy and hold may not be the best strategy I did chronicle a couple of lucky partial sales in each name and a lucky re-buy with STO but had that not happened still plenty of value added over the longer term with these names. I would note that both examples are mega caps in their respective home markets as opposed to obscure microcaps.
The portfolio as it stands now is vulnerable to stretches where the dollar goes up. This has been the case for quite a while. I do not buy the fundamental case for a stronger dollar but the dollar can go up for any reason at any time and when/if that happens the portfolio will lag. It it looks like the dollar might rally for an extended period it would be possible to add another domestic stock or two to lessen the impact but if not done successfully the portfolio will lag.
This line of thinking is probably easier for clients who have been with us for several years than for someone new, and if you have not thought about it in these terms then it might be difficult for you to really grab on to, but I am convinced it makes the task easier.
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