An Independent Registered Investment Advisory

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    Growth vs. Value: The Myth

    There is a never ending discussion over which is better, owning growth stocks or value stocks. Depending on your timeframe the returns are the same for both. The two styles vary their performance returns, one coming into fashion and then a couple of years later the other style will outperform. Vanguard funds did a study some years ago that was most surprising. Over a 60 year period from 1937 to 1997 the returns were almost identical. Growth stocks returned an average of 11.7%, while value stocks returned an average of 11.5% over the same time period. What is important to take away from this study are two points; both growth and value perform the same and over 60 years the companies returned 11.5% compounded.

    If you had invested $100,000 in 1937 through 1997 and reinvested your dividends, the annual compounded return was 11.5%. Your $100,000 investment turned into $76,393,000! No that is not a typo, $76 million. So if the question is which is better, growth or value, the answer is yes! That is the power of compounding over 60 years.

    Let’s take a more recent shorter period of 20 years, from 1995 through 2015. We are all more familiar with this timeframe. The dot.com bust, 9/11 and the resulting war in the Middle East, two recessions and two huge stock market selloffs. Your $100,000 during that time period, invested in the market with dividends reinvested returned an annual return of 9.44% compounded. Your $100,000 would be worth $665,000. If we used a 10 year period from 2005 through 2015 the same $100,000 turned into $212,000.

    These calculations are based on the actual yearly returns and dividends for the time periods indicated.

    The point of my illustration is to ask you not to be alarmed when there is another selloff in stock prices. There will be another selloff as there always has been since there have been markets. Rather than succumb to all the hype and hysteria by the press during declining markets, think of it as an opportunity to add to positions in great companies at lower prices. Declining markets feed on fear and selloffs occur much faster than markets rise. The declining prices usually only last months, where gains go on for years. The stock market is the only place customers run for the exits when prices are marked down.

    Average returns are a smoothed out single number, such as 11.5%, the average return from 1937 to 1997. Rarely will any one year return be 11.5%, instead one year returns may be +17% and the next year return may be down -5.5%. Do not expect for markets to only go up, they do not. Just know the average over a long period of time, coupled with the miracle of compounding has been very rewarding. Even with all the ups and down, the long term investor that invested in stocks has done very well, better than anywhere else.


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    2015 Review

    Market

    The Market performance for 2015 was uninspiring with the Dow Jones Industrial Average down -2.2% and the S&P 500 off -0.78%. The year was marked by a substantial August and September sell-off. Following that sell-off we had an October recovery that was equally substantial. Volatility has increased all over the world because of a slowdown in China. The big loser for the year was oil, it was down -31% and the Industrial Commodities Index was off -15% in 2015. The big gainer was the U.S. Dollar up 9.3%. The NASDAQ composite was up 5.7% because of Amazon, Alphabet (formerly Google) and Facebook that are all at lofty PE ratios.

    The increasing U.S. Dollar has dampened export earnings and industrial companies have borne the brunt with lower prices. We do not expect another 9% plus increase in the dollar for 2016 and as a result some industrials are becoming more attractive. Healthcare, Technology and the Financial sectors hopefully all look to have positive returns along with some recovery in energy prices. We find high quality equities more attractive than investment grade bonds for 2016. Selectivity will be most important for good results.

    Our Pacific Portfolios performed in line with the market indexes, with one major difference. The portfolios held an oversized position in cash and short term U.S. Treasuries of about 20% for a good part of the year. Our accounts took less risk to produce approximately the same return as the Dow Jones or S&P 500 index. We at Pacific Coast Investment Advisors are risk adverse investors and seek to receive the going rate of market return while at the same time taking less risk than the market. We have maintained extra cash reserves to await opportunities during part of the last year and into 2016.

    Bonds

    The 10 year U.S. Treasury bond yield was almost unchanged for 2015 at 2.23%. Bonds overall held their prices for the year with the exception of “Junk Bonds” or “High Yield” bonds which declined -10% during the year. Junk bond issuers sold more junk bonds than any time in their history. We are always surprised to see new clients bring in old portfolios that have an abundance of junk bonds. The surprise is to see these low quality bonds in conservative investors’ portfolios to the degree that they are today. Bond quality is important, the low quality is reflected in junk bond prices which are declining and many will default in 2016 and 2017. We have avoided these bonds for just that reason; the risk to principal exceeds the income potential. For 2016 we expect another relatively unchanged return for bonds except for junk or high yield bonds. There is a global slowdown that is being offset by QE (quantitative easing). We expect this QE to continue. If oil and other commodities remain near these prices junk bonds will continue to suffer. Beware high yield!


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    December 2015

    Market Update

    The long awaited increase in interest rates may arrive soon. It has been 9 years since the Fed last increased rates.

    The global economy has been slowing, especially China and other Asian countries. Europe has limped along flirting with recession and low growth rates. Oil prices and especially industrial commodities have sold off because of slower Asian demand. There is excess capacity in manufacturing and employment offshore, adding to low inflation and slow growth worldwide. Most world currencies are lower than a year ago. The one exception has been U.S. dollar. The dollar is higher with increased interest rates in the outlook. Low oil and other commodities have added to better consumer spending, low mortgage rates and high corporate profit margins. The unemployment rate is nearing 5%, a number the Fed feels is full employment and a number which inspires inflation. Since oil prices and other commodities along with interest rates may not go a lot lower from here, profit margins may not increase. If the U.S. economy can continue forward there may be a surprisingly quick up-turn in inflation and a reflection in interest rates.

    U.S. stocks as a whole are valued higher than European and Asian companies. Asian markets have sold off on the heels of the China slowdown.

    China announced their new 5 year plan to grow their economy 6.5% at a minimum. That is a big number compared to the rest of the world, but much slower than their last 5 years. They are also going to redirect their economic focus from a low cost manufacturing nation to a balanced economy that is consumer driven.

    European shares are a good value as to their prices but offer very slow growth. The ECB and its Chairman Dragi, intend to continue a policy of Quantitative Easing, which will provide a lot of liquidity. Liquidity in the system, especially banking, allows borrowers time to make adjustments to negative changes in their industries. When liquidity dries up sellers are forced to sell to fewer buyers and prices can decline dramatically.

    The increase by the Fed to normalize interest rates along with increasing wages and eventually higher commodity prices, will increase the headwinds for American companies' growth in profits.

    We think it is wise to diversify, slightly, into some less expensive European and Asian blue-chip companies with a part of the equity portion of the portfolios.