We are not high-risk investors, but we are here to make money for you. Like the door prize rule: “You must be present to win”. Together, (we invest your money the same way we invest ours) we have all been present for a very profitable year. Despite troubling forecasts from experts, we held our usual complement of equities all year and favored emerging market stocks. The results have been more than pleasing. Our equity funds earned between 23 and 34 percent for the year 2017. Excepting bond holdings where appropriate, all of you have enjoyed these results.
We take no credit for the great year. And we can’t predict the next market downturn. Markets have a mind of their own and do not dance to any piper, so our managers don't invest based on forecasts. They don’t follow trends or try to be in or out of the market at the “right” time. The quality of the company and the share price dictate most everything. Companies are sold when they get expensive or when changes in the business make the investment no longer attractive. That's why one of our best growth stock funds was fully invested last January but is presently holding 20% cash. It sold stocks that recently got pricey relative to earnings. That cash will be reinvested but only when better value becomes available. So, we do “go to cash” but not for reasons you’d expect. Since decisions are based on things that are known rather than unknown, we do expose you to wild market swings but have little exposure to underlying investment failure. We aren’t gambling—and time is on our side. This is the secret to how we have kept a loyal family of clients for decades.
Oddly, some of the smartest money on Wall Street made very modest returns last year. Most were forecasting an unpleasant year and invested accordingly, so their clients' accounts weren’t positioned to benefit when stocks took off. Now that the economic picture is brighter, many of these same experts are forecasting a better year for stocks and are increasing exposure....in effect buying stocks after they have gone up. That is the inherent flaw in focusing on the headlines and the macroeconomy. Nothing in last year’s headlines looked encouraging for stocks. They went up anyway. You must be present to win.
So, what do we see now? Economies are picking up steam globally. The U.S. has led with Europe and the emerging world following not far behind. Profits are now increasing from revenue growth rather than from cost cutting....good for employees as well. The numbers keep coming in stronger than expected.
But.....we think American stock prices fully reflect this. The biggest names dominating the indexes look expensive to us. There is still plenty of upward momentum, but the bargains just aren’t there. Trillions of dollars in index funds own stocks indiscriminately....concentrated by weight in some of the biggest and most popular companies....and they can sell with a hair trigger. Indexing has worked well in recent years, but we are convinced things are out of proportion, that seismic shocks are inevitable, and that careful selection is the only sensible course. I'll also continue to warn of a possible disruption in the bond market if or when the Exchange Traded Funds (ETFs) face heavy demands for liquidation.
The emerging markets look different. They've had a great year but are still deeply discounted to reasonable valuations. Very attractive long term.
What do you need to know regarding the new tax law? Not much....unless you are a successful small business owner with high “pass through” earnings. Ignoring politics, personalities and polemics, I think the tax changes are good. Our corporate tax rates have been the highest in the world and shareholders are double taxed on dividends. The corporate cuts will bolster earnings and cannot help benefitting the country, not just the fat cats. Real take home will also increase for the largest swath of taxpaying families.
We've packaged this letter with an Outlook report from Capital Group. It will flesh things out in more detail. From all of us, thank you for your trust.
— Brent Forrest