October 16, 2012
“With interest rates at all-time lows, stocks continue to offer investors the best prospects.” – Jeremy J. Siegel, Kiplinger’s Personal Finance, June 2013
We have certainly had a nice year so far. Most of our mutual funds are in the ballpark of where they should be given my high expectations for the underlying fund managers. Of course, the year is not over yet and we have a pretty significant presidential election that is just a few weeks away. In this letter I would like to address the phenomenal performance of Apple as well as pass along some of the information I have gleaned about future market return expectations.
There is one stock that I feel I have to mention due to its significant outperformance over the past several years. Apple Inc., which makes the popular iPhones and iPads, is up an astonishing 65.37% year-to-date. We own Apple via our Schwab and Vanguard total stock market and S&P 500 index funds where Apple is currently the largest holding at 3.63% and 4.41% respectively. This gigantic return so far this year represents 15% of the total S&P 500 return not including dividends. If a mutual fund did not have Apple in their portfolio over the past couple of years, chances are they are going to lag the S&P 500 for that time period. The value funds we own tend to shy away from fast growing technology companies for fear that they might over-pay due to unpredictable revenue streams. As we all know by now, value managers prefer financially sound companies that are selling at a discount; companies that have strong dividends.
- “The most important asset in the global economy is intangible human capital.” – First Eagle Funds Global Value Team investor letter – June 2012.
- “We still believe that equities remain the best way – maybe the only way – to beat inflation and build wealth over the long term. (We also think that equities are capable of beating the fixed income markets over the next five years.)” – Charles M. Royce, W. Whitney George and Jack E. Fockler, Jr. of Royce funds.
I am always thinking of alternatives to the investments we currently hold. Will these alternatives and will our current mutual funds hold up under extreme inflation? How will all of our securities perform if we encounter the government’s “fiscal cliff” that we keep hearing about every day on the news? Which securities will give us the biggest bang for our buck? I want to make sure that we have our bases covered regardless of the global economic outlook, the current corporate earnings picture and, of course, this fall’s election outcome. I want to make sure we participate in the upside, but I also want to be diversified enough to protect us on the downside. The above two quotations I have picked out from our managers’ semi-annual reports say it all in my mind: A strong case can be made for equity investing over the next several years.
John Bogle, the founder of the Vanguard Group, was recently interviewed on CNBC. When asked what his return expectations were for bonds and stocks, he explained that the S&P 500 is currently paying about a 2% dividend. Mr. Bogle suggested that stocks should have a 5% average return on earnings over the next decade (sometimes higher, sometimes lower) so if you add the two together you come to a 7% nominal average return. If you subtract 2% off for inflation, you end up with a 5% real return for stocks. He expects a nominal average return of 2.5% for bonds. If you factor in inflation for bonds, you are looking at a breakeven scenario. He went on to say that there is a 85-90% chance that stocks will post greater returns than bonds over the next 10 years. Who says there isn’t any risk to owning bonds?
Regarding the fixed income portion of your portfolio: I plan on keeping the 50% short-term and 50% intermediate-term mix of bond funds for the time being. As we get closer to the year 2015 – the year the Federal Reserve plans to possibly begin increasing short-term rates – I will move more money to short-term fixed income investments such as money market, Certificates of Deposit and short-term bond funds. Vanguard has submitted an application to the SEC for a short-term Treasury Inflation Protected Securities (TIPS) exchange traded fund that looks very promising. That might be a wonderful tool to use as rates and inflation edge higher in the years to come.
Best regards,
Bill