2020 Q1 COMMENTARY:
Contrary to what logic might suggest, the most difficult time to be an investor is when the financial markets are in the late stages of a multi-year upward trend. As we witness market levels hit record highs, the appetite for adding new money to investments can start to wane for fear that the most opportune time to buy has already passed us by. It’s an innate thought process. Since we were little, we’ve all been taught that too much of a good thing is not always a good thing, and it’s a legitimate lesson that I’m sure we’ve all learned multiple times in our lives.
Looking back on the 2010’s decade, it was a good one for the stock market. The exchange-traded fund (ETF) index investment designed to mirror the performance of the S&P 500 index, which we informally call the “Spider”, fared very well in the decade. It recorded an annual average rate of return of 13.4% over its full duration. Furthermore, each of the nine primary U.S. stock sectors we track also finished with positive annual average returns for the decade. That’s the fruit that a “rising tide” market can bear. However, when the tide goes out, which it does from time to time, investment selection and management becomes much more challenging. One way to attack a falling market is to become even more tactical in the investment selection approach by trying to find mispriced investment opportunities.
In 2019, we began placing more emphasis on individual stocks as part of our portfolio construction process. With trading commissions now removed, the barrier to entry to cost-effectively own stocks without sacrificing diversification can be achieved. We can’t control short-term swings in any stock, but we can confidently accumulate shares of companies that we feel are built for the long haul. It starts by examining leadership stocks in each sector. We study market demand, revenue growth, earnings growth, R&D pipeline, chart patterns, width of competitive moat, relative strength, and a host of other metrics as they relate to a specific stock. If a stock checks all of the boxes for us, we complete the process by asking ourselves one question, “Is this a company we’d be willing to own under any type of market condition?” If the answer is yes, we accumulate shares across portfolios. Below is a sample of some of America’s favorite stocks vs. the S&P 500 during the last decade. Of course, past performance is not a guarantee of future returns, but this table does illustrate historically the validity of the logic behind owning individual leadership stocks.
Not every investor should own individual stocks. For some, owning single stocks just doesn’t fit their risk profile. For others who are just getting started in investing, gaining exposure to stock market investing through exchange-traded funds (baskets of stocks that comprise an index) is more prudent. However, for well-capitalized accounts that carry a growth objective, individual stocks will become a more integral part of our investment portfolios in the decade ahead. Our core strategy will still be in ETF investments, but we’ll seek alpha returns by utilizing individual stocks when and where it makes sense.