The Value of Prognostication
“Not moving because things are unfamiliar-and you haven’t bothered to
learn how to operate on them-I think is really a crime. The uncertain is the
unknown, and the unknown is the future, and you cannot predict the future.
But the unfamiliar? You can learn how to operate in that.”
Welcome to 2014.
I start this commentary with a quote about risk from a prominent international consultant and strategist. I carry it in my wallet and read it almost daily.
This is annual forecast time; the gurus of finance will tell us what to expect for 2014. The only problem is that, as Ms. Gadiesh states, you cannot predict the future. According to the “experts”, 2013 wasn’t supposed to be a very good year.
The short term is always unpredictable, but the historic long-term has a predictable trend for over 200 years, upward. How thankful we are that our general buy and hold and re-balancing strategy produced very decent double digit gains for nearly all accounts. We will continue in that vein again.
“A Barron’s cover story appearing in November 2012 warned investors to “get ready for the recession of 2013.” The title of a Time article on the outlook for financial markets that same month shouted, “Why Stocks Are Dead” in oversize type. A prominent economic forecaster who predicted the downturn in 2008 suggested that four elements—stagnating US economic growth, the European debt crisis, a slump in emerging markets, and military conflict in the Middle East—could combine and lead to a “superstorm.”
Another prognosticator—and longtime Forbes columnist—ticked off a long list of worries, including a new wave of housing foreclosures, persistent government deficits, weak consumer spending, high unemployment, and unsustainable corporate profit margins. His prediction for 2013: “the S&P 500 Index drops to 800, a 42% decline.” Others fretted about a deepening slump in China that could drag the rest of the world down with it.
Detroit’s bankruptcy filing in July—the largest American city to do so—and the acrimonious debate over public finances in many cities and states suggested to some that a tectonic shift in municipal finance was underway with worrisome consequences. One prominent Wall Street researcher observed that “the aftershocks of the largest municipal bankruptcy in US history will be staggering, and Detroit will set important precedents.”
Individual and professional investors alike braced themselves throughout the year for a sharp selloff that never materialized. At times, the perverse reaction to rising prices was not delight but apprehension of an even steeper decline to come. On March 5, 2013, for example, the Dow Jones Industrial Average finally eclipsed its previous record of 14164.53, set in October 2007. But the Financial Times reported that the prevailing mood among veteran New York Stock Exchange floor traders was “more anxious than joyful.”
Month after month, a Greek chorus of financial journalists recycled the same arguments we have heard regularly for the past several years: Economic growth is well below average, stocks are expensive relative to earnings, corporate profit margins are historically high and can only come down, earnings growth is too weak, asset prices have been artificially inflated by an expansive monetary policy, and so on. A sample of headlines that might have unsettled investors appears below.
January 12 “Rebirth of Equities Ain’t Necessarily So,” Financial Times
February 8 “Scant Pickup in Economic Growth Seen for 2013,” Wall Street Journal
March 7 “Stock Markets Defy Economic Woes,” Financial Times
April 2 “Lesser Expectations: Earnings Hopes Dim for First Quarter,” USA Today
May 18 “Stock Market Optimism on This Scale Hard to Explain,” Financial Times
July 7 “As Investors Rush in, Stocks Are Sending Warning Signals,” Wall Street Journal
August 24 “Lofty Profit Margins Hint at Pain to Come for U.S. Shares,” Wall Street Journal
September 1 “Profits Boost Needed for Wall Street’s Equities Run,” Michael Mackenzie, Financial Times
October 7 “Get Ready For a Drop in Stock Prices,” Shefali Anand, Wall Street Journal
November 16 “Is This a Bubble?” Joe Light, Wall Street Journal
With so many economic hobgoblins to frighten them, many investors found it easy to dismiss more positive developments as unsustainable or irrelevant. Auto sales, for example, have been surprisingly strong in recent years, but investors could find plausible reasons for caution in 2013. A New York Times financial reporter observed, “After steady increases for decades, Americans are driving less. … Walkable cities are growing faster than suburbs. And wherever people happen to move, they are buying smaller, more fuel-efficient cars. … This means that autos—one of the biggest industries in the United States—will not soon regain the explosive growth of the early 2000s.” Another sorry forecast?
What can investors learn from this year’s market behavior? Most of us accept the idea that predicting the future is difficult. And predicting how other investors will respond to unpredictable events is harder still. But, for some of us, the temptation to engage in such efforts is irresistible. If only we could do so, we could be so much wealthier, have the satisfaction of outwitting other clever market participants, and make ourselves more attractive to members of the opposite sex. But results from this past year tell us we should be skeptical of our ability—or anyone else’s—to do this well enough to outperform a simple buy-and-hold strategy. When investors are studying the long-run record of US stock market returns several years from now, we suspect many of them will find it difficult to recall exactly what it was that they were so worried about and discouraged them from pursuing the capital market rewards that were there for the taking.” (Wellington, Surprise! No Selloff in 2013)
A New Beginning
Ferguson Asset Management will begin doing business as Ferguson-Johnson Wealth Management in 2014. Derek Johnson joined me over thirteen years ago and has grown to be an excellent investment advisor, a truly ethical colleague, and perhaps most importantly, a friend. Derek and I will be joint owners of the company and, in case I am unable (I hope very far in the future) to manage my own personal assets, Ferguson-Johnson will, just as it does for others. I will continue working with clients just as I have for over 35 years. As a firm we are looking ahead – just as we do for you.
We have outgrown our office space and have been looking for a new location in the Potomac-Bethesda-Rockville area. We haven’t had a “house warming” event since 1986, but I hope to invite you to our new office location, when we find it, sometime in 2014.
In the future we expect to be sending you your quarterly report and commentary via e-mail. You will receive it faster than snail mail, while saving a few trees along the way. We have a few clients that are unable to download reports, so we will continue to send them via hard copy. If that is your preference, please let us know.
We are in the process of again updating our client relationship programs. We add notes to your file each time we speak. We schedule meetings and update your financial information so that your goals are updated and meetings don’t fall through the cracks or get postponed by either of us.
In the end of December, we added a state-of-the-art phone system that allows us to physically take the phone with us. We can communicate, receive, and make calls as if we were at our desks in the office. I was brain dead for a couple of days trying to cope with the system, but after a day of training we were able to get the hang of this wonderful, new means of communicating.
Change in Charges
The investments we make on your behalf are primarily in no-load, low-expense, mutual funds. We have migrated to this style of wealth management over the years because we are statistically convinced that it is a superior approach to asset management that rewards you with greater returns over the long run.
The typical expense ratios for mutual funds fall into the 1.5% range. This fee covers the funds’ operating expenses. The top 10% of funds have fees of 2.28% or higher according to the Financial Industry Regulatory Authority (FINRA). Some funds, Class A, charge front end fees and Class B funds have a contingent deferred sales charge. The fees in both of these Classes may be as high as 5%, although they do decline for higher initial purchases.
The funds we primarily use, such as Dimensional and Vanguard, have some of the lowest expense ratios in the industry. They do not compensate brokers or investment professionals. They do not pay custodians, such as Fidelity or Schwab, as other funds do. The ticket charge by Fidelity for the purchase or sale of the funds had previously been $25.00. Effective for 2014, Fidelity will now be charging $40.00 for purchases and $20.00 for sales. Please know that all of these charges go to Fidelity and we receive no monetary benefit.
We were informed of this additional charge by Fidelity in late November. We diligently analyzed what it meant to you, what our options were, and how meaningful this was to the performance of your portfolio. We concluded, because of the very low turnover created by our investment philosophy, that the effect on your portfolios would be trivial
Where do we go from here?
Last year our January 2013 report concluded that John Ferguson was as optimistic about the five year outlook for investments as he had been in the past 35 years. His optimism remains intact.
We wish you the best in health and comfort for 2014.
John, Derek, Christina, and Jon