Despite our monetary skepticism, we believe at this point the market is behaving very rational. The equity market is no longer at a discount at current levels, nor is the market overvalued. We believe the most likely course for the equity market will be to move sideways as investors wait for economic growth. We believe the current growth rate should provide an average 6% to 8% rise in the equity market over the next 3 to 5 years. We believe that as long as the Fed and Congress develop growth policies such as rational tax reform.
We believe a revenue neutral tax reform emphasizing growth and rational regulation would generate economic growth exceeding 4% in the U.S. and over 5% growth globally. This type of growth without inflation above 2% could assist the U.S. in reducing its debt, reduce unemployment, creating real growth in wages and easing world tensions. Without any tax and regulatory changes, we believe growth will remain slow and the equity market will move higher and possibly too high for the fundamentals.
In either case we recommend an overweight to equities and zero allocation to fixed income above 7 years. We would only use fixed income for liquidity to fund 1 to 5 years of financial needs. We recommend to bar bell your investments with at least 60% to a global equity portfolio and the remainder allocated to 1 to 5 year maturities in fixed income, mostly corporates and mortgage backed securities.
Recently, CNBC commentators provided us with timely advice on the upcoming stock market correction. One prescient financial expert even projected as much as a 60% correction in the U.S. Stock market. Each commentator pointed to a particular factor in our economy that was blinking a red light for the stock market. The biggest culprit was the Federal Reserve according to many commentators. According to them, the Fed was manipulating asset prices higher by creating artificially low interest rates and we investors were drinking the Kool Aid and would suffer the consequences. After 30 years as an investment advisor, I have never been provided such advance warning on a correction in the stock market. I also reflect back on my 30 year career and suddenly realized that I did not know anyone or any organization that successfully predicted a top in the market and then successfully put me back in at the low or even close to the low.
Never have I experienced such a trade not even one of the 13 stock market down turns since 1968 and subsequent upturns was I provided advanced warning. Although, I began my career in 1984 not 1968, I have experienced the greatest bull market, the most severe down markets and crashes (even the new FLASH crashes).
Although, there are many individuals that have provided solid insight on overbought markets and even identifying over sold markets, but no one in my 30 years has identified all of them and then successfully advising when to sell and then when to successfully re-enter. Unfortunately, for many investors fear of loss is a far more significant motivator than a rational buy and hold strategy.
The greatest hurdles Investors have encountered in my financial career has been their inability to follow the most successful investment strategy that is available to them. The strategy I refer to is the much maligned strategy of creating a global diversified buy/hold long only portfolio. In the past decade, we have witnessed the explosion of hedge funds of all flavors. The fees attached to these strategies have dwarfed the mutual fund industry. Quite often, I have been lectured on the inferior, boring, unimaginative and feeble academic approach of recommending buy/hold long only portfolios. However, the buy/hold long only strategy has generally outperformed all other strategies during my career in the investment management business. I know it’s boring but I believe it works.
Our research has led us to believe that love may make the world go around but “Money” makes the stock market go up. I suspect money may make the world go around as well, despite our romantic inclinations. As stated earlier in this paper, the stock market in the U.S. has experienced 13 negative calendar years over the past 45 years*. On the other hand the total revenues of the stock market, as measured by the S&P 500, only experienced 5 negative years*. So investors predicted 13 of the past 5 recessions. When we discovered this fact it caught us by surprise because of the efficient market theory. So we reviewed the U.S. Equity market total nominal returns for the past 150 years. We identified six, 10 year periods since the U.S. Civil War in whichthe stock market returned less than 4%.