Monday, March 26, 2012

Focus on Fundamentals, Not Predictions

Famed Fidelity mutual fund manager Peter Lynch used to say that if you spent 10 minutes a year studying the economy, that was 10 minutes too much.

From 1977 until 1990 Lynch managed the Magellan fund for Fidelity.  During that period Magellan averaged an incredible +29.2% annual return.

Peter Lynch's success was largely due to his relentless focus on fundamental research.  He would spend hours listening, learning and analyzing stocks, looking for opportunities that others had overlooked.

However, as much as Lynch believed in fundamental research, he disdained investing based on broad economic or market themes. 

As he once wrote in his "20 Golden Rules for Investing":

There is always something to worry about. Avoid weekend thinking and ignore the latest dire predictions of newscasters. Sell a stock because the company's fundamentals deteriorate, not because the sky is falling.

Nobody can predict interest rates, the future direction of the economy,or the stock market. Dismiss all such forecasts and concentrate on what's actually happening to the companies in which you've invested.

Over the years I have come to fully appreciate the wisdom in what Peter Lynch was saying.

Economic forecasts are notoriously unreliable, and usually wrong.  Moreover, even if the forecast is actually correct, it offers little help in developing a successful investment strategy.

I was reminded of this again when I read Floyd Norris's column in Saturday's New York Times.

Norris points out that while the performance of the economy has been relatively poor since President Obama took office in early 2009, the stock market has turned in one of the best returns of any American president's tenure in office (I have added the emphasis):

From the fourth quarter of 2008 through the final quarter of 2011, the American economy grew at an annual rate of just 1.4 percent. Of course, the economy declined during the first two quarters of 2009, reflecting the financial crisis and recession that began before Mr. Obama was elected, and has since recovered all of the decline and more. Nonetheless, over comparable periods, the economy performed better in 21 of the previous 24 administrations. 

But since the presidential inauguration on Jan. 20, 2009, the stock market has risen at an annual rate of 16.4 percent, even after adjusting for inflation. That is better than all but four previous administrations.

Norris's piece is largely focused on the President's reelection bid, and what the divergence between the economy and stock market might mean.

To me, however, the larger point is this:

If I had told you in early 2009 that economic growth would average only slightly better than +1% for the next three years, you might have concluded that stocks should be avoided.

But, as the +16.4% compound return indicates, this would have been the wrong decision.

And so it is true today:  no one knows what the growth in the economy might be in the months ahead, or what the direction of interest rates is likely to take.

But the relative valuation of stocks - based on the fundamentals - suggests that stocks continue to offer the best opportunities to investors.