Wednesday, November 14, 2012

News Flash: Equity Markets Don't Move In One Direction

Yesterday I posted some sage advice from the Oracle of Omaha.

In the clip that I embeded, Warren Buffett said that investors should focus less on political and economic events, and more on finding good companies selling at reasonable prices.

I would take it a step further, using some advice from Buffett's business school professor Benjamin Graham.

In his seminal book The Intelligent Investor, Graham urged investors to consider the risks and rewards of the available asset classes, and allocate their investment portfolio according to where the best opportunities seem to lay.

Graham, like Buffett, was not a big fan of market timing.  However, he recognized that returns in markets are not linear, and that periodic rebalancing of portfolios based on sound analytical work made sense.

Four years ago, the financial market were reeling in the aftermath of the bankruptcy of Lehman Brothers in September 2008.  Many investors were running away from "risky" assets such as stocks in favor of secure government bonds.

Buffett wrote an editorial for the New York Times dated October 17, 2008, urging investors to avoid the temptation to flee stocks in light of the prevailing economic turmoil.  His words then are still true today, in my opinion:

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts. 

Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”

If you had followed Buffett's advice, you profited handsomely.  Not including dividends, the S&P 500 is up nearly +60% over those dark days of 2008, far outpacing the returns of nearly every other class.

Note that the returns did not occur evenly.  There was the scaring slide of -26% in early 2009, followed by declines of -16% in both 2010 and 2011.   Even this year, stocks declined by nearly -9% in the spring.  Markets rise, they fall; this has always been the pattern.

But the longer term trend remains upward.

Yet you still hear the same advice:  Head to the sidelines, and the safety of cash, until the "coast clears". The fiscal cliff looms, the euro is a mess - you name it, there are any number of reasons to be concerned.

However, history suggests that investors who focus on the asset classes offering the best chance for growth, income, and inflation protection will surely be rewarded.

And the only asset class that fits the bill on all three counts today is stocks.