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Investment Commentary: July 2, 2019

“In the short run, the market is a voting machine but in the long run, it is a weighing machine.” –Benjamin Graham

To a young student of economics and capital markets, this sentence was a revelation, a simple but powerful clue to the nature of markets—why they jump around as they do, manic one day, depressed the next, yet able to prove herds of investors and experts wrong again and again. At the time many brilliant scholars were satisfied with a theory that markets are efficient in their pricing and every move in price is a correct signal of a change in value. They felt little need to broaden or deepen their understanding of markets or market psychology. (Many still feel this way.) Graham’s words implied a bigger and more nuanced approach to markets was required.

The shorter-term, longer-term dynamic is rather intuitive. Stocks fluctuate daily and are caused by a number of factors, including news headlines, interest rate changes, currency moves, economic data, weather reports, and many others. Very seldom is a move in a stock in the course a day due to changes in the actual business or its earnings. As stock prices fluctuate to a much greater degree than the underlying fundamentals of companies or the economy as a whole, many, if not most, moves in prices in the short term are more noise than signals.

The longer-term, weighing market has but few drivers, and the most important is earnings. Simply put, a company’s stock price won’t grow and compound over time unless its earnings grow and compound over time. The stock market as a whole has little chance to grow and compound over time unless the earnings of corporate America grow and compound over time.1

A single product recall or earnings miss at Costco may make the voting market pessimistic about the company and even punish its stock price over a day, week, month, or year. However, the bad news will likely be meaningless to the weighing market over time if Costco continues to open new stores and gain millions of happy members. (Costco has 536 stores in the U.S. and 237 internationally; the company says it has the opportunity for 1,000 stores in the U.S. and 1,000 internationally over the long term.) Graham’s lesson was also a hopeful one: not every market move in the short term can be explained (or needs to be.) There is more wisdom in markets over time.

Investing at its best is identifying severe dislocations between shorter-term myopia in markets (whether unduly euphoric or panicked) and longer-term realities. Unfortunately, those conditions are few and far between, especially for the stock market as a whole. There seem to be healthy amounts of both optimism and pessimism currently.

1 The general level of interest rates over time matters, too. Lower interest rates mean higher value for stocks over time; high interest rates mean less value. For example, all things equal, if government bonds pay 10% annually, risk-free, over the next 10 years, the market would likely pay less for stocks than it would in a world where government bonds pay only 2% annually.

Still, Graham’s wisdom is relevant today. There are bouts of euphoria and panic; they just seem iterative and short lived. Nothing seems to guide markets more than Trump’s Tweets and casual comments from the Federal Reserve. Tariffs are declared only to be repealed or postponed. Just six months ago the market expected—and feared—the Federal Reserve would raise interest rates three times in 2019, possibly choking off economic and market growth. Today, the market is pricing in three interest rate cuts in 2019. There are rising concerns about the global economy, but U.S. stocks are up this year and are back at all-time highs.

The shorter-term market action suggests it’s time to be bullish. But zoom out a bit and you’ll see the stock market is virtually unchanged over the last 18 months, probably because both bulls and bears can find a lot of supporting arguments. Our guess is there is more market wisdom over 18-months than the last month.

We have been participating in what has been a good year for returns but have been defensive. We feel this is still prudent but acknowledge the market could break out of its 18-month slumber, possibly on news the trade war will de-escalate officially. For now, like the market, our attitude is wait-and-see and being mindful of the voting machine—especially regarding Tweets.

Notable Trades

The following summarizes new and exited positions during the past quarter in our Core strategies (conservative, asset allocation‐driven and absolute return‐focused portfolios representing a majority of our clientele). Note that not all portfolios participate in every trade idea due to clients’ circumstances, portfolio size, or other factors. Some portfolios are managed primarily, or exclusively, with exchange traded funds.

New buys:

The Walt Disney Company (Ticker: DIS)
Disney owns and operates media networks (including ABC and ESPN), theme parks, hotels, cruise ships, and Hollywood studios (including acquired franchises in 21st Century Fox, Lucas Films, Pixar, and Marvel). Content is king now with internet supplanting traditional media distribution, and Disney is now better equipped to compete with Netflix and other powerful platforms after a late start. Disney’s recent control of Hulu and a focus on Disney+ should help it move forward in amassing video streaming subscribers. The other parts of Disney’s business are booming, and the company remains well managed. Dividend yield: 1.2%.

Cisco Systems, Inc. (Ticker: CSCO)
Cisco is a leading maker of products and software for networking and transporting data, voice, and video. 5G is the upcoming fifth generation wireless technology that will allow for an exponential amount of data to be transmitted faster and with lower latency and more connectivity across devices. The Internet of Things will be possible with 5G, and Cisco should play its part as enabler and beneficiary. Dividend yield: 2.5%.

Vanguard Real Estate ETF (Ticker: VNQ)
Heightened uncertainty justifies increased diversification and yield. Traditionally we have avoided real estate investment trusts, our biggest concern being managements’ incentives to maximize size and square footage under management (because they get paid more) rather than maximize value for shareholders. REITs constantly raise capital by selling shares and taking on more debt, almost ensuring that at some point current investors will be diluted with bad real estate acquisitions. The current environment of cheap and cheaper capital, lower yields, higher uncertainty, and a Trump tax code that increases REITs’ tax-preferred status lead us to investing a small amount in this diversified REIT ETF. Investors get ownership of cellular towers, data centers, self-storage facilities, office buildings, warehouses, hospitals, nursing homes, malls, strip malls, apartment buildings, hotels, and timberland. Dividend yield: 3.9%.

Freeport McMoRan Inc. (Ticker: FCX)
Freeport is the large producer of copper, gold, molybdenum, and other commodities. While anything commodity-related is inherently speculative, our small investment Freeport stock adds to our “weak dollar” hedge. A trade deal could send Freeport stock higher, especially given poor sentiment and years of underperformance. Dividend yield: 1.8%.

Raytheon Company (Ticker: RTN)
We returned to this prime defense contractor due to valuation and its upcoming merger with United Technologies aerospace division. One way of looking at this “merger of equals” is Raytheon getting United Technologies’ valuable franchises—including its Pratt & Whitney engine business—for no premium. Dividend yield: 2.1%.

Sells:

We sold health care giants Amgen (Ticker: AMGN) and Johnson & Johnson (Ticker: JNJ) on deteriorating fundamentals and increasing odds of some form of price controls.

About the Author


Neil Rose, CFA
President & Chief Investment Officer
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