Focus On Fundamentals

The colorful New York Yankee catcher Yogi Berra is credited with saying: “baseball is ninety percent mental—the other half is physical.” It is clearly not a stretch to say that many savers and investors today are ninety percent mental about the stock and bond markets. There have been only a few times in history when all asset classes (stocks, bonds, real estate, commodities) have depreciated in value at the same time.       

We have just been through one of those periods. One result of the uncertainty is that the savings rate of the United States has risen from below one percent to an estimated four to five percent. As readers of this column know, savings and investment are what separate the little piggy who built the house of straw from the one who built the house of brick.

Of course, there are many factors for savers to reconcile these days, such as the value of currencies, inflation, deflation, foreign trade, oil prices, massive deficit spending, too much debt, global warming, and where are the 49ers going to end up. Joking aside, the overall picture is important to keep in mind.

During periods when all assets go down, diversification or asset allocation, which is the buzzterm of the day, did not help to insulate or differentiate portfolios. But the recovery in stock prices this year has been a remarkable validation of the power of diversification and perseverance. As of this writing, the index of small foreign stocks known as emerging markets has made a round trip in the past twelve months. That is, the index value was cut in half during the year but has recovered fully. Rip Van Winkle would have woken up and wondered what all the commotion was about. The large company domestic stock index is about fifteen percent off its last year level, and the mid-size company index is just slightly better than that.

Investing can be said to be like a game of golf. If you messed up the last hole, just restart on the next hole and get going again. Did you have a stroke of insight that led you out of everything last summer but never got around to buying back in when things were low? Or did you become very nervous watching your savings dwindle and sell near the bottom? Life is about what’s next, so what do you do from here?

A strong investment program addresses short-term and long-term circumstances. Growth of capital may be a longer-term goal so future income can be taken from a larger pot. For some investors, income is important right now. As I mentioned, last year was a tsunami for both, but this year, bonds have stabilized and stocks have recovered to more normal levels. Portfolios are being looked at with a longer-term perspective and an eye to stable returns. As an aside, one time I asked a small bird why he flies. He answered that he was a bird, and it was his nature to fly. Likewise, stocks, and to a lesser degree bonds, will fluctuate because that is their nature.

Income investors have always relied on bonds to provide income and return of principle, while stock investors must have a longer-term perspective to compensate for the volatility that is their nature. A prudently chosen combination of these assets may still be a winning formula for investors. If a portfolio allocation consists of a combination of these high quality assets and turns out to yield an annual return averaging eight percent, the portfolio will double in nine years, if you reinvest the earnings and don’t take anything out. Now eight percent doesn’t sound too exciting to many people, but doubling sounds very sexy to most.

Stock market gains for the decades of the 1980s and the 1990s were significantly above the long-term averages, returning annual average gains in the mid-teens. Two market collapses in this decade have erased those happy twenty years from many memories. Nobody knows the future and that is why the solid fundamentals of planning are as important today as they ever were.

Rick Glaze’s first novel, The Middle Fork, was published in May. He is the president of Glaze Capital Management of Los Altos as well as a General Securities Principal offering securities through First Allied Securities.