Blue Period

Courtesy of Mertim Gokalp

With tax-loss selling behind us, it’s time to contemplate 2015 and what the markets may have in store. Pundits predict a generally robust year, albeit with increased volatility. Despite the blather about the market being rational, it’s as zany and fickle as the people who trade in it. How else to explain seasonal effects like the “Santa Claus Rally”, “January Effect”, and the fact that years ending in a “5” give positive stock markets? (The number 5 was certainly lucky for Coco Chanel who named her first perfume Chanel No. 5. Its financial success has made the brand the juggernaut it is today.)

Despite attempts to explain these effects as expressions of rational behavior, I think it’s best not to overwork the dough, so to speak. Is the January Effect, when stock indices get a bump, the result of investors buying back stocks after December’s tax-loss selling?  I say, when Nature gives you a boon, just say ‘thank you’ and shuffle off before She changes her mind.

Pablo Picasso said, “If I don’t have red, I use blue.” This is great investment advice.

The latter half of the year saw a lot red. When the price of West Texas Intermediate dropped through the floor, the share valuations of many senior, mid-, and junior-oil and gas companies went along for the ride. Of course, some are now in oversold territory and may attract investor interest next year. Others, particularly those with overly-leveraged balance sheets, high production costs, and unhedged contracts, will find the capital markets unobliging, forcing them to slash dividends, put themselves up for sale, or simply close shop. Until sentiment towards this sector changes, best to put down the red brush and pick up the blue.

In 2015, it’ll be blue skies over the country the world loves to hate, America. Lower fuel costs will be a boon for consumers— and Americans do love to spend their way to happiness. Hence small-and mid-cap companies that sell within the domestic economy like Coach, Nordstoms, Home Depot, and TJX Cos., as well as those who typically spend a significant chunk on transportation, like Fed Ex and Amazon, for example, are sure to see fatter margins in 2015 and beyond.

Another ‘blue’ area is luxury products. According to a recent special report in The Economist, shares of public luxury companies have outperformed those of other companies since 2005. Hermes, LVMH, Prada, Burberry, Swatch, Kering, Richemont, and Diageo are doing smashing business. Avid consumers in Asia are more than compensating for lower demand in Europe and North America. But don’t cry for Europe. Its luxury industry sold $726 billion of covetable mercy in 2013 and has 70% of global sales. So, while its citizens have cooled it on luxury spending, the continent is still running the show and reaping the rewards through employment, exports, and increased GDP.

Bernard Arnault, the sharp-eyed LVMH honcho was once asked by the late Steve Jobs for his advice on retailing. “I’m not sure we’re in the same business,” replied Arnault. I don’t know that we will still use Apple products in 25 years, but I am sure we will still be drinking Dom Perígnon.”

So, let’s raise a glass of Dom to next year’s most promising sectors: U.S.consumer goods companies, U.S. financial institutions (the regional ones too), small-and mid-cap U.S. domestic companies, and U.S. pharma and technology companies. Russia is a dud but India is looking interesting, and if monetary policy loosens up in Japan, that region may be worth a gander. Higher interest rates in the U.S. and, by extension, Canada, will put a damper on the allure of high-dividend paying stocks. But don’t be blue because steady growth in the U.S. economy will more than off-set this. And, for those going long, you could do worse than investing in luxury goods. No red ink in sight.

Here’s to good health and good fortune to all in the year that ends in “5”.

Scratch & Sniff

Photo Courtesy of Jônatas Cunha

A good first impression goes a long way. It can get you a good table at a popular boîte. It can give you an edge in landing a plum job. It might even get you a hotel or airline upgrade. Not surprisingly coming on like gangbusters pays off for portfolio managers too who the reap rewards for years to come—even when their performance lags.

A recent study published in Financial Analysts Journal, (eye glazing stuff to be sure), was covered this week in The Economist. After examining the performance of 1,824 managers of American mutual funds over a 12-year period it turns out that active managers do not outperform the market.

While this isn’t exactly news, it bears repeating because investors are prone to magical thinking for which they pay dearly. Most investors, even and maybe especially those who consider themselves sophisticated, desperately want to believe that paying a premium to a star fund manager is worth it. They are wrong.

For starters, the hotshot will not be able to maintain her performance record. The study showed that there is no relationship between a manager’s performance in the first five years and the subsequent five years. Now factor in the dilutive effects of the premium fees charged by active managers. Not a pretty picture.

To get a real sense of what long-term market returns will be take a glance at the risk-free rate. This is the rate of return you would get if you bought a government-secured T-bill, for example. Now look at corporate earnings. They are hovering around two or three-percent, right?

So you get the picture: Over the long haul, say, 10-15 years, it’s highly unlikely that you’ll do better than five or six-percent if you’re willing take on some risk.

Why twist yourself into a knot for five percent?

Instead, work with a low-cost portfolio manager, (or go the DIY-route if you have the time and inclination), and buy a bunch of  common shares of medium-to-large cap, dividend-paying companies in the U.S.A and Canada, and a low-cost bond index or mutual fund. Or, if you don’t want to hold individual securities, go for an all-fund portfolio of low-cost actively managed mutual funds and some ETFs. (An all ETF portfolio is suboptimal because managers must constantly trade to track an index. This herd mentality guarantees underperformance relative to the benchmark after fees.)

When I worked in the fashion biz, there was a rumour going around that certain firms would initially use high-quality ingredients for their new perfume creations. Once the punters were hooked, the formulas would be tweaked using lower-cost substitutes. The companies rightly figured that the halo effect from the initial product would keep customers coming back for more.

That’s not unlike the investment biz. Hotshot fund managers sure smell nice at first. However, the prudent investor should perform a scratch-and-sniff test a few years later. Is the aroma still so rosy?