Despite the ongoing political acrimony that dominated the headlines during the first quarter, equity markets delivered strong results. Building on to the post-election rally, U.S. stocks returned 6.07% (S&P 500 Index), foreign stocks returned 6.81% (MSCI World ex USA Index), and bonds returned 0.82% (Bloomberg Barclays U.S. Aggregate Bond Index).
Overshadowed by the drama centered in Washington, D.C. was the continued improvement of the global economy. The progress of the economy not only led popular U.S. stock indices to breach new all-time highs during the quarter, it also prompted the Federal Reserve to raise the target federal funds rate range to 0.75-1.00%. This was the second increase since the election, but just the third since the range dropped to 0-0.25% eight years ago. With global markets beginning to pick up steam, and the U.S. economy continuing to expand at a moderate pace, 2017 may bring multiple interest rate hikes from the Fed.
The Intersection of Politics and Financial Markets
The current political environment is as uncertain as we’ve experienced in some time. At the heart of that is the unconventional nature of President Trump. Considering his often-contentious relationship with both Democrats and the Republican Freedom Caucus, as well as his frequently impulsive and emphatic tweets on many topics, projecting the ultimate impact of this administration remains extremely difficult.
What is clear is that President Trump has repeatedly focused on six major policy initiatives:
- Reduced government regulation
- Immigration reform
- Healthcare reform
- Tax reform
- Trade policy reform
- Increased infrastructure spending
The administration has already been active in many of these areas, but the lack of success in repealing the Affordable Care Act is a great example of the challenges inherent in enacting policy change. So not only is it unclear what policy changes may prove successful, but projecting the final form of those changes, and the resulting economic impact they may have, is implausible at best.
The paradox of high political uncertainty and thriving financial markets is making some investors nervous, sparking concern that a market correction may be near. While the future is always unpredictable, perhaps especially now, here is what we do know: Since 1946, there’s been an average intra-year decline in the S&P 500 Index of about 14%.
Consequently, a market pullback should not be unexpected, nor should it be unwelcome given the portfolio rebalancing opportunities it would provide. The key is to maintain this perspective amid the media hysteria that will inevitably be going on around you. While the direction and degree of political bias from the different networks varies, the objective across all media outlets is the same – to win your constant attention.
The goal of the financial media is for investors to believe that a keen focus on daily events will improve their investment outcome. The truth is, most investors would be better off ignoring the news completely.
A Source of Sage Advice
There was one financial media interview during the first quarter that is worthy of your attention. Upon the February release of Warren Buffett’s annual letter to Berkshire Hathaway shareholders, Buffett was interviewed on CNBC. We consider Buffett’s letter a must-read every year, and the most recent version is particularly insightful.
In fact, we think the most valuable content we can relay to you this quarter is direct excerpts of Buffett’s guidance to investors. We’ve included below both text from his letter and quotes from his subsequent CNBC interview.
On President Trump
Last year it was clear I was for Hillary, but I was asked about the market based on who got elected. And I said, America’s going to do fine – in terms of economically – under either candidate as president. . . . I’ve watched it all my life, and probably half the time, I’ve had a president other than the one I voted for. But that has never taken me out of stocks. . . . If you mix your politics with your investment decisions, you’re making a big mistake.
I will judge President Trump after four years based, number one, on how safe the country has been kept. That is job number one of the chief executive of the United States . . . Secondly, I will judge him, to a degree, although they have less control over this, on how well the economy does overall. And then third, I judge him on how, if the economy does well, which I expect it to do, how wide the participation is in that better economy.
On the Unpredictability of the Markets
I don’t know anybody that can time the markets over the years. A lot of people thought they can.
Things are always unpredictable. I can’t predict what’s going to happen tomorrow. . . . I can predict what’ll happen in 10 or 20 years in a general way, but I have no idea what’ll happen tomorrow.
The years ahead will occasionally deliver major market declines – even panics – that will affect virtually all stocks. No one can tell you when these traumas will occur – not me, not Charlie [Munger], not economists, not the media.
During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted.
On His Hedge Fund Bet
[In 2006] I publicly offered to wager $500,000 that no investment pro could select a set of at least five hedge funds – wildly popular and high-fee investing vehicles – that would over an extended period match the performance of an unmanaged S&P 500 index fund charging only token fees.
Though there are thousands of professional investment managers who have amassed staggering fortunes by touting their stock-selecting prowess, only one man – Ted Seides, co-manager of Protégé Partners – stepped up to my challenge. . . . For Protégé Partners side of our ten-year bet, Ted picked five fund-of-funds whose results were to be averaged and compared against my Vanguard S&P index fund.
[Since the 2008 inception of the bet] The compounded annual increase for the index fund is 7.1% . . . The five fund-of-funds delivered, through 2016, an average of only 2.2%, compounded annually. That means $1 million invested in those funds would have gained $220,000. The index fund would meanwhile have gained $854,000.
In my opinion, the disappointing results for hedge-fund investors that this bet exposed are almost certain to recur in the future. . . . A number of smart people are involved in running hedge funds. But to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose on investors.
The bottom-line: When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.
On His Advice for the “Elite”
Over the years, I’ve often been asked for investment advice, and in the process of answering I’ve learned a good deal about human behavior. My regular recommendation has been a low-cost S&P 500 index fund. To their credit, my friends who possess only modest means have usually followed my suggestion.
I believe, however, that none of the mega-rich individuals, institutions or pension funds has followed the same advice when I’ve given it to them. Instead, these investors politely thank me for my thoughts and depart to listen to the siren song of a high-fee manager . . .
The wealthy are accustomed to feeling that it is their lot in life to get the best food, schooling, entertainment, housing, plastic surgery, sports ticket, you name it. Their money, they feel, should buy them something superior compared to what the masses receive.
In many aspects of life, indeed, wealth does command top-grade products or services. For that reason, the financial “elites” – wealthy individuals, pension funds, college endowments and the like – have great trouble meekly signing up for a financial product or service that is available as well to people investing only a few thousand dollars. . . . My calculation, admittedly very rough, is that the search by the elite for superior investment advice has caused it, in aggregate, to waste more than $100 billion over the past decade.
Human behavior won’t change. Wealthy individuals, pension funds, endowments and the like will continue to feel they deserve something “extra” in investment advice. Those advisors who cleverly play to this expectation will get very rich.
Spreading the Words of Wisdom
For decades, Truepoint has been a small, but consistent, voice attempting to educate investors on the investment industry fallacies of stock-picking and market-timing. So each time the world’s most famous investor beats the drum with us, we cheer him on as loud as we can.
In an industry still dominated by “traditional investment management,” we pride ourselves on delivering, and advocating for, an intellectually honest investment approach. As Buffett emphasizes, the merits of low-cost and broad-diversification are undeniable. If you know of family or friends who still fall for the siren song of active management, please turn them on to the wisdom of Warren!