With less than 8 trading days remaining in 2009, we're pretty much sitting on our gains with our fingers crossed. About the only thing that could ruin our year at this point is a terrorist attack on the Rockefeller Center Christmas Tree in New York City. Between al-Qaeda and Hezbollah, that's a fear we will never forget.
In our September letter, we noted that the current decade was on track to be the worst or second worst for stocks in the 140 years we have valid data. Updating our chart through today, we see that the current decade, in net price appreciation and net of dividends, has pulled ahead of the 1930's.
That's cold comfort considering that a dollar invested in the S&P 500 January 1st 2000 is currently worth 91 cents - only the second decade of negative returns in the last fourteen. The same dollar invested in the S&P 500 on January 1st, 1980 was worth $3.27 December 31st, 1989, $13.60 at the end of 1999, and even now is worth $12.38.
Why were the 1980's and 90's such great decades for investors and the current decade so crummy? Probably the single biggest factor was the long term decline in interest rates from the 1984 peak to the lows of 1998. The ten year treasury yield fell from 13.8% to 4.4%, a post war low not touched until the "flight to safety trade" of last winter, which dropped yields to 2.2%. As risk free yields decline, price/earnings ratios of riskier assets like stocks can expand, which drives stock price appreciation faster than mere gains in earnings.
The US economy completed the transition from a manufacturing economy to a service economy in the 1980's and saw two huge boosts to productivity, first from the widespread adoption of personal computers in the 1980's, then from the roll-out of the Internet in the 1990's. The "baby boom" demographic bulge hit its peak productivity years in the 1980's and 1990's, while the follow-on "baby bust" left the country undersupplied in highly qualified workers. Add on the drag to the economy in the 2000's of two major wars, dealing with terrorism, soaring healthcare costs, the crippling effects of too much leverage and the return of stock prices to more sensible valuations, and it's easy to understand why the market took until October 2007 to eclipse the dot-com highs. The financial crisis took stocks 55% below that record peak, and even after the 61.3% rally from the March 6th lows, the S&P 500 remains 29.2% below the all-time highs.
What can we expect from the next decade?
About the only thing we can predict with confidence is that the next decade will be better (or worse) than the current decade, but certainly not the same. For a moment, roll back to 1999. E-mail, cell-phones and flat-screen TV's were just starting to achieve mass market penetration, while NetFlix, Google, and Tivo, all incorporated between 1996 and 1998, were barely past the start-up stage. The iPod wouldn't debut until October 2001, and legal music downloading services such as iTunes and Napster didn't appear until 2003.
Back in that quaint era, people watched television on TV's, movies in movie theatres, listened to music on CD's, read books on paper and newspapers on newsprint. In 2009, people can get their TV, movies, music, books and news on a cell-phone, a Kindle, a lap-top or any device they choose, wherever and whenever they want, at home, at the office, in their car! Meanwhile the music industry and newspapers are in an economic death spiral, while traditional retailers such as Tower Records and HMV went out of business. People still listen to music or read the news, but not from traditional sources and not paid for in traditional ways. The business and distribution models of television, movies, books and magazines are all frantically adapting to the new world. How do you attract "eyeballs" when content is increasing exponentially and long ago exceeded the daily absorption capabilities of any one person?
Even industries far less glamorous than consumer electronics advanced over the decade. The physics of delivering food, water, electricity, motor fuel & heating oil, and containerized goods does not change, but the efficiency of sourcing and delivering those commodities does. We think that major breakthroughs in alternative energy will be achieved in the next decade because supplies of easily extractable conventional energy are running out, even if there are decades or even centuries of fuels still left in the ground.
As investors, we're always trying to understand which industry groups are in decline, which are holding steady, and which represent the future. We didn't own any automobile, airline, newspaper or media stocks in the last decade, but we did own a lot of technology, healthcare and utility stocks. We owned a lot of bank stocks, which was a winning strategy right up until August 2008. We regrouped on that sector in 2009, and have money invested in those banks that gained market share during the crisis and emerged stronger.
Heron Capital Management evolved into Heron Financial Group
Our own firm evolved over the decade to meet the needs of our clients. Through 1999, our firm was focused primarily on plain vanilla US large, mid and small-cap stock picking. However, as we entered the current decade, our "baby boomer" clients asked us if an all-stock portfolio was "right" as they approached their retirement years. The answer is, "No, that allocation is too risky if you will rely primarily on your portfolio instead of social security or a pension for your retirement income."
We began building portfolios with allocations to bonds and bond mutual funds. As we gathered the assets of our clients' relatives and friends, not every portfolio was of sufficient size (at least $250K) for separate account management, so we offered portfolios exclusively of mutual funds and also added international mutual funds and ETF's to further diversify the portfolios of our clients who are invested primarily in US stocks. We created a "manager of managers" program for clients with at least $5 million in assets who wanted to spread those assets among multiple strategies. We maintain the assets at a single custodian, manage the allocation of assets among the managers, provide the overall performance reporting and take care of account distributions.
We spent more time with our clients talking about tax strategy, college saving, estate planning, and charitable giving, developing the necessary expertise in-house as needed, but also bringing in outside experts to advise particularly complicated situations. We now advise our clients on how to allocate their 401k's and also advise corporations on how to set up those 401k's. Lastly, as part of our relationship with Fidelity Investments, we are able to offer trust services, life insurance and annuities at very competitive rates because we operate outside the traditional "commission" fee structure.
We knew we succeeded in 2009 when, despite the worst bear market in stocks since the 1930's we did not need to cut the "allowance" of a single one of our clients who relies on their portfolio for monthly distributions.
Purpose-based Wealth Management
Up until now, we always offered these services on an "as requested" basis. However, we realized that we can't always count on our clients to "know" what services they should be asking for. We also observed that those clients whose assets were divided up into multiple pools with different purposes (the "emergency cash" pool, the "college tuition" pool, the "saving for retirement" pool) and different strategies (cash, fixed income, stocks for growth) were best able to "stay the course" not only in the most recent crisis but in previous crises such as after the dot-com bubble burst, and after 9/11.
The clients with all their assets in a single risk pool were the most likely to abandon their investment strategy in March 2009, and sell stocks at the worst possible minute. Performance will always remain important to us and benchmarking portfolios on a MTD, QTD and YTD basis is a critical tool in alerting us of problems. However, we will be even more focused on the purposes of the client, building portfolios that achieve those purposes with the least possible risk.
Starting in 2010, our clients will receive periodic reminders of what we can do for them beyond straightforward asset management, and we will broaden our annual client reviews to expand on these topics. Our website is currently being rebuilt to further emphasize these solutions. About a third of our clients currently receive their monthly statements via e-mail, but all will be able to retrieve their monthly HFG statements, Fidelity custodial statements and tax information from a single secure "vault" on our website. In mid-January, all clients will receive a "Financial Self-Assessment" questionnaire, which will ask, among other topics, "What are your top five financial goals for the next 10 years.
We've taken the last tax loss and rebalanced the last portfolio. We expect the markets to drift gently through year end as there's no significant news to be expected in these last days. Compare this year to last year, when the US presidency was in transition, the banks were cratering, the markets were falling, and there was a chance, albeit a small one, that the world would be plunged into the Great Depression 2.0. Although the worst fears were not realized, the recovery ahead is long and slow. From the second week of January forward, we'll get the next round of earnings reports and get further information on how companies are regaining momentum.