Successful Investing: The Ultimate Test of Strategy, Patience and Long-term Endurance

Each new year tends to be a time for reflection. Most of us make assessments of the past year and the longer-term past, we identify goals and priorities for near term, we ponder the future. We count our blessings, we grieve the loss of loved ones and we commit to living our lives the best we can. One goal I have is to write shorter, less technical letters. Hopefully this will prove to be one of my longer letters in this new year. In any case, I want to take this opportunity to reiterate our belief that broad strategic allocation is the essential ally of long-term investors. Since most of the assets we manage are held in taxable portfolios, strategic diversification, keeping implementation costs low and tax efficiency high are the three pillars of our long-term oriented approach to providing effective management to you. This letter delves into the diversification component by comparing its attributes to other approaches. I have shared the chart below in prior letters. Here is a recent update –

Ownership of the S&P 500 has been rewarding over extended periods of time. For instance, from the end on 1996 thru November 30, 2024, its price has increased roughly 9-fold. After the strong gains in the mid ‘90s till early 2000, data shows that investment flows into U.S. large cap stocks reached record levels in early 2000. Investors, liked what the saw, expected more and invested accordingly. From its March 2000 high, it failed to make a new high for nearly 14 years. Instead of adding to positions in late 2002, late 2008 - early 2009, when the PE ratio for the S&P 500 was low, investors were net sellers (e.g., investment flows were negative until about 2014). On a net basis, investors added aggressively to positions in things like the S&P 500 when prices fueled by large gains in the PE multiple were very high. Collectively, investors did the reverse when prices and valuation metrics were low. They bought high and sold low.ⁱ Had they not focused on price change, but instead on what they were paying to buy ‘Corporate America’ they would have refrained from chasing performance and took advantage of buying when stocks were attractively priced.

Large cap U.S. stocks (especially ‘growth’) have led investment returns by a wide margin in recent years. The S&P 500 and NASDAQ (large cap growth) indexes are once again trading at the high side of their historical valuation metrics. At present, investment flows into large cap U.S. stocks are again robust. Can these ‘in favor’ market segments keep posting gain? For sure, strong investment flows and favorable earnings could enable these trends to continue. However, we believe better intermediate and longer-term investment returns may well lie in other market segments. Careful consideration of valuation is a key input in our investment process.

In the late 1990s, I wrote several cautionary letters. As I have shared in prior letters, investor return expectations were high and I felt obligated to throw some cold water. I recall one recipient of my letters then pushing back and explaining that ‘we need high returns because none of us have adequate savings for retirement.’ Sadly then and now, as much as we might wish it were otherwise, markets don’t respond to our near term wishes or concerns. Sometimes they deliver significant reason for concern – when the news is distressing and likely to get worse. At others, the lights appear to be ‘all green’ with no impediments in sight. Both are times when many investors make what prove to be costly mistakes.

Emotions cause action but not necessarily sound ones. We all want a good outcome - especially over the long term. We want and expect our share of success. When large cap U.S. stocks (e.g., the Dow Jones, S&P 500 and NASDAQ indexes) are on a roll and prognosticators, analysts, news reports are positive – and there are seemingly no disruptions in sight, many investors are convinced they should allocate most if not all of their equity allocation in these market segments. Confirmation of ‘this is a great time and place’ are all around us. Conversely, poor market environments that are characterized by so-so or sharply declining prices prevail when economic conditions are poor and consumer and investor sentiment are negative.

The following is a quote from investor Stan Druckenmiller -“I have found it’s very important to never invest in the present. Always try and envision the situation as you see it in 18 to 24 months.” John Kenneth Galbraith said - “Nothing is shorter than the memory of investors.” Winston Churchillⁱⁱ said - “Democracy is the worst form of Government except for all the others that have been tried from time to time.”

Why we invest the way we do -

It goes without saying, different investors deploy very different strategies. That said, when large cap U.S. stocks (e.g., the S&P 500 and NASD) have performed well, diversification vis-a-vis other major market segments including mid and small and international seem unnecessary and frankly costly. They aren't keeping pace, so they are an unambiguous drag. At times like these, some investors prefer to concentrate their allocation into just one market segment (e.g., large cap U.S. or technology or energy …). This approach entails considerable risk. An investor who owned only the most heretofore winning segment (e.g., large cap U.S. growth) and took only modest distributions (e.g., 3% of their portfolio value at retirement) likely could have seen her life’s saving fully depleted over the next 10 or so. Obviously, that is an unacceptable outcome.

Our long-practiced approach to investing entails elements of a relay race through a never-ending obstacle course. When one member of the team needs to rest, others step in to carry the load. The terrain and direction change in an unpredictable manner. When they do, one or more leaders shift the load to others who are rested and ready to move the valuable cargo forward. It's exciting to watch and trust in each other is paramount. No single participant is responsible for success; it's a team effort. Sometimes, the terrain and conditions are favorable and certain athletes look like they could run at a steady pace seemingly without injury or setback. Alas they can’t. They need to rest so they trust others to step up. Sometimes it’s about advancing with ease and at others it’s about not losing time like the proverbial hare who collapses and takes an interminably long nap.

We agree wholeheartedly with Stan Druckenmiller. Investors need to extend their outlook beyond the here and now. Indeed, because we aren’t prone to buying and selling a lot (so we can keep Uncle Sam at bay), we focus on the prospect for favorable returns over the next 5+ years. Today, there are segments that have trailed things like the S&P 500 by a wide margin since the Great Financial Crisis. At present, they are available at very reasonable valuation metrics. Might they continue to languish in the months or quarters ahead? Without question. However, historically segments that are selling at the low side of their historical ranges can provide significant gains in the future.

As I mentioned, large cap U.S. stocks – especially growth are trading at the top end of their historical range. Other segments including what they deem ‘Deep Value’ (e.g., the lowest quintile in terms of valuation) as well as international equity markets are trading near the bottom of their respective ranges. Take a look –

In most of the past 15+ years conditions in the U.S. stock market have been highly favorable. Especially for large caps and large cap growth indexes. From the depths of the GFC (e.g., the Great Financial Crisis), the two pillars of bull markets namely, significant increases in the S&P 500’s earnings and valuation metrics have increased considerably. There’s a lot to like, especially for those that have owned large cap stocks these past 15+ years. Of course, it’s not always this way. The period before the market’s low in March 2009 was distressing to most investors. Getting knocked down is not fun – it produces great anxiety.

In addition to U.S. large and mid-cap value and international value, other segments including U.S. small caps are available at attractive valuations. As has been the case when the S&P 500 is priced attractively, we believe investors are well-served to lean in and invest in other market segments when they are priced attractively. Most investors don’t do this because, they focus more on price trends than on valuation metrics. We fully intend and expect to hold meaningful allocations in all of these equity market segments as part of our broad strategic allocation. Included in the addendum is a slide that shows current valuation metrics for the U.S. and other market segments.ⁱⁱⁱ Along the way, we will also actively seek to add ‘tactical’ allocations in segments that from time to time are available in the ‘out of season and on sale’ sections of the equity markets. This is the essence of our approach of managing enduring portfolios that can weather the likely, but highly unpredictable, setbacks that lie ahead. The great news is major equity markets perform differently along the way. That’s why diversification is so important and necessary.

Happy New Year and thank you for your continued confidence in our team. It is our pleasure to serve you and we are committed to fostering favorable long-term outcomes. Lastly, if we are not advising you, but you would like an objective opinion on your current portfolio, we would be pleased to visit with you and see if we can be of service.

W. Richard Jones, CFA
Partner, Harmony Wealth Partners

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ⁱⁱSeveral weeks ago, I watched the 4-part Netflix series Churchill at War. If you like history, it was very well done and interesting. With respect to his quote on Democracy, we believe broad strategic asset allocation is the worst form of portfolio management except all of the others. Diversified portfolios are never the best performing type, but importantly they are never the worst. Investment returns are less volatile and therefore timing risk is diminished as are the unacceptable returns of things like the S&P 500 from year end 1999 through 2013. When economies and markets perform poorly and valuation metrics are low, this tends to prime the pump for better prospective economic and equity market returns.