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What to do with your equity portfolio in 2016

By Roger Montgomery

What to do with your equity portfolio in 2016

Forecasting doesn’t work

The sagest advice I have received on the subject was that if I wanted to be successful at predicting markets, I should simply do it often.  As investing professionals, we are regularly asked for the insights that stem from our crystal ball gazing and for many it pays to participate. Those that get it right are lauded as if they have an omnipotent connection to the future, and such is the brevity of our memories that those who get it wrong are simply forgotten.

And such is the ability of some self-proclaimed prophets to spin their incorrect predictions into divine prophesy that they see no diminution in their monthly newsletter sales.  I recall one magniloquent and high profile commentator state with almost daily certainty that the Australian equity market would end 2016 above 6000 points.  At the time the prediction was made the market was indeed very close to that level.  Of course the market ended significantly below 6000 and traded below 5000 points after the prognostication was made.  But in early 2016, the commentator may have slipped in that he got the call right thus (emphasis added);

“…the return of stock buyers whenever we hover around 5000 or just below tells us that the majority of stock players doesn’t see our market worthy of being at 6000, which we missed by five lousy points on March 23.”

Desist from forecasting altogether

Long-term investing success has nothing to do with forecasting share prices, politics or economics and everything to do with buying businesses whose intrinsic values rise over the long run.  The share price will look after itself if the value of the business is rising steadily over the years, but more on that in a moment. 

To offer any forecast of where the stock market will be demonstrates a lack of understanding of this basic investing principle.  Therefore a forecast tells you a great deal about the forecaster but nothing about what is to come.

Those who presume to understand the machinations of the economy and the markets and then offer their ‘insights’ simply haven’t learned that 1) they will never do better than 50/50 with their forecasts and 2) their forecasts aren’t required by you for you to be a successful investor.

There’s a constant temptation however to believe the facts one has collected amount to some undeniable insight about the future that one can bet the farm.  To save ourselves at Montgomery from falling into this trap, with 50/50 outcomes, we developed a process.  And much as one does when marrying - vowing to have and to hold for better or worse – we publicly committed to our investors, their advisers and the ratings houses to follow the process come what may.

At the beginning of 2015 I was asked whether I thought the market was expensive or cheap and I argued that the market seemed expensive because value did not abound, and that it would be difficult to generate meaningful returns. 

It isn’t wise for fund managers to say such things because rather than appearing knowledgeable, it risks influencing investors to zip up their wallets.  Of course while we may have been right (50/50 remember!) with our prognostications - for the year to 31 December 2015 the Australian All Ordinaries Index declined by 0.8 per cent to 5,344.6 points, add in dividends and the return was just 2.8 per cent - the Montgomery Fund returned 19.35 per cent after all fees and expenses.

Even if I had accurately predicted a 2.8 per cent return for the market and decided the risks outweighed the benefits, so listening to myself, put all of my money into a term deposit, I would have missed the strong return.

Invest in strong businesses and be patient

And that’s the point. The stock market index is not where you are or should be investing. You should be investing at rational prices in businesses you are reasonably confident, if not virtually certain, will be materially larger and at least equally profitable in many years hence.  Stock market and economic forecasts are largely irrelevant over the time frame I am contemplating. 

When we observed early in 2015 that the market was expensive, we also noted that banks and mining companies, at the highs, were unsafe investments, but this was not a prediction about the direction of the share prices of these stocks or what would happen next.  What we simply observed is that investors were behaving dangerously and without regard to risk when they were chasing high yields and ignoring whether those dividends they were chasing were being supported by growth.  We were simply saying that it was a mistake to chase yield at the expense of growth.

A business adds value by retaining profits and redeploying that incremental capital at attractive rates of return.  It’s that simple.  To maximize your returns you simply have to fill your portfolio with companies able to retain large amounts of capital and generate large returns on that capital.  The share prices of these companies will look after themselves over the long run.

The short run is merely the period over which stock prices for these companies overreact on both the upside and downside and therefore it is the period over which you can take advantage of the market’s manic moods.

Ignore everything else in 2016 and you should do well over the long run.

 
Roger Montgomery
Roger Montgomery

Roger shares his stock market insights at his Insights blog, blog.rogermontogmery.com. Investors can also follow Roger on Facebook and watch media interviews at his YouTube channel. Grab your Second Edition copy of Value.able and learn how Roger Montgomery values the best stocks and buys them for less than they're worth. Grab the book now at special price!