Fourth Quarter 2016 Letter to Clients

The New Year arrives to find U.S. stocks in the midst of one of the more robust and unexpected market rallies in recent years. With the uncertainty surrounding the U.S. Presidential election resolved in early November, stocks surged upward during the last half of Fourth Quarter 2016 and never looked back. The Dow Jones Industrial Average, S&P 500 and Russell 2000 (small stock) indices all enjoyed substantial gains to close out the year, with all three reaching record highs in December.

Predictably, the talking heads on Wall Street are now wringing their hands that the market is “overvalued,” a term that implies stocks have gotten ahead of themselves and are due for a fall. A quick Google search on this subject is instructive – because it shows such articles appearing every year going back to the 2008-09 bear market. (There were even articles arguing that stocks were overvalued at the Dow’s low point of 6,627 in March 2009!). 

When investment managers assert that the market is overvalued, the extension of this logic is that investors should do something to diminish the risk to their portfolios by reducing stock exposure, or even exiting stocks entirely. It is therefore worth examining the track record that stock-picking managers have posted in recent years to see if their attempts to forecast the direction of the market and make moves accordingly have panned out. By every measure, they have not:

As the prior table shows, 85% or more of conventional managers (those who attempt to beat the market) have underperformed their market benchmark in one, five and ten-year periods. Keep in mind that these statistics only include funds that have survived for those periods of time – the underperforming funds that were closed during the period are omitted from the data. Had they been included, the numbers would be even worse!

Thus, when we are bombarded with articles asserting that the market is overvalued, it is important to remember that those whose job it is to make such forecasts and act accordingly have failed miserably at the task. Moreover, it is important for long-term investors to keep in mind that the notion of the market being over (or even under) valued at any point in time is irrelevant in the bigger picture. Stocks over the long term have been on an inexorable upward climb, flying in the face of the many dramatic pronouncements in the media that equities were no place for investors to be:

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One of the central tenets of investment success is maintaining a sense of faith in the future – holding fast to the belief that the overall state of humanity is improving. From an investment perspective, it stands to reason that businesses, being collections of people, will both be the catalyst for, and beneficiaries of, this state of perpetual improvement and future stock returns will therefore reflect these improvements.

At this point, we suspect there are many reading this letter who are either shaking their heads or rolling their eyes – or maybe both – at the notion that “things are improving.” After all, when we are bombarded daily with constant examples of how things are going terribly wrong in the world, how can anyone assert that things are getting better?

A fascinating article we ran across recently entitled “Why are we so determined to deny that things are getting better?” ( highlights the disconnect between what we perceive to be reality versus what is, in fact, reality. In the article, author Johan Norberg notes that, despite dramatic reductions in violent crime, poverty and infant mortality around the globe, most people still perceive things to be getting worse instead of better. Mr. Norberg attributes much of this skewed perspective to the saturation of negative news stories in the media and the instantaneous availability of those stories via smart phones. He noted one particular study in which people in the U.K. and U.S. were asked about their beliefs about global poverty and how far removed their beliefs were from reality: 

“In Britain, only 10 percent of people thought that world poverty had decreased in the past 30 years. More than half thought it had increased. In the United States, only 5 percent answered (correctly) that world poverty had been almost halved in the last 20 years: 66 percent thought it had almost doubled.”

Mr. Norberg pointed to studies by psychologists who have found that humans are wired to take note of the high-profile exceptions – and worry about them – rather than take comfort in the relatively benign status quo: 

“The more memorable an incident is, the more probable we think it is, so we imagine that horrible and shocking things, which stay in our thoughts, are more frequent than they are. We are built to be worried. We are interested in exceptions. We notice the new things, the strange and unexpected. It’s natural. We have been hardwired this way by evolution. Fear and worry are tools for survival: the hunters and gatherers who survived sudden storms and predators were the ones who had a tendency to scan the horizon for new threats rather than those who were relaxed and satisfied.”

To bring all of this back to an investment perspective: Investors who embrace a negative world view tend to manifest that belief in their investment decisions, becoming overly cautious in their desire to hold riskier assets like stocks even when their age and financial goals dictate the need for such assets. It is therefore important not to let anecdotal examples in the media – however jarring those examples may be – drive us toward an overly cautious approach to investing that will only serve to diminish our financial wellbeing in the future. 

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Along these same lines, there was a bit of underreported but extremely pertinent information that crossed the wires a few months ago regarding the United States’ quest for energy independence. In November, geologists with the U.S. Geological Survey reported the discovery of an oil and natural gas field in Texas that is the largest ever found. The Wolfcamp oil field in Texas is thought to contain some 20 billion barrels of oil, worth more than $900 billion in today’s prices.

As we have noted in this space before, it was only a few years ago that the media was full of stories asserting that the world had reached “peak oil” – the point at which global oil availability was maxed out and thus would begin to decline until, at some point, the world ran out of oil. And yet many experts now believe the new technology that enabled the discovery of the enormous Wolfcamp oil field will likely lead to many billions of barrels of additional oil being discovered in the years ahead. By some estimates there is as much as 680 billion barrels of oil potentially recoverable in U.S. oil fields – enough to last the U.S. a century at current consumption levels. 

Just another example that “the end of the world as we know it” has, yet again, been postponed!