Thoughts on Investing

Thoughts on Investing

July 18, 2006

There is so much hand-wringing going on by market watchers that I thought it would be a good idea to haul out a little common sense. Markets have been going down in recent months. I lost money too. But the world rarely ends. When people regain their senses I want to be in the market. Here are 5 things to keep in mind when you watch the news.

1. Don’t be distracted by the daily news. Investors are bombarded daily by a crisis du jour of confusing and conflicting news reports. The positive news on U.S. growth, productivity, and profits, is being drowned out by a tsunami of reports on oil prices, Iran, North Korea, Trade, immigration, inflation, and the Fed. Investors are confused, frightened, and sitting in cash. This is a reaction, not a strategy. The world is not going to end and we still need to educate our children and save enough to retire. This is when an investor needs the discipline to stay focused on long-term objectives, investment fundamentals, tax planning, and a long-term strategy for building family wealth.

2. Long-term investment fundaments are actually very strong. Productivity is rising and the U.S. economy is growing strongly. Profits and growing in double-digits and are at the highest percent of GDP ever recorded. Dividends are rising. The global economy is growing too, led by the reforms in China and India. Japan and Europe are growing too. Capital owners have more choices where to invest at attractive returns than ever before. The Fed and other central banks have shown that long-term inflation will be 1-2%. Bond yields are likely to remain near current 5% levels. Stocks are cheap at only 14 times next year’s earnings. These are great long-term fundamentals for equity markets.

3. Understand and manage risks but don’t let risk drive your investment strategy. Understand strategic risks. China’s growth has fundamentally changed world oil markets; high oil prices are here to stay. High oil prices have brought Iran, Russia, Venezuela and the Gulf back into the headlines. Iran and North Korea’s nuclear ambitions must and will be stopped. The Fed and other central banks have been aggressively raising short-term interest rates—more than 90 increases around the world to date. But tight oil and commodity markets have run their course and the Fed is almost finished tightening. The two big risks are getting caught holding last year’s winners—stocks driven by rising commodity prices—and being out of the market when people come to their senses and stock prices once again rise to reflect the value of the companies.

4. Investment strategy should focus on long-term returns. Defensive strategies—some extra cash, short (2-5 year) bond maturities, defensive sectors–are OK in the short-term. Long-term, focus on high quality U.S. companies with strong cash flow and rising dividends and on countries, sectors, and industries selling products and services to fast-growing Asia. I think U.S. stocks will produce 10%+ returns over the next 5 years, compared with 5% for bonds, 4% for cash, and 0% for real estate. Asian equity markets will produce 12-15% returns. Don’t chase hot commodity prices or Asian IPO’s.

5. Diversification and tax planning still matter. I like to use ETF’s (Exchange Traded Funds) to place small bets on countries, regions, sectors, or industries where policy or technology change has raised after-tax returns on capital relative to the market. I reserve company bets for (rare) situations where I believe I have an information advantage over the market. ETF’s have low expenses and provide at least some level of diversification against adverse company or manager events. Many investors are not aware of the tax liabilities they will face when they ultimately distribute their IRAs. Tax rates are more likely to rise than fall in future years, making tax planning very important.


Pamela Rutledge

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