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Hi friend! This blog post – Stock Market Forecast Next Five Years and Beyond – gives you a window into where the market will be five years out and even further. You may be pleasantly surprised at what lies ahead, if all the stars align.
TradingSmarts is dedicated to all things trading and investing.
While I am quite open about my personal preference for trading the forex, I am fully cognizant of the fact that my readership is also involved with investments and trading stocks and commodities that deserve equal treatment.
To that end, I dedicate this blog post to putting forward the best possible advice I can muster for where your investment money should be allocated.
As always, please do your own due diligence in reacting to the information contained herein, before you act on it.
Tip of the Day
Active management over the long run is a loser’s game.
Buy the index, and forget about it.
More specifically, the Vanguard S&P 500 Fund or ETF (symbol VOO), that covers the S&P 500 in a wide swath, represents a good buy-and-hold play.
Buying it on the cheap (on price weakness) would be the thing to do.
Warren Buffett said on CNBC that, in retrospect, he would have been better off buying the S&P than IBM.
Table of Contents:
Tip of the Day
TradingSmarts News Alert
Wall Street’s Panic Attack
Market Forecast 2017
The Elephant in the Room
Dirt Cheap by One Measure
Watch for That Banana Peel
The Bond Effect
As Warren Buffett Sees It
TIF vs ETF
Managing Risk Premiums
The Master of Disaster
Dow Transports Have a Say
Dogs of the Dow
The Fear Index
Big Fat Juicy Dividends
Dividend Risk Management
Gunslingers No More
How to Outsmart Buffett
The Trillion Dollar Man
News is Noise
A Dollar Measure
An Investing Legend
Doctor Turned Investor
The Indexing Craze
Hedge Funds’ New Normal
In Sum
Free Stock Trading
Required Reading
Inspiration and Quotes
Free Cash Flow Defined
References
Conclusion
TradingSmarts News Alert
Let’s face it… I read a lot – it’s my lifeblood.
Not much of what I read really captures my imagination.
But, every once in a while along comes a piece that really grabs my attention.
Will the stock market crash soon?
Keep reading to find out.
I thought this piece was worthy of your attention, because you undoubtedly have investments in the form of a 401k, or whatever, and obviously have a vested interest in knowing where they are headed – especially if you’re nearing retirement.
While waiting to board a flight from Washington, D.C., to Denver, Colorado, a while back, I overheard a captain talking to a stewardess in the lounge.
He said that, at the time, if his 401k performed, he would retire.
Let’s hope it worked out for him.
Funny how young pilots are clambering to climb into the captain’s seat, and here was a full-fledged captain anxious to get out.
Not surprising, given how badly their salaries and pensions have been decimated.
In light of recent turmoil in the airline industry with passengers getting kicked off flights, it’s no wonder tensions are running high in that industry.
I digress.
Let’s get a grip.
Enter Brian Belski:
BMO’s Brian Belski (chief investment strategist at BMO Nesbitt Burns) sees the early stages of a long bull run.
How long?
Read on.
You will be shocked.
Why should you listen to him?
His Track Record:
Late 2015, he foresaw the S&P/TSX composite index outperforming the S&P 500 in 2016, setting a target for the S&P/TSX composite of 15,300.
Outperform it did, closing at 15,288.
His Forecast:
Okay, so we’re mired in a long bull run.
That’s great news, but how long will it last?
Keep reading, and you will find out.
Any guesses?
I doubt you will come up with the right answer.
Mr. Belski says investors are too myopic, and pay way too much attention to news noise.
Stocks aren’t driven by news – but by fundamentals.
Investors need a disciplined approach that they stick with over the long haul.
He sees the U.S. outperforming Canada for perhaps the next three-to-five years given that, with Trump in the saddle, the U.S. is headed towards fiscal policy changes, such as health care changes, infrastructure, repatriation, and the promise of massive corporate tax cuts.
Strong forces prevail – improving corporate earnings and solid GDP growth, boosted by more robust global growth.
The strongest push so far is coming from increasing consumer spending, higher employment rates, and wage growth – all of which could result in higher inflation.
As domestic demand ramps up, so too do corporate profits.
Also helping is Trump’s anti-regulation stance.
Growth and regulatory policy indirectly impact profits, whereas corporate tax cuts would flow through to company bottom lines.
The rejuvenation of the Keystone XL pipeline was certainly a plus for Canada.
Trump is even reconsidering his stance on NAFTA, indicating that he is willing to sit down and talk turkey – at least with Canada and Mexico.
After all, he needs Canada for the oil, the paper, the railroad, and the wood.
Mr. Belski claims that the bull market hasn’t even found its legs yet.
The move so far has come from momentum and multiple expansions – not from real growth (eight years of zero growth, as a matter of fact).
He says you can’t recess from zero growth.
There’s no recession on the horizon, as far as he is concerned, because recessions sprout from higher levels of GDP, and are instigated by an inversion of the yield curve.
He opines that we might experience a “chicken little correction,” but that would represent a great opportunity to buy high-quality companies on the cheap.
Corrections are fundamentals-driven or influenced by a geopolitical surprise.
They are not driven by noise.
Mr. Belski sees Canada as being on a solid footing with the firming of oil prices (what with Canada being a net exporter of oil) – mired within a US$40-60 per barrel trading range for the next several years.
Marginal cost of production is US$50.
His Likes/Dislikes:
His favourite sectors in the U.S. are financials, health care (think Medtronic), industrials, and materials.
In Canada, it would be financials, industrials, and materials.
Favoured are banks and insurance companies – especially insurance companies in Canada over the U.S. and banks that have U.S. exposure.
Canadian banks are the most excellent stewards of capital in the world.
With the North American recovery in mind, industrials should do well – the aerospace, railroad, and waster management companies.
Under-weights go to anything that has anything to do with yield – health care, REITS and utilities in Canada.
Likes include telecom in Canada – more so than telecom in the U.S.
And the answer is…
So, how long will this bull run last?
If you go by Mr. Belski, we are in for a 20-plus-year bull run.
I’ll take that.
How’s that for a stock market forecast next five years and beyond?
Fasten your seat belt friend.
This is going to be one heckuva ride.
(Info via Brenda Bouw, as reported in The Globe and Mail. Mr. Belski’s views appear to be his own and those of BMO Nesbitt Burns.)
Wall Street’s Panic Attack
“Wall Street’s recent panic attack over Trump didn’t last long.”
“This whole bull market is all about panic attacks, followed by relief rallies, and this was another one.”
“My hunch is that the Trump-impeachment panic attack was a one-day wonder, and we’ll move on from there.”
Ed Yardeni, President of Yardeni Research Inc.
(Info via Saqib Iqbal Ahmed, as reported in The Globe and Mail, May 19/17)
Market Forecast 2017
This calculation takes into consideration the market’s current price in relation to a multiday trailing average.
A ratio higher than one is indicative of the market rallying higher, and vice versa.
The theory goes that the prediction is stronger the higher that ratio.
Take Wednesday, May 3/17, for example.
The $SPX S&P 500 Large Cap Index INDX read 2388.13 at the close.
Its 200-day exponential moving average settled in at 2256.59.
The resulting ratio of 1.06 is suggestive of a modest bullish signal.
This is up from 1.05, December 28/16. Translation:
*** Further Highs ***
If you are wondering where the market will be in one year’s time, give this formula a try.
Not exactly a stock market outlook next 5 years, but one year is not too shabby.
The only caveat is that it does not predict market turns.
(Info via Nir Kaissar, Dec. 28/16, The Globe and Mail)
Regarding market forecast tools, please consult my blog post on pivot points:
I also covered them in this blog post.
Pivot points are an incredibly powerful tool.
They demonstrate the probable high and low for the next trading session for any given market.
Add ADR (Average Daily Range) to the mix, and you have a very powerful combo at your disposal.
Take a look at my blog post on ADR here:
The Elephant in the Room
You may be wondering what happens if interest rates pop.
There’s no particular reason to suggest that hiking interest rates will gut the stock market.
Quite the opposite… Fed tightening could be seen as a positive for stocks, if it signals that the Fed is bullish on the economy.
What is more worrisome is the more unsustainable trend of companies paying out more than they earn to shareholders in the form of share buybacks and dividends.
It’s also possible that wages could start climbing with the stronger economy, and erode corporate earnings.
But, have no fear.
There’s no reliable link between interest rates and the stock market outlook.
According to John Higgins of Capital Economics, “The historical relationship between the stance of Fed policy and the value of the U.S. stock market has been weak.”
The venerable British commentator Andrew Smithers agrees wholeheartedly.
He maintains that the supposed link “is not only nonsense but the most egregious piece of data mining that I have encountered in the 60-plus years I have been studying financial markets.”
Nor is there a demonstrable tie between bond yields and earnings yields.
History proves otherwise.
The theory goes that, in choosing between bonds or stocks, investors consider stock market earnings yield in relation to that of a high quality bond, making their choice accordingly.
Beyond that consideration, they also factor in how growth and inflation will play out in the ensuing years, before casting their votes in either direction.
Inflation diminishes the purchasing power of most bonds, given they pay fixed amounts that aren’t adjusted for rising prices.
Stocks, on the other hand, benefit from the effects of inflation, in that rising prices goose corporate earnings, and hence share prices ascend.
So, stop worrying about what Janet will or will not do.
If you can’t sleep at night, load up on companies with low debt, as that would minimize the impact of any interest rate increases.
If you can sleep at night, go for robust sectors like health care and technology.
Apple and Medtronic (medical device maker) come to mind.
(Info via Ian McGugan, as reported in Report on Business, May 2017; also Norman Raschkowan, President of TenSquared Investments)
Rising interest rates favour three sectors: consumer discretionary (benefitting from increased consumer spending on positive economic growth), financials (which benefit from increased lending rates across business lines), and industrials (benefitting from increased production through higher demand for goods).
Stocks that could benefit from rising interest rates: Cdn. National Railway (CNR.TO) and Waste Connections Inc. (WCN, WCN.TO)
Getting back to the future direction of interest rates, according to David Rosenberg, the economist with wealth management firm Gluskin Sheff + Associates, we will remain in a low-interest rate environment.
He reasons that higher rates would raise debt service costs and weaken the economy.
He also maintains that the lack of inflation is further putting a ceiling on rising rates.
According to Mr. Rosenberg, there is a similar deflationary environment in the U.S., reflected in a deflating U.S. core goods consumer price index.
He asserts that, in this low-interest rate environment, bonds are not meeting their cash flow demands, which sees investors shifting their focus to stocks.
He goes on to say that further eroding the allure of bonds is the cornucopia of companies paying a better yield than bonds.
Ten years ago, only bonds had that claim to fame.
Dirt Cheap by One Measure
Mr. Buffett calls U.S. stocks “dirt cheap,” if you believe interest rates will stay low for a long time.
Add to that the fact that the U.S. economy is stronger than the rest of the world, and you have a recipe for future gains.
Refer back to Market Forecast 2017 for further evidence of bullish sentiment.
And, of course, we had Brian Belski’s take on stock market forecast next 5 years and beyond earlier on.
Watch for That Banana Peel
I dedicate this section to a dear friend of mine who tried to convince me that preferred shares were the way to go.
Not.
If you’re looking for true diversification, they will disappoint.
Known as a ‘widows and orphans’ type of investment, they are sensitive to changes in interest rates – both up and down moves.
And, they are a big let-down in a market meltdown.
For example, they got hammered in 2008-2009, while bonds soared.
For the five years to April 21/17, the S&P/TSX preferred share index racked up a cumulative loss of 18.2 percent.
But, that index has had a nice little 12-month run of 13 percent of late, demonstrating that prefs are clearly unpredictable over the long haul.
Better bets for diversification are bonds and GICs – not more stocks, preferred shares, or dividend-paying common shares.
Bonds look like they are dead in the water for the time being but, if the stock market swoons, they will come back to life.
The same can’t be said of prefs.
(Info via Rob Carrick, April 26/17, The Globe and Mail)
Etcetera:
Prefs are equity instruments that appeal to debt investors, because of their regular dividends.
However, they are sensitive to rate movements.
And, it all depends on their yield spread to fixed-income or yield.
In Canada, preferred shares pay a dividend that is linked to government bond yields.
They are not necessarily safe investments in the short-term, and liquidity is poor.
Given that only common shares sit below them on the capital structure in the event of a failure, they carry more risk than debt securities.
(Info via Allison McNeely Kristine Owram, as reported in The Globe and Mail, April 7/17)
The Bond Effect
A sustained rise in bond yields would lead to growth stocks outperforming and popular dividend-paying sectors lagging.
On the other hand, falling yields would signal sluggish economic growth and strong performance from stable dividend players.
(Info via Scott Barlow, as reported in The Globe and Mail, April 7/17)
But, hold on – not so fast…
As to the point that falling yields signal slower growth ahead, it’s not quite that simple.
Buying in bonds might be facilitated by rising yields, especially when you consider that government bonds in Japan yield nada, zero, zilch, zip.
And still there are investors who may not believe that higher rates will materialize, and decide to lock in gains accordingly.
Another factor to consider is that fixed income markets don’t behave like stock markets do – in part because institutional investors, like insurance companies and pension funds, are motivated differently than your average retirement pension investor.
Pension funds, for example, save with people’s retirements in mind.
Since the recession, pension funds have increasingly embraced risk in order to make sure that there is enough money for retirees.
They look out decades, not quarters, and don’t fret about short- or even medium-term volatility.
They buy bonds to keep returns and liabilities in synch, as part of their risk management strategy.
Many pension funds now target a bond exposure of 20-30 percent, down from the typical 40 percent a few years ago.
Even if yields are low, inflation is on the rise, or growth gains traction, institutions will still hold bonds, and buy them again when they mature.
That way, demand is maintained, which in turn keeps yields in check.
But, the yield picture could change.
The Fed has been hinting that it will start reducing the trove of bonds and mortgage-backed securities it has on its balance sheet – in excess of US$4.5-trillion – which, of course, would flood the market with debt, thereby driving up yields.
Were they to do so in a measured way, bond investors might not even take notice.
Unwinding the balance sheet could have the effect of deferring any further rate hikes, given it would be a form of monetary tightening.
At any rate, the true meaning of falling bond yields is not all that obvious.
One thing that may not be implied is the end of the bull market.
(Info via Joe Chidley, as reported in the Financial Post, May 4/17 and Robert Tattersall, as reported in The Globe and Mail, April 6/17)
Low rates reduce the attractiveness of bonds and other investments.
Jeremy Grantham, co-founder of money manager GMO, believes it may be years before we see rates begin to rise to any serious degree.
He also does not foresee an explosive or quick decline in the S&P 500 for a considerable length of time.
He’s not ruling out a garden variety correction that might take the market down 15 to 20 percent, but he doesn’t anticipate a catastrophic collapse.
This is in concert with what Mr. Belski said at the outset of this blog post about stock market outlook next 5 years.
A while back, I wrote a piece ‘Bonds Equal Low Returns’ in the following blog post:
“Safe-haven, government-type bonds tend to be an asset class that goes up when stocks go down,” according to Scott Newman, vice president of global investment strategies at Invesco Canada.
As Warren Buffett Sees It
Mr. Buffett likes to own companies with strong competitive advantages that have earnings he can predict way out into the future.
Companies like Costco and Nike would be on his radar.
(Info via Noah Buhayar, as reported in The Globe and Mail, May 2/17)
Mr. Buffett emphasizes long-term cash flow generation, and values consistency above all things.
His Berkshire Hathaway requires a ‘competitive moat’ – a competitive advantage that protects market share, and provides the ability to raise prices.
Historically, he has favoured strong brand names, like Budweiser or Gillette.
His favourites have also included companies like railways, given new rail capacity wasn’t being built – that scarcity providing existing companies with strong pricing power.
Mr. Buffett also demands strong management teams – measured by profitability in the form of return on equity or return on assets (depending on the industry) in relation to competitive companies.
Berkshire Hathaway doesn’t buy stocks trading at high valuations – instead focussing on a price-to-earnings ratio (or other relevant valuation measure) lower than the 10-year average.
Warren Buffett thinks investors should invest in stocks, not bonds.
(Info via Scott Barlow, as reported in The Globe and Mail, April 18/17)
TIF vs ETF
Mr. John C. Bogle, the father of the traditional index fund (TIF), favours buying and holding such an instrument over ETFs (exchange-traded funds), due to the fact that it was much more stable during the financial crisis.
He also cautions against aggressive trading of ETFs, which today account for about 40 percent of buying the U.S. market.
And, he warns against investing money in smart beta funds (also actively-managed ETFs, I respectively submit) on the basis that these financial instruments haven’t stood the test of time, nor have they been subjected to a big market meltdown.
He cites those funds, which are based on factor investing, as an example of too much innovation in the finance industry.
(Info via Sarah Jones, as reported in The Globe and Mail, April 28/17)
Managing Risk Premiums
Even with risk premiums on the wane, hedging a portion of one’s gains risk management could come in the form of adjusting or rebalancing one’s asset mix.
Of course, there are other ways to hedge those gains without actually selling the underlying securities.
As an example, one approach would be to purchase a put contract on a position as a measure of insurance.
This is the only sure way to protect a position, while at the same time maintaining possible future upside potential.
Buying a put option gives you the right, but not the obligation, to sell a stock you own at a set price.
If the share price falls, you can execute the option to sell the stock at the agreed-upon higher price.
If it doesn’t fall, you are only out of pocket the premium you paid for the put, which is a fraction of the cost of the underlying stock.
Stop losses are not nearly as effective.
Stop-loss orders automatically sell a security, when its price falls to a pre-determined level.
The downside is that the decrease in price might be short-lived.
Secondly, adding some income to a position could be accomplished by selling a covered call – an at-the-money call option.
This premium would offset some of the downside in the event of a market correction, while at the same time forsaking some of the upside beyond the premium.
And thirdly, there is the collar options strategy, which calls for buying an out-of-the money put, and selling an out-of-the money call.
This offers some material protection against a market correction, while retaining some attractive upside.
(Info via Martin Pelletier, as reported in the Financial Post, May 2/17, and Joel Schlesinger, as reported in The Globe and Mail, May 17/17)
The Master of Disaster
Bond ETFs are a good way to introduce bonds to your portfolio.
Bonds are insurance against disaster in either the economy or the stock market.
According to Bernard Leahy, one bond ETF in particular stands out as providing such insurance.
It’s the iShares 20+ Year Treasury Bond ETF (TLT).
He says, “The U.S. dollar long bond is the ultimate store of value when things go awry.”
Mr. Leahy is the former chief investment officer for the Hydro-Quebec pension fund and currency manager at the Caisse de depot et placement due Quebec.
Given the upbeat mood of investors lately, the TLT has suffered.
For the year to February 28/17, the total return of interest, plus share-price changes, amounts to a negative 4.7 percent.
The TLT could further deteriorate, if the U.S. economy picks up, and interest rates rise.
The effective duration of the portfolio is just over 17 years, meaning a rise of one percentage point in interest rates would culminate in a loss of 17 percent (vice versa, if rates decline).
Mr. Leahy posits that including TLT in a portfolio is an efficient way of providing diversification and facilitating insurance against disaster in the process.
He promotes the idea that a portfolio should be constructed in such a way that there are assets that perform during rising markets and those that stand up well in a down situation.
He favours the TLT instrument for Canadians, in that they would be the beneficiaries of money flowing into the U.S. dollar, as a result of a shock to the market.
The value of TLT converted into Canadian dollars would rise in such a situation.
And, long bonds benefit the most in dire circumstances, while proving to be risky in buoyant markets.
Mr. Leahy advocates that you add TLT to the other bond ETF holdings in your portfolio.
(Info via Rob Carrick, as reported in The Globe and Mail, April 5/17)
Dow Transports Have a Say
Investors, who espouse the Dow Theory, recognize that the transport index issues a sell signal when it, together with the industrial index, falls below the low of a previous retreat.
The notion is that the behaviour of shippers and truckers provides clues about the economy – the feeling being that those industries form the basis upon which goods and services are moved around.
(Info via Bloomberg News, as reported in The Globe and Mail, December 16/15)
Dogs of the Dow
The Wall Street veteran Michael O’Higgins came up with this strategy in the early 1990s.
It goes as follows: Invest in the 10 companies in the Dow Jones industrial average that have the highest dividend yield, and rebalance the portfolio once a year to always hold the highest yielding stocks.
His basic premise was that the high-dividend yields are a result of a general price decline of these out-of-favour companies.
People who favour this approach maintain that such companies will eventually shine, and outperform the index the following year.
In 1991, Mr. O’Higgins back-tested his strategy over many periods going back to the 1920s, and found that following it generally resulted in market-outperformance.
Since his study, though, the results have not been as convincing.
(Info via Charles Martin, as reported in The Globe and Mail, December 16/17)
The Fear Index
Forget about Brian Belski’s stock market forecast 5 years and beyond.
How about stock market forecast next 6 months or more?
The U.S. stock market volatility, as measured by the VIX indicator (CBOE volatility index), is close to record lows and, judging by history, that paints a bleak picture for the next 12 months.
It is a given that the VIX moves inversely to stocks, and that a low VIX normally translates into bullishness for stocks.
But, this time feels different.
If the past is any indication, this week’s (week of May 1/17) low level for the VIX could be a troubling sign for stocks over the course of the next 12 months.
This week, the index fell to its lowest level since February, 2007.
It briefly slipped to single digits.
Twice in the past two weeks, it closed below the 10.5 mark.
Since it originated in 1990, the VIX has closed below that mark on only 46 days – in and around December, 1993, December, 1995, July, 2005, December, 2005, November, 2006, to February, 2007, and July, 2014.
Excepting the December, 2005, instance, the one-year returns for the one-year S&P 500 headed into the low volatility period.
For instance, the S&P 500 index was up about 13.7 percent over the previous one-year period up to January 24, 2007, at which point the VIX fell to 9.89.
A year out, the S&P 500 was down 6.3 percent.
(Info via Saqib Iqbal Ahmed, New York Reuters, as reported in The Globe and Mail, May 5/17)
For more coverage on the VIX, please refer back to my previous blog post on that index:
Various theories have been put forward to explain the low level of the VIX: more efficient markets, ETFs tamping down volatility, more hedging methodologies, advances in technology, etc.
Etcetera:
The volatility index is compiled by the Chicago Board Options Exchange.
It uses stock options to measure the expected turbulence in the S&P 500 over the month ahead.
Analysts, including Barry Ritholtz of Bloomberg, posit that the VIX is more of a coincident indicator than a contrarian, or leading, indicator – meaning, it signals what is happening, not what will happen.
Assuming the present low reading of the VIX is correct in signalling that there’s no need to worry about the lofty stock prices, this could mean that stock prices might remain elevated for a quite some time.
Refer back to The TradingSmarts News Alert at the beginning of this blog post to remind yourself that Brian Belski is suggesting we are in the early stages of a 20-plus-year bull run.
The VIX could very well be supporting that notion.
Until bond yields and interest rates rise strongly, stocks are pretty much the only game in town.
Let’s face it, bond yields are so low, and the global economy is growing at a reasonable clip.
So, where else are you going to park your money, if it’s not in the stock market?
Let the facts speak for themselves.
Bonds at today’s prices offer no real return at all.
Add to that a standard portfolio comprised of 60 percent stocks and 40 percent bonds, which is destined to generate a real return of only 2.7 percent a year – before you even pay fees and taxes.
Such meagre returns don’t even come close to matching investors’ expectations – nor the returns required by most pension funds.
Apocalypse no, but a stock market decline of say 15-20 percent would actually be welcome news, in that it would create a great buying opportunity, bringing prices back down to levels closer to normal valuations, and it would facilitate stronger returns ahead.
Just just how low is low?
Wall Street’s favourite fear gauge has tumbled to some of its lowest levels in almost a quarter-century.
May 9/17, the VIX rose slightly, but continued to hover round 10.
Over the past five years, it has spiked above 30 on several occasions, and averaged just more than 15.
Per Schaeffer’s Investment Research, the last time the VIX broke less than 10, after spending at least a month above that level, was in January, 2007.
We all remember, at least I do vividly, how that played out several months later.
The financial crisis erupted with all its might.
Aarrghh!
As it turns out, what a great buying opportunity that was.
Don’t worry… there will be more such opportunities – hopefully not quite as dramatic.
(Info via Ian McGugan, as reported in The Globe and Mail, May 10/17)
Big Fat Juicy Dividends
Big fat juicy dividends that continue to grow, that is.
Without that combo, you’re left with mediocre total returns, share price stagnation, and a business in decline to say the least.
But, what to look for?
First and foremost, I look for momentum situations, where the trend, as defined by the 200 EMA, is steadily up.
I’m not saying that is the only consideration, but I am not interested in having a stock in my portfolio that is not performing to the max.
I want my money to work for me big time, all the time.
Or say, “Sayonara baby.”
Yes, companies should have above-average dividends that will grow over time, supported by rising earnings and sales.
That’s a given.
A prospering company will throw off a growing dividend and a rising share price.
A great read on dividends is ‘The Single Best Investment’ by U.S. portfolio manager Lowell Miller.
He identifies dividend growth as crucial to ensuring that a portfolio works its magic throughout the years.
His formula for fleshing out promising companies is quite simple: high quality + high current dividend = high total returns.
At a minimum, he wants to see a yield that’s 1.5 times the market yield.
(Info via John Heinzl, as reported in The Globe and Mail, May 10/17)
Dividend Risk Management
Dividends have tax advantages over bond interest in non-taxable accounts through the dividend tax credit, not to mention the much higher yields from dividends over bonds.
But, these advantages are not without consequence.
Better returns carry higher risk.
Dividends are not as safe an income source as interest generated by bonds, or guaranteed investment certificates, issued by either corporations or governments.
In recessionary times, a company might maintain interest payments to bondholders, but cut or suspend its dividends to shareholders.
Mitigating this risk entails limiting exposure to dividend payers in certain sectors – like energy and mining, where dividends are at the mercy of resource prices.
Instead, the emphasis should be on proven, sustainable businesses that pay steady, or better, growing dividends year after year.
An unavoidable risk facing all investors in dividend stocks is falling stock prices.
In the event of interest rate appreciation, pipeline, real estate, telecom, and utility stocks could take a hit.
By the same token, a housing market correction or recession could negatively impact financials and industrials.
(Info via Rob Carrick, as reported in The Globe and Mail, May 19/17)
Gunslingers No More
Long gone are the hot shots of yore, each with their money-managing strategies that eventually flamed out.
Take Warren Buffett, for example.
If you ignore the first chaotic year of the downturn, and start monitoring his returns from February, 2008, over the ensuing nine years, he trailed slightly behind a plain-vanilla S&P 500 investor, who simply reinvested the dividends.
And then there’s that mutual fund manager Miller, who beat the S&P 500 15 years in a row, from 1991 to 2005.
His winning streak went kerplunk in 2006, and then he lagged the market for four of the next five years.
Enter Hawkins, a classic bargain hunter.
In the decade before the crisis, he racked up returns of nearly 13 percent a year by working with a small number of thoroughly-researched, deeply undervalued stocks.
Since the crisis, he has done a face-plant, like all the others.
Well, maybe not all the others.
Warren Buffett claims that, over all the years, he can only recall a handful, if that, of hedge fund managers, who had the Midas touch of outsmarting the markets.
Hawkins’ style of generating big returns by focussing on a few big bets has all but evaporated into thin air.
And, finally, there’s Chou, dubbed by Morningstar as Canada’s fund manager of the decade back in 2004.
He has his own unique style that has paid off handsomely for him periodically.
But, over the past few years, his well seems to have run dry.
His flagship fund produced an average return of a measly 3.3% in the decade ending January 31/17.
And, so it goes… they all keep trying to beat the markets – but few have any real staying power.
Bring on the index funds and ETFs.
They should complement Mr. Belski’s stock market forecast next five years quite nicely that I presented earlier on in this blog post.
More specifically, the Vanguard S&P 500 Index ETF (VOO) is a sure-fire winner.
Sorry, the fund itself is not available in Canada, but the ETF itself is the next best thing.
(Info via Ian McGugan, as reported in Report on Business, April/17)
How to Outsmart Buffett
Here’s further ammo for buying an index fund, and trusting the market to allocate your funds, rather than listening to Mr. Buffett himself.
His praise of index funds is tacit admission that it would be a leap of faith to assume he can continue to beat the market.
Berkshire’s results since 2010 have been mediocre at best.
As well, there have been recent missteps – from a poorly timed miscue on IBM to a customer-abuse scandal at Wells Fargo – one of Buffett’s long-time favourite stocks.
He’s even confessed to blundering by not buying Google shares years ago, and for being stupid in avoiding Amazon early on.
He seems to have overcome his disdain for tech stocks, gobbling up Apple shares, citing his view that he could “very easily determine” Apple’s competitive position “and who is trying to chase them.”
He also views the iPhone as a consumer appliance, as opposed to a technical thing.
Adding fuel to the fire is Berkshire’s sheer size.
It is now so big that it’s difficult to find opportunities large enough to make a material difference in its results.
Buffett’s track record can be explained away by his proclivity for stocks that meet three criteria: cheap, high-quality, and low risk – this according to a 2013 paper titled ‘Buffett’s Alpha’ by Andrea Frazzini and David Kabiller of AQR Capital Management and Lasse Heje Pederson of New York University.
According to that paper, neither luck nor magic appear to influence his returns – but rather his use of leverage, combined with a focus on such stocks.
(Info via Ian McGugan, as reported in The Globe and Mail, May 9/17)
The Trillion Dollar Man
Blackrock is one of the behemoths of low-cost, passive exchange-traded funds.
Mark Weidman leads its iShares ETF platform, which has more than US$1-trillion under management.
According to Mr. Weidman, index investing is so under-subscribed relative to its potential.
Trillions are trapped at very high fees – especially in Canada, where there’s a $100-billion in ETFs and probably $1.5-trillion in mutual funds.
His Guiding Principle:
Here, he specifically targets new investors – especially the young ones.
For them, he posits that they should invest in North America, if they plan to sock their money away for a long time.
He maintains that it’s the safest place to invest on the planet, with great natural resources and the most dynamic population.
(Info via Tim Kiladze, as reported in Report on Business, February/17)
News is Noise
Richard Bernstein, a former strategist with Merrill Lynch, now heads up his own buy-side boutique.
He is keen on U.S. stocks, despite worries about the aging bull market.
He advises investors to avoid all the noise.
By paying attention to it, you run the risk of buying high, and selling low.
(Info via David Berman, as reported in Report on Business, February/17)
A Dollar Measure
Marilyn Cohen’s top metric is the Treasury International Capital figure.
It gives the net transactions by foreigners in U.S. securities, plus foreign demand for U.S. securities, and the U.S. dollars needed to purchase them.
According to Ms. Cohen, a fall in TIC holdings often portends a weaker dollar.
She has become one of the leading bond managers in the U.S. through Envision Capital Management, which she founded 20 years ago.
It has US$395-million in assets.
(Info via Brian Milner, as reported in Report on Business, February/17)
An Investing Legend
By now, if you haven’t already heard of John C. Bogle, you are not from this universe.
He is the founder of Vanguard Group (1974) – the world’s largest provider of mutual funds, managing US$3.8-trillion in assets.
Added to his credits is the world’s first index mutual fund.
A graduate of Princeton University in economics, he devoted his career to pioneering and championing low-cost index funds that mimic benchmarks, such as the S&P 500.
He discovered that few active managers could beat them.
Today, he is president of Bogle Financial Markets Research Center, where he plays an indexing-advocacy role, and does research.
Even Warren Buffett is a big fan of Mr. Bogle and the Vanguard S&P 500 index fund.
Mr. Buffett has been quite vocal about owning the market at a very low cost.
He even plans to put 90% of his wife’s inheritance into the Vanguard fund.
Mr. Bogle reiterates what we have all heard before – that fund companies can’t beat the market over a long period of time.
He maintains that mutual funds are on the wane, and that many will go the way of the Dodo bird.
On the subject of investing internationally, he says that half of the earnings and revenue of U.S. corporations comes from outside the U.S. – so, investing outside its borders is not necessary.
Mr. Bogle is of two minds, when it comes to gold, which he sees as pure speculation.
On the one hand, it can guard against run-away inflation.
But, in the long run, investing in gold is a mug’s game.
It has no internal rate of return.
Compare that to bonds that have their interest rates and stocks that have a dividend yield or earnings growth.
Mr. Bogle advises Canadians to put some money to work in the U.S., because of its diversified industrial base, innovation, technology leadership, and strong pressure to build companies that grow.
He also cautions Canadians to be careful of costs, arguing that fees for Canadian mutual funds are very high.
As to his own investments, he has 50% in bonds and 50% in stocks.
His favourite holdings include the Vanguard S&P 500 Index Fund.
Who could have guessed?
Of course, I would be remiss in not mentioning Mr. Bogle’s delightful little book, ‘The Little Book of Common Sense Investing.’
It is a must-read for investors of all ages – especially those new to the game and the younger ones, who have time on their side.
(Info via Shirley Won, as reported in Report on Business, February/17)
Doctor Turned Investor
William Bernstein didn’t need to find a way to get rich.
He was a clinical neurologist.
He just wanted to find out how best to invest his money.
To make a fat story thin, he has concluded that you would be well advised to invest through low-cost index funds.
Where have we heard that one before?
(Info via Ian McGugan, as reported in Report on Business, February /17)
The Indexing Craze
Index funds and ETFs via Blackrock and Vanguard own 12 percent of the stock market.
That number is expected to grow rapidly, with 75 cents of every new dollar invested in the U.S. ending up in these two companies’ index-based products.
Index funds typically beat two-thirds of discretionary stock-picking managers, who are burdened by higher fees and transaction costs.
Data shows “that the vast majority of active managers are unable to produce excess returns that cover their costs.”
The hedge fund industry experienced net outflows of US$5.4-billion in the first quarter of 2017, according to Hedge Fund Research (HFR).
That followed US$70.1-billion in outflows in 2016 – the largest calendar year loss since 2009.
During that time, public pension funds in states, including Illinois, New York, and Rhode Island pulled money out of hedge funds.
Again according to HFR, the average hedge fund returned 7.5 percent from the start of May, 2016, through March, 2017 – approximately half the 14.4 percent gain in the benchmark S&P 500 index during the same period.
You can tell how well passive managers fare by using an underrated metric called ‘tracking difference.’
It basically tracks how far off an index fund or ETF is from its index’s return.
As an example, Gerard O’Reilly, manages the Vanguard Total Stock Market Index Fund, which charges a measly 0.05 percent.
That fund has only missed its index over the past few years by 0.01 percent.
How does he do it?
The managers at Vanguard consider that costs matter more than the level of trading activity.
They are ruthlessly efficient, and drive costs down.
The Vanguard Group is an American investment management company founded by John C. Bogle
Based in Malvern, Pennsylvania, it has over US$4-trillion in assets under management and total assets of US$1.86-trillion.
BlackRock, Inc. is an American global investment management corporation based in New York City.
Founded in 1988, initially as a risk management and fixed income institutional asset manager, BlackRock is the world’s largest asset manager with US$5.4 trillion in assets under management.
BlackRock operates globally with 70 offices in 30 countries and clients in 100 countries.
Due to its power, Blackrock has been called the world’s largest ‘shadow bank.’
The shadow banking system is synonymous with the collection of non-bank financial intermediaries that provide services much like traditional commercial banks, but outside the usual financial regulations.
Shadow banking has gained traction to the point of rivalling traditional depository banking.
It was a contributing factor to the subprime mortgage crisis of 2007-2008 and the global recession that followed.
(Info via Eric Balchunas, as reported in The Globe and Mail, March 7/17 and David Randall/Svea Herbst-Bayliss, as reported in The Globe and Mail, May 9/17)
Hedge Funds’ New Normal
According to a Goldman Sachs survey, the churn in hedge fund portfolios has been falling steadily over the past seven years, hitting a new low recently.
They seem to be catching the indexing drift of putting a lid on portfolio turnover.
This year through April/17, hedge funds sit at slightly more than three percent – about half the nearly 6.5 percent gain of the S&P 500 stock index since the beginning of the year.
Buy-and-hold (low turnover) is the bedrock of the index fund mantra, and the hedge funds seem to be catching on.
Hedge funds appear to be in a bit of a slump, but maybe that’s a good thing.
Steady-as-she-goes is now the in-thing.
Just ask John C. Bogle.
What’s the rush?
It looks like we’re in for a very long bull run, according to Brian Belski (see his opening remarks about stock market forecast next five years and beyond).
(Info via Stephen Gandel, as reported in The Globe and Mail, May 11/17)
In Sum
Warren Buffett insists that investors would be better off putting their money in low-cost indexing strategies, and avoiding high-fee actively-managed funds.
He maintains that professional investors, over a period of years, will under-perform the returns achieved by amateurs, who do nothing more than put their money to work in an index fund.
Last year, according to S&P Dow Jones Indices, 90 percent of active stock managers failed to beat their benchmarks over the prior one-, five-, and 10- year periods.
According to S&P Dow Jones Indices SPIVA Canada scorecard for 2016, released April 19/17, a mere 17.3 percent of active managers investing in domestic equity outperformed the S&P/TSX composite index last year.
That’s less than one in five.
The percentage of outperformers gets ever worse over 10 years – down to nine percent.
Mr. Buffett best advice is to stick with index funds, because they were developed as a way for investors to match the market’s return as closely as possible.
Accordingly, they get the diversification they need without the hassle of trying to find the right active manager.
A growing body of research generally supports a low-cost, passive approach as the most effective for the masses.
The ETF has proven well-suited to execute that kind of approach.
Like mutual funds, ETFs offer exposure to segments of the bond, commodities, and stock markets, but with substantially lower fees.
Equity ETFs account for about 80 percent of the US$2.8-trillion U.S. market.
(Info via Rachel Evans, as reported in The Globe and Mail, April 7/17, John Reese, as reported in The Globe and Mail, April 17/17, David Berman, as reported in The Globe and Mail, April 20/17, and Tim Shufelt, as reported in The Globe and Mail, May 13/17)
Canadians can participate in the broad S&P 500 market through the iShares S&P 500 ETF (XSP), which is hedged in Canadian dollars.
A falling loonie enhances returns from U.S. holdings for Canadian investors, while a rising currency erodes returns.
If your U.S. exposure is hedged, you’re not affected by all of this.
You miss added gains when the currency swoons, but are protected when the currency takes flight.
An index is almost impossible to beat in the long run – especially the S&P 500, which is the world’s most difficult index to beat.
At the time of this writing, the S&P 500 is still soaring to new heights with no end in sight.
If stocks begin to fall, buying this basket of stocks might be the prudent thing to do.
In the event of a correction, the blue chip Dow, which consists of just 30 stocks, and is weighted by stock price, would suffer more severely than the S&P 500.
It has been outperforming the S&P 500, because of its heavier weighting towards U.S. financials (Goldman Sachs in particular).
The S&P 500 would represent a better buying opportunity than the Dow, due to its superior diversification.
Canadians can also use the Vanguard S&P 500 ETF (VOO) vehicle to achieve similar exposure to the S&P 500 market – the fund itself not being available in Canada.
For coverage of the Canadian market, there’s the Vanguard FTSE Canada Index ETF (TSX: VCE) with assets under management of $158 million and an MER of 0.11%.
This is the cheapest offering in its class.
It is based on an FTSE index, not a variation of the S&P/TSX Composite.
That’s an important consideration, in that the S&P/TSX Composite is highly concentrated among just three sectors: energy, financials, and mining.
Those three sectors account for 75% of the market, so ETFs that track the S&P/TSX Composite may be in danger of being insufficiently diversified.
Per Vanguard, “the FTSE Canada Index is a market-capitalization weighted index representing the performance of Canadian large- and mid-cap stocks… [that] represents about 75% of the Canadian equity market.”
This ETF hasn’t achieved significant penetration in Canada yet (just $158 million in assets), but it still offers the cheapest exposure to the performance of the broad Canadian stock market.
Given an expense ratio of just 11 basis points, that’s well below the weighted-average management expense ratio for ETFs in Canada (42 basis points).
It should be noted that the Canadian market has been the best performing market for the past 115 years and counting, so choosing an ETF like this one is certainly worth considering.
There is also the Vanguard FTSE Canadian All Cap Index ETF (VCN).
And, then there’s Canada’s biggest ETF – the iShares S&P/TSX 60 index ETF (XIU).
It owns the six largest Canadian banks, which together account for nearly 30 percent of the fund.
There is a single ETF that holds a basket of 17 other ETFs that invest in Canadian, international, and U.S. bonds, dividend stocks, preferred shares, and real estate.
It’s the iShares Balanced Income CorePortfolio Index ETF (ticker CBD), with an MER of 0.73 per cent.
If you are more aggressive in your outlook, there’s an ETF that’s tilted more heavily toward equities, and has a slightly higher MER of 0.83 per cent.
It’s the iShares Balanced Growth CorePortfolio Index ETF (CBN).
When it comes to buying an ETF or a fund, remember the old adage (the ‘Golden Rule’ of trading) – ‘buy the dips in the uptrend.’
In other words, buy weakness (when the market is on sale).
Keep that in mind, if you espouse Brian Belski’s earlier comments about stock market forecast next five years and beyond, and you want to participate along the way.
If you are struggling with asset allocation, go to the Vanguard Investor Questionnaire online, and take their free test.
Based on a series of 11 questions, it will provide a suggested stock-bond split, based on your risk profile.
Free Stock Trading
Stock brokerage app Robinhood lets traders buy and sell individual stocks for free.
The app was officially launched on Apple’s App Store December, 2014.
It is now also available for Android devices via the Google Play Store.
Required Reading
‘Am I Being Too Subtle’ is an indispensable read for the next generation of disrupters, entrepreneurs, and investors.
The title, a reference to Zell’s favourite way to make a point, takes readers on a ride across his business terrain, sharing with honesty and humour stories of when he got it right, when he didn’t and, more importantly, what he learned in the process.
Its author, Sam Zell, is one of the world’s most successful entrepreneurs and one of the most enigmatic, entertaining, and surprising mavericks in American business.
A self-made billionaire, he sees what others don’t.
Year after year, deal after deal, the story remains the same… from finding a market for overpriced Playboy magazines among his junior high classmates, to investing in often unglamorous industries with long-term value, to buying real estate on the cheap after a market crash, Zell acts boldly and decisively on supply and demand trends to grab the adopter.
He can suss out opportunity virtually anywhere – from an arcane piece of legislation to a desert meeting in Abu Dhabi.
“If everyone zigs, you zag,” he says.
An independent thinker, he does his own homework, shutting out the noise of the crowd, gathering as much information as possible, and trusting his own instincts.
Even though the Tribune Company went into bankruptcy a year after he agreed to steward the enterprise, his razor-sharp instincts are legendary on Wall Street, and he has sponsored over a dozen IPOs.
He’s known as the Grave Dancer, because of his tendency to target troubled assets – this despite the fact that he’s created thousands of jobs.
Within his own organization, he has an inordinate number of employees at every level who are fiercely loyal, and have worked for him for decades.
Zell’s personality is larger than life; he is often blunt, contrarian, and irreverent – always curious and hardworking.
This is the guy who was wearing jeans to work in the 1960s, when offices were a sea of gray suits.
He’s the guy who told The Wall Street Journal in 1985, “If it ain’t fun, we don’t do it.”
He rides motorcycles with his friends, the Zell’s Angels, around the world, and he keeps ducks on the deck outside his office.
As he writes: “I simply don’t buy into many of the made-up rules of social convention.
The bottom line is: If you’re really good at what you do, you have the freedom to be who you really are.”
Zell is a seller of real estate, claiming that it is too frothy, and that there will be more supply than demand.
(Info via Google books)
Inspiration and Quotes
(Image via Matt Boudreau, Small Business Development Manager, Calgary South District at Scotiabank)
“To each there comes a special moment in their lifetime, when they are figuratively tapped on the shoulder, and offered the chance to do a very special thing, unique to them, and fitted to their talents. What a tragedy, if that moment finds them unprepared or unqualified for that which could have been their finest hour.” Winston Churchill
“Shined shoes save lives.” General Norm Schwarzkopf (of Operation Desert Storm fame)
He explains that, in the heat of battle, the fog of war, under pressure, the undisciplined die.
“The most important thing in our lives is consistency.” Steve Wynn
“Love companies where management have a large stake in ownership.” Steve Wynn
“Rule No. 1: Don’t lose money.” Warren Buffett
“Do what you love, and do it a lot.” Hanson
“You are the author of your personal narrative.” Donald Trump
“Outsiders change the world.” Donald Trump
“Don’t let the critics or naysayers get in the way of your dreams.” Donald Trump
“Never give up; things will work out just fine.” Donald Trump
“A day without laughter is a day wasted.” Charlie Chaplan
“To understand someone is to repeat back to them what they said better than they originally described it.” Dale Carnegie
Free Cash Flow Defined
Free Cash Flow (FCF) is a measure of a company’s financial health, calculated as operating cash flow minus capital expenditures.
FCF represents the cash that a company has left over, after spending the money required to maintain, or expand, its asset base.
References
http://www.chartpatterns.com/ascendingtriangles.htm
http://www.investopedia.com/terms/f/freecashflow.asp
https://en.wikipedia.org/wiki/BlackRock
https://en.wikipedia.org/wiki/Shadow_banking_system
https://en.wikipedia.org/wiki/The_Vanguard_Group
https://investor.vanguard.com/home/
https://www.bmo.com/nesbittburns
https://www.hedgefundresearch.com/
https://www.invesco.ca/ivz/home
Conclusion
I hope you found this Stock Market Forecast Next Five Years and Beyond blog post to be helpful, and that you are now pretty excited about the prospects for the stock market.
If you buy into a long-term perspective for growing your money, then this blog post has served its purpose.
If you still have lingering questions about anything I have shared with you, please feel free to contact me here.
If you would like to arrange private consulting lessons with me on better understanding investment strategies, you can make your request at the same link.
Or, if you would just like to have me as your trading adviser, the same link will do it.
If you missed any of my previous blog posts, here they are:
Three Winning Stock Trading Strategies
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Here’s To Your Success and Quality of Life,
Peter R. Bain
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About Peter R. Bain
Peter R. Bain
I am a speaker, trader, writer, aviator, car nut, Harley enthusiast but, above all else, I am here for you at TradingSmarts, which I founded some 15 years ago.
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