95 years young

Sir John Templeton may not be a household name, but in the investment world, he is a legend. Born in 1912 in humble surroundings, he attended Yale University during the Great Depression and was named a Rhodes Scholar to Balliol College at Oxford.

He began his career on Wall Street in 1937 and borrowed $10,000, a hefty sum in those days, after World War II began. With the cash, he bought 100 shares in just over 100 companies that were trading at $1 per share or less on the New York Stock Exchange.

One of his favorite maxims, “Invest at the point of maximum pessimism,” paid off handsomely.

While four of those firms eventually went bankrupt, he made a handsome profit on the others after holding each for an average of four years.

Eventually he founded Templeton Funds, which became one of world’s largest and most successful international investment funds. In 1999, Money magazine said he was “arguably the greatest global stock picker of the century.”

On July 8, 2008, the investment community lost one of the great investment minds and philanthropists of our time when Mr. Templeton passed away (sirjohntempleton.org, The Economist, Wall Street College).

Source: Wall Street Journal, MSCI.com *Annualized **USD

The Nasdaq recaptures a milestone

Another principle Templeton adhered to, “The four most dangerous words in investing are: ‘This time it’s different,’” went against the grain, particularly when many in the crowd really believed it was different when the Nasdaq Composite crossed 5,000 during the dot-com era.

This flip-side of his “Buy when pessimism is high” also helped him avoid the devastating selloff in the tech-heavy index when the dot-com era came to an end. In early 2000, he jettisoned his tech holdings just as the index was set to decline by 78% over a 2.5-year period (St. Louis Federal Reserve).

Fast forward 15 years. On April 23, the Nasdaq Composite closed at 5,056.06, surpassing the old closing high of 5,048.62 reached on March 10, 2000 (St. Louis Federal Reserve).

The time it took the Nasdaq to reclaim its old high almost takes my breath away. The downward descent was nothing short of brutal, and honestly, some thought it might take an entire generation for the Nasdaq to hit a new milestone.

At the time, too many investors thought they were diversified simply by holding a large number of tech and dot-com shares. In reality, a well-diversified portfolio must include a stake in all the major sectors of the economy.

Even with a mix of bonds, a truly diversified portfolio would not have sidestepped the bear market of 2000, but it would have cushioned the decline, and you would have been well positioned to benefit when pessimism was at its peak.

Stock bubbles

The ascent of the Nasdaq highlights the dynamic nature of the U.S. economy. But it also leads us to another question, and one that keeps coming up. Are we in bubble territory? Is there too much enthusiasm, which might lead to an extended selloff?

Trying to accurately forecast where stocks might be over the next 6 to 12 months is much like trying to guess the final score of a sporting event when both teams are in the locker room at halftime. Not even the most thoughtful and well-reasoned sports analyst has that kind of crystal ball. For that matter, no one else does.

One thing is clear—there are some stark differences between today’s Nasdaq and the Nasdaq of the 1990s that surged from 752 at the end of 1994 to over 5,000 in five years.

We’re no longer in the dot-com era, when firms were selling shares to a public that hungered for companies that simply had an idea and little profitability. Even firms that were profitable at the time had valuations that were in the stratosphere.

This the called the Greater Fool Theory: It doesn’t matter how much one pays for a stock, because there is the belief that a greater fool will willingly pay even more!

Today, many of those same established companies sell at much more reasonable valuations, many pay dividends, and many of the newer faces on the block are profitable.

That doesn’t mean it hasn’t gotten frothy in some sectors, including some social media and biotech companies.

Where we are at today illustrates a simple principle: the importance of sticking to a carefully crafted investment plan that takes the emotion out of the investment decision. Just as the time in a long car trip includes pit stops or unexpected breaks, the investment plans we recommend incorporate downturns in shares.

While we don’t know when the next bear market will begin, it will occur. If the history of the last 200 years is a good guide, it will be followed by a bull market that takes shares to new heights.

Bond yields in the basement

Many investors continue to fret about the low level of interest rates for safe investments. Lets go through a quick explanation of today’s low-rate environment.

When the financial crisis began in late 2008, the Federal Reserve embarked on an unusually aggressive monetary policy, driving short-term interest rates to zero and buying trillions of dollars in longer-term Treasury bonds and mortgage-backed securities.

Bond prices and bond yields move in opposite directions. The Fed’s goal was to push up bond prices and therefore lower interest rates in the hopes it would encourage consumers and businesses to borrow and spend, stimulate economic activity and hiring, and jumpstart the faltering economy.

Only then would it begin to “normalize” interest rates.

Given the substandard economic recovery, it’s hard to argue the Fed’s plan has been a resounding success. A quick glance at a three-month T-bill, which continues to hover barely above a yield of zero, is a stark reminder the Fed has yet to raise short-term rates.

While it doesn’t set longer-term bond yields, the Fed does hope to influence rates. A number of factors play into the bond-yield equation, and that forces us to turn our attention to the international arena.

The global market can and does influence what happens here at home. It’s something we can’t avoid, and it’s why I monitor international events.

While a 2% yield on the 10-year Treasury bond frustrates many of you, a quick trip across the Atlantic paints a much different picture, and it’s affecting bond yields in the U.S.

A recent analysis by Goldman Sachs that appeared on CNBC revealed that about $2 trillion in government bonds in the eurozone (the 19 countries in Europe that use the euro) have a yield below zero.

That means the bond buyer is paying money to lend his/her cash to that particular government. Most of these bonds are short-term, less than two years, but a few of the more stable economies allow their respective governments to attract cash at a negative yield for as long as seven years.

Notably, Switzerland, which is not part of the eurozone, recently saw its 10-year yield slide below zero. That’s simply astounding.

Germany, which is Europe’s largest economy, sported a yield of just 0.07% near the end of April, and France saw its yield briefly slip below 0.40% (Bloomberg).

Thank (or blame) everything from anemic growth on the continent to the threat of deflation and the European Central Bank’s January decision to begin buying 60 billion euros (about $66 billion) in various government bonds each month.

Today, capital can easily move across borders, and rock bottom returns on government bonds in Europe are attracting cash into the U.S., where returns are more reasonable by comparison.

While the U.S. fiscal situation is far from ideal, the relative strength of the U.S. economy, the depth and transparency of the country’s capital markets, the safe-haven status of U.S financial markets, and the dollar’s status as the global reserve currency are among the factors that attract capital.

Taking into account the above factors, as well as the relatively higher yield a foreign investor can earn on U.S bonds, it makes sense for some foreign investors to seek out bonds in the U.S. Simply put, those purchases are working to keep a soft lid on U.S. yields.

We believe the primary job for bonds is to reduce volatility and protect the portfolio from the ravages of a downturn in the stock market.  Given this philosophy, we continue to invest in high quality, shorter term bonds on a global basis.