Part 2
By Richard L. Kesner, President
The CommonWealth Group
February 2006 Year End Summary
2005 ended quietly with the overall markets showing little strength through the end of the year. For the year the S&P was up 3% without dividends and 4.91% including the dividends. The DOW was negative for the year as was NASDAQ.
The winners as you probably know are the managers who invested in Energy Stocks. The Energy Sector was up 31% last year, and basically provided all the gains for the S&P 500 and minimized the losses for the DOW. If you did not own Energy the performance of your portfolio suffered. In hindsight it’s easy to understand how Energy was the big winner, but is there really anyone who knew that oil was going to go from about $42 a barrel to $68 per barrel in a year? That is a 50% increase in that one commodity. People who knew this was going to happen should have purchased lottery tickets.
A great many of our clients like to be conservative. They do not want to take enormous risks with their investments and we have structures their investment portfolios to minimize the volatility of the investments. Because of that we use many value managers to handle their stock portfolios. Since the price of oil rose so quickly the value managers either sold out of their energy stocks or never purchased them since they were outside of the value arena. It would have been outside of their discipline to hold these stocks and it would have provided more volatility than the clients had requested when designing the asset allocation. Some portfolios were flat for the year, still not losing money, but not making money also. This is a one-year point in a ten or 15-year plan and it needs to be looked at in that context.
If the risk parameters of the investor have changed, then we can revisit the structure of the portfolio and move forward at that point. This will again create a long-term plan under the new risk structure with more volatility and different styles of management. In hindsight it is easy to see where your investments should have been. It is like asking the Dentist to predict where your cavities will be over the next five years and to treat the teeth presently. It just doesn’t work that way.
1970s
Small Company Stocks……………….11.5%
Large Company Stocks……………….. 5.9%
Long Term Government Bonds………..5.5%
Treasury Bills…………………………. 6.3%
Inflation………………...…………….. 7.4%
The most notable item is that inflation has jumped off the chart. From the 30s through the 60s inflation ranged from -2.0% to 5.4%. This 7.4% is staggering to fixed income investors as they lost money in each category. Large Stocks also performed poorly at 5.9% leaving only the small company stocks at 11.5% a winner over inflation.
The cause is easily remembered by many of us who stood in gas lines. The ARAB Oil Embargo started in 1973 and oil prices tripled. Other events included the resignation of President Nixon, the deregulation of securities brokerage fees and the 1979 Oil Crisis in Iran. Does this sound somewhat like what is going on today?
1980s
Small Company Stocks…………………15.8%
Large Company Stocks……………….. 17.5%
Long Term Government Bonds………..12.6%
Treasury Bills…………………………. 8.9%
Inflation………………... …………….. 5.1%
All of the investments outperformed inflation for the first time. That was great news for fixed income investors during the decades, but the winners were still equities as the Large Company Stocks had their best returns since the 50s. Small Company Stocks continued providing double-digit returns and have provided double-digit returns for each decade except the 1930s.
On the Global front there were a lot of event starting with the divestiture of AT&T in 1984. In 1989 oil prices collapsed, hurting speculators, in 1987 the Berlin Wall opened signaling the demise of Russian Communism.
1990s
Small Company Stocks………………...15.1%
Large Company Stocks………………..18.2%
Long Term Government Bonds………...8.8%
Treasury Bills………………………….. 4.9%
Inflation………………... …………….. .2.9%
Inflation remained low for the second consecutive decade, and all of the investments outperformed the CPI. Large Company stocks enjoyed their second consecutive decade of the highest returns, but small company stocks completed their sixth consecutive decade of double-digit returns. That is 60 years of fabulous growth.
This was the decade of growth as the Dow Jones Industrial Average passed 10,000 in 1999. Mutual Fund assets passed the $1 trillion mark in 1990. In 1991 we experienced the first Gulf War and in 1997 we weathered the Asian Financial Crisis.
In summary we can see that despite all of the outside influences, Wars, Oil Embargoes, Presidential resignations, the fall of communism, etc., equities win. Small Cap stocks averaged 12.12% since the 1930s. Large Cap averaged 9.75% which is double the 4.75% return by long-term government bonds. Treasuries barely beat inflation at 3.31% vs. 2.94%. This is without taxes so the return for long-term bonds and treasuries would be negative to inflation for high taxpayers.
The stock market is resilient. The key is to develop a long-term strategy and stick with it.
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