(PUB) Investing 2016

managers who will pick and choose which stocks and bonds are cheaper than normal and avoid those they think are a bit too pricey. Even if these man- agers are only successful on the mar- gins—and we know from experience that they do a whole lot better than that (see page 16)—we’ll come out ahead over the long haul. One thing I don’t recommend, and hope you won’t fall prey to, is the “buy the beaten down” mantra that is cur- rently making the rounds as pundits and prophets gush about their “best” ideas for the year ahead. The most popular topic: Oil and energy stocks. As I read the financial press, as well as analysts’ reports and even the letters to share- holders fromVanguard’s managers, one of the biggest themes I’m seeing again and again is an unwavering belief that oil prices are destined to rise in 2016, and therefore, so are energy stocks. Of course, there’s no question that this is one of the most unloved sectors >

of where relative values lie between the two major asset classes. You might ask what happened dur- ing the financial crisis. Yes, the gap nar- rowed dramatically by the end of June 2007, and then rebounded to a high dur- ing the first quarter of 2009. The only time the gap has widened that far again was during the third quarter of 2011, when stocks were pummeled amidst uncertainty over government budget battles and the debt ceiling, and gold was moving towards $1,900 per ounce. Treasury yields flirted with sub-2% levels, and investors were frightened. Over the next four years, though, stocks returned 84.4%, while the bond market gained 9.6%. So where are we today? Neither hot, nor cold. The yield-earnings gap is trending right around its average over the past 30 years. If companies begin earning a bit more money, the needle will point more towards stocks, while a rise in yields will tip the scale more

Stock Earnings Yields vs. Bond Yields

10% 12% 14% 16% 18%

0% 2% 4% 6% 8%

Earnings Yield 10-year Treasury Yield

9/87

9/89

9/91

9/93

9/95

9/97

9/99

9/01

9/03

9/05

9/07

9/09

9/11

9/13

9/15

towards bonds. Given this scenario, I’m neither pounding the table for stocks, nor am I recommending retreat. I’m a bit more optimistic about this when I think about our portfolios than when I think about investors who trust their investments to the whims of the stock and bond market indexes. Why? Because you and I invest with some of the smartest managers on the planet—

if you were “Ready for $20 Oil,” though, of course, as the year ended oil was trading closer to $37. He also called for the 10-year Treasury’s yield to fall to 1.0%. You have to love this one: MarketWatch ’s Lawrence McMillan wrote that 2015 would be bullish because “years ending in ‘5’ far outperform any other year of a given decade.” Of course, that didn’t hold true for 2005, which was only the sixth best of the years from 2000 through 2009, but nonetheless he was willing to get investors’ juices flowing with this lovely, useless and wrong tidbit. In fact, with the Dow having fallen 2.2%, 2015 is, so far, the worst year of the current decade by a country mile. Chris Rupkey, the chief financial economist at Bank of Tokyo-Mitsubishi UFJ, told Bloomberg that the 10-year Treasury yield would rise to 3.4% by the end of 2015. He wasn’t far off…from his peers, at least. The median forecast of 74 economists and strategists that Bloomberg surveyed was 3.01%. Now, just in case you weren’t keeping track, the 10-year ended 2015 at 2.27%. Speaking of surveys, the Wall Street Journal ’s survey of 70 economists saw the average seer predicting oil rising over 2015 to a bit more than $63 per barrel. While the forecasters’ average prediction for unemploy- ment was 5.2%, a handful actually expected the rate to fall below 5% by year-end. Jeremy Siegel told CNBC that the Dow Jones Industrial Average could hit 20000 in 2015, which sounds pretty wild. But that would have been a rise of about 10.9% from where it stood when he made his prediction around year-end. The author of Stocks for the Long Run and Wharton professor is a perma-bull, and has often been right. But on this one, he got gored.

Bond guru Jeffrey Gundlach said that the 10-year Treasury could see its yield fall below its 1.38% low of 2012, particularly if oil prices fell to $40. Well, oil did, but bonds didn’t. Another bull, Brian Wesbury, chief economist for First Trust, predicted oil stabilizing in the $55 to $70 range. It didn’t. He also said the fed funds rate would end 2015 around 1%, and the 10-year Treasury’s yield would rise to 3%, while the S&P 500 would rise 15%. Nope. Oh, and so much for the famous Dow Theory . Its best-known practitio- ner wrote that the “third phase” of the bull market was going to begin in 2015 and “the stock market boom will envelope [sic] everything from housing prices to precious metals to all commodities.” The envelope please: Wrong. I’m also quite wary of stock pickers and their top picks. Michael Farr of Farr, Miller & Washington had 10 for CNBC followers at the end of 2014. In fact, he said he would buy all of his picks on the afternoon of Dec. 31. How’d he do? Well, here’s the rub. If you had bought equal shares of each of his 10 stocks, which were priced anywhere from under $48 per share (PDCO) to over $530 (GOOG), you’d have seen your portfolio gain 12.0%. But had you bought equal dollar amounts of each stock, your portfolio would have sunk 2.3%. Now, Google was a massively smart purchase for 2015, though another stock, Qualcomm, was a pretty lousy choice. Take those two out of the mix and, well, no matter how you bought the other eight stocks, you lost money—lots of money. The bottom line: To protect your own bottom line, tune out the pundits and predictors who fill the airwaves with buys and sells. Build a strong, diversified portfolio of some of the best stock and bond pickers in the business (see page 2 if you’re having trouble identifying good ones), and don’t be too smug as you laugh your way to the bank.

The Independent Adviser for Vanguard Investors • January 2016 • 5

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