Note from the CIO: Essential Principles and Current Observations

Part One: Essential Principles

• It will be worth reiterating, in the context of this quarterly letter, the nature of our philosophy of advice at Abacus. Generally speaking, our experience has been that successful investing is goal-focused and planning-driven, while most of the failed investing we’ve observed was market-focused and performance-driven.
• Another way of making the same point is that the successful investors we’ve known were acting continuously on a plan—tuning out the fads and fears of the moment—while the failing investors we’ve encountered were continually (and randomly) reacting to economic and market “news.”
• Most of our clients are working on multi-decade and even multigenerational plans, for such goals as education, retirement, philanthropy and legacy. Current events in the economy, politics and the markets are in that sense distractions of one sort or another. For this reason, we make no attempt to infer an investment policy from today’s or tomorrow’s headlines, but rather align clients’ portfolios with their most cherished long-term goals.
• We don’t forecast the economy; we make no attempt to time markets; and we cannot—nor, we’re convinced, can anyone else— consistently project future performance of specific investments based on past performance. In a nutshell, we’re planners rather than prognosticators. We believe our highest-value services are planning and behavioral coaching—helping clients to avoid overreacting to market events both negative and positive.
• Our essential principles of portfolio management in pursuit of our clients’ most important goals are fourfold. (1) The performance of a portfolio relative to a benchmark is largely irrelevant to financial success. (2) The only benchmark we should care about is the one that indicates whether you are on track to accomplish your financial goals. (3) Risk should be measured as the probability that you won’t achieve your financial goals. And (4) investing should have the exclusive objective of minimizing that risk to the greatest extent practicable.
• Once a client family and its Abacus advisor have put a long-term plan in place—and have funded it with the investments that seem historically best suited to its achievement—we rarely recommend changing the portfolio beyond its regular rebalancing. In brief, our principle is: if your goals haven’t changed, don’t change the portfolio. Our unscientific sense is that the portfolio is like a bar of soap: the more you handle it, the less you have. We agree with the Nobel Prize-winning behavioral economist Daniel Kahneman, when he said, “All of us would be better investors if we just made fewer decisions.”
• Every year we expect our portfolios to decline at some unpredictable time during the year, for some unpredictable reason. Going back to 1980, the average annual intra-year decline in the S&P 500 has exceeded 14%. Yet even without counting dividends, annual returns have been positive in 28 of these 38 years, and the Index has gone from 106 at the beginning of 1980 to 2,673 at year-end 2017. We believe the great lessons to be drawn from these data are that — historically, at least — temporary market declines (or “volatility”) have been very different from permanent loss of capital, and that the most effective antidote to volatility has simply been the passage of time. We can’t guarantee that it will always work out this way. We can only fall back on the wisdom of the great investor and philanthropist John Templeton, who said that the four most dangerous words in investing are “this time is different”.
• The nature of successful investing, as we see it, is the practice of rationality under uncertainty. We’ll never have all the information we want, in terms of what’s about to happen, because we invest in and for an essentially unknowable future. Therefore, we practice the principles of long-term investing that have most reliably yielded favorable long-term results over time: planning and a rational optimism based on experience, patience, and discipline. These will continue to be the fundamental building blocks of our investment advice in 2018 and beyond.

Part Two: Current Observations

• A year of global growth. The year 2017 was noteworthy in that for the first time in this century, all the major economic basins of the world were growing simultaneously, albeit at different rates. Before this, at different times, Europe or Japan or the emerging markets dealt with significant headwinds, or growth here at home was plodding and sluggish. We regard the synchronization of global growth as a somewhat underappreciated positive that is continuing.
• The U.S. accelerates—and feels better about it. Steady if unspectacular hiring has driven the unemployment rate down to 4.1% for two months at this writing, putting the economy on track for a potential third straight quarter of 3% growth—a breakout of sorts. The consumer, by all important measures, is feeling better about things than he/she did before the Great Recession, and retail sales are quite robust. Household net worth in the fourth quarter may have reached $100 trillion, and consumer balance sheets continue to be healthy. Business investment is accelerating at long last. Although there are many still struggling in the U.S. economy, these positive trends are continuing as we enter the new year.
• The Federal Reserve begins normalizing. Many have suggested that the Federal Reserve should be unwinding its bloated balance sheet and letting interest rates follow their normal course in an expanding economy. It began to do both in 2017 and the economy still improved.
• A genuinely great year for equities—with muted volatility. With a total return of 21.8% for the S&P 500, and the deepest intra-year price decline a mere 3% (versus the average, since 1980, of 14%), our philosophy of staying the course was well rewarded in 2017, with a bare minimum of volatility. We are, as you know, long-term equity investors who know that markets can’t be timed, even when geopolitical trends (Brexit, Trump, N. Korea) seemed to portend a financial meltdown. We remain positive on the equity markets for the coming year. All of that said, we can’t imagine returns in 2018 will match this year, or that volatility will remain this quiescent. Equity investing is rarely as easy as it was this past year.
• Hysteria about valuations remains overdone. Valuation isn’t a tool for timing the market (nor is anything else), so as long-term equity investors we tend to tune it out. That said, we don’t buy the idea that equities are “overvalued.” Indeed, compared to the yields on competing fixed income investments, equity valuations appear to us pretty reasonable, a view shared on more than one occasion in this commentary as well as this year by Warren Buffett. We’re happy to walk you through the math supporting our conclusion if and when you’d like us too.
• Bull markets are a matter of perspective. It is commonly touted in the financial media these days that we are in one of the longest bull markets in recent memory, referring to the current period that began nearly nine years ago in March 2009, and suggesting that it can’t last much longer. However, as financial planners we prefer to think in decades, not quarters or years. For the past 20 years through the end of 2017, the S&P 500 has averaged 7.2% per year, well under its long-term average since 1926 of over 10% per year. In fact, if you permit some cherry picking, the average annual return since the peak of the Dot.com bubble in March 2000 has been only 5.4% — hardly suggestive that this bull market must end soon.

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