Well that was a fast year and frankly an exhausting year. 2016 is done but before we move forward into 2017, let’s take stock (sorry) of what we've just been through. One of the values I feel strongly about with my investment coaching practice is that I practice what I teach…and to be transparent about it. It’s one thing for me to coach people how to make better decisions and develop and teach courses on how to buy and sell stocks and ETF’s. It’s another thing to model the behaviour. Throughout the year I’ve shared and tweeted (#trades2016) with you the investment decisions I’ve made throughout the year. Well let’s take a look and see what I did right and more importantly what I did wrong…and did I learn anything from it?
2016: A tale of 3 flashpoints
In 2016, there were three key events which all of us investors were challenged. The first happened wayyyy back in January when the China stock markets were cratering. The next was the Brexit vote and finally…Trump. How you and I responded to those events, had a pretty big impact on how our portfolios. Let’s pick them off.
China stock market crash
January 2016 marked one of the worst performing January’s in a long time. Chinese stocks were in free-fall and stock markets around the world were worrying that it would have spread to the rest of the world. Many people were calling for the China bubble to pop. Some people thought the sell-off was the first shoe to drop after the Federal Reserve in the US raised interest rates in January. Who knows. Let’s be clear, it looked ugly back then , however I viewed the panic as an opportunity to pick up quality companies that may be on sale now. From my post in January 2016:
Instead of panicking and making emotional decisions, I used the pullback in stock prices to strategically build on current stocks that I held as well as to execute my investing ideology buy purchasing companies that I have identified in my cheat sheet (aka The List) which have fallen to earth a little bit.
Market psychology was pretty lousy so I took the opportunity to slowly open and build positions and/or add to existing positions in companies like Las Vegas Sands (LVS), Cisco Systems (CSCO), Southern Copper Company (SCC), Nordstroms (JWN), Williams Sonoma (WSM), Tiffany (TIF), Imperial Oil (IMO), Potash Corp (POT), and iShares Canada ETF (VCN). What was common was that these were high quality, wealth creating companies that were out of favour by the market and Bay Street/Wall Street. As oil prices were tanking in late 2015, I started looking at the blue chip oil companies as they were getting killed. The Canadian equity market was also languishing because of the fall in commodity prices so I added them. Essentially I bought low.
The next market moment was the June referendum in the UK to decide whether to stay or leave the European Union. Every smart person said the UK would vote to stay. It didn’t work out and for two days more panic selling. More babies being thrown out with the bath water. Again. From my post in June 2016.
The pullback forced me to dig up The List of stocks to see if there are discounts on companies I’d really like to own. Fear had returned to the market with vengeance. When there is fear in the market, I really start to pay attention. While nothing jumped out as screaming buys, I did use the opportunity to add to some existing positions to take advantage of the falling prices.
I bought more Nordstrom as the stock was tanking because of weak earnings. I bought more luxury retail like Tiffany and William Sonoma.
I can’t remember a time in my life when one person sucked up so much oxygen in our day-to-day news than this guy. It will studied for centuries how a man of this ilk could democratically be elected president. Bottom line is it happened, however unlike China and Brexit, after a brief 3 hour seizure in the pre-markets, stocks resumed their ascent. This time though I sold those stocks which were out of favour in January (Tiffany and Southern Copper) which were now surging.
Lessons from above
The big lesson for me was I didn’t panic and make an emotional decision. I didn’t sell anything in January and June when everyone was. Instead I was looking to execute my investment ideology by methodically and calmly pick up stocks that were on sale. I wasn’t reactive. I was proactive. I wasn’t playing defense. I was playing offense during periods where we’re wired to run and hide. I had my List of companies and ETF’s that I knew I was comfortable buying if the prices were right and in some cases they were good and I jumped in confidently.
Despite my deep dive in buying stocks, I started 2016 in the same position as in 2015 which was in a heavily short position on the S&P 500, while the events of January did bring my portfolio to a more healthy state, as we saw the event just didn’t stick. On five occasions I added to my short position. I still remain very skeptical on the overall market. It has and continues to be a tough position and there were times especially after the election in November where I seriously thought about reducing the position, but I held off. Again, at the end I still feel that these market levels were not sustainable in the long run and the higher and more inflated stock prices go, the uglier the reset will be.
To the scoreboard!
By the end of the 2016, my portfolios achieved the following returns:
Portfolio 1: -1.75
Portfolio 2: +2.65%
Portfolio 3: +7.92%
RESP Portfolio 1: 8.14% (not including the Government Education Grant)
RESP Portfolio 2: 12.99% (not including the Government Education Grant)
In 2016 I took on managing a couple of other portfolios in my family. I setup and managed my younger son’s RESP and a portfolio of another family member.
Portfolio 1 closed the year negative for the second straight year. The big reason was my continued short position on the S&P 500. Despite my long positions generating strong realized returns, the short position has held back overall returns. OK I'm making excuses. It's just a fact. In January when the market was tanking, the portfolio was tracking up quite nicely. If I took the snapshot then, it would have been a nice story. I'll have more to stay about snapshots shortly.
I ended the year with my portfolios in about 2/3’s cash. If you look at it from a snapshot perspective the results were not great mainly because of my very high cash positions. I’ve said many times that a good year is where returns for stocks are at or greater than the long term performance of stocks which is in the 6-8 percent range so based on this benchmark I would say it wasn’t a very good year. If I was working on Bay Street, I probably would get scraps for bonus or just outright pitched. On the other hand, I did achieve returns that were greater than inflation, which I’ve commented many times is the minimum you should try achieve as an investor, so I was at least at a high level preserving my purchasing power. On the surface it’s still meh.
So on the surface, not exciting, but when I drilled down into the numbers however, I continue to see some things that give me greater comfort.
Evaluating Investment Decisions: Realized Returns
The thing about looking at returns at a macro portfolio level is that they are snapshots and provide little colour into the nuts and bolts of the portfolio namely the stocks and ETF’s. At the end the output and success of our portfolios will be driven by the decisions we make on how invest, and allocate our savings in our portfolios. This is much more tangible. The metric I focus most when evaluating my portfolios and just as importantly, my decision making capability, is realized return. This is a return generated when I actually sell a stock. When you sell a stock you are tangibly getting cash in your pocket and hopefully you will have made some investment decisions that will enable you having more cash in your pocket than when you started with. To me if I’m making a decision that results in me having more money at the end, then I think I’ve make a good decision. In 2016 I made just 11 selling decisions. Below are the realized returns from those decisions.
Las Vegas Sands +8.5%
Cisco Systems +20.6%
Tiffany (2nd portfolio) +23%
Southern Copper Corporation +29.5%
General Electric +20.3%
Southwest Airlines +26%
Canada all-Cap ETF +20.8%
Cal-Maine Foods +19.6%
Overall the realized return on these investments in 2016 was 19.51%. In 2015 it was 7.7%. In 2014 was 20.6% and in 2013 it was 14.2%. I’m really OK with this. The decisions I was making was yielding tangible returns that were well ahead of inflation. So my purchasing power is being enhanced.
All 13 stocks I sold were profitable. 11 of the 13 sales generated returns greater than 20 percent. One of the disciplines I have continued to maintain is to sell stocks when they cross at least a 20% return level. This tells me I appear to be disciplined in executing my strategy.
The next paragraph I wrote in my 2014 review and I said in my 2015 review and it still applies…
“I’m also not going to kid myself into thinking that their performance was pure stock picking talent. The low interest policies by the Federal Reserve have forced investors to pour money into stocks as it has been the only game in town for yield. Stocks have had a nice Jetstream behind them to propel them higher in 2014.”
Exploiting market psychology continues to pay
I continued to utilize market psychology more and more in framing my investment decisions. I am always looking for great companies that are on sale, and often those companies go on sale when either the overall market sentiment is tanking or the professionals are trashing the stock. As I look at my portfolios, I can see these type of companies are well represented (Whole Foods, Southwest Airlines, Tiffany, Southern Copper, Imperial Oil, Potash). All of these companies have been talked down by experts or are operating in a weak business cycle within their industry. What’s interesting is that despite these takedowns, these companies are still creating tangible wealth and have very clean balance sheets so they can withstand the storms. From this perspective, I would consider these companies as less financially risky than a company that is at the altar of dependency on hyper growth (See Exhibit A-Valient). At some point the pendulum will turn and these companies will positioned for a ramp up in values. When will this happen? I have no idea but I’m prepared to be patient and wait when I buy these types of stocks. When we make investment decisions, we are in essence taking an educated guess on the long term performance of a company and the outcomes of those guesses take time to come to fruition.
Keeping Costs Low
For this year I decided to calculate my costs and associated fees a bit differently. Instead of taking a weighted average approach, I actually tried to put a dollar amount to my costs and calculate those costs at as a percentage of total portfolios. Here’s what Excel spit out.
Portfolio 1: 0.88%
Portfolio 2: 0.226%
Portfolio 3: 0.416%
RESP Portfolio 1: 0.446%
RESP Portfolio 2: 0.474%
TOTAL ALL PORTFOLIOS: 0.521%
It’s not a surprise that Portfolio 1 carried the highest costs given it was the portfolio with the most transactions and it was also the portfolio that had the most expensive investment in my short position on the S&P 500.
The other portfolios that I manage carried much lower costs and maybe that I was much more conscious about keeping costs lower by using cheaper ETF’s and just making fewer transactions.
Overall for the total cost of all portfolios that I managed to come in at about ½ percent which is very reasonable to me.
I know the passive, couch potatoes will have a field day and several heart palpatations on this. That’s fine. Have at it. As long as my costs are coming in well below 1 percent, I’m OK with it. You have to realize that as much as it is to keep costs to next to nothing and the math clearly shows us the way, the reality is you do have to spend some money to make more money.
This year I made a heck of a lot more trades than in previous years. In 2015 I made 28 trades and in 2014 I made 32 trades. For 2016 I made 83 trades.
To put some perspective, I manage 5 portfolio so 83 trades over 5 portfolios comes out to about 1-2 trades/month which is not a lot and is definitely not going to get me the brokerage companies giddy. The three moments that the market hiccuped, triggered a fair amount of buying to take example of stocks that I thought were being misplaced.
Cash still king in my neighbourhood
At one point my cash holdings went has low as 50 percent which is among the highest points it has been in many years. My pessimism on the overall stock market and the difficulty in finding cheap value stocks has continued to force me to hold more cash than I would like to. I ended the year with about same amount of cash as when I started which is about 67 percent. I really want put more money to work as my investment horizons are getting shorter and at some point I will need to take out some risk in my portfolios as I get into the golden age of my years. At the same time, I don’t want to invest in assets just for the sake of it which will not make the portfolio theory folks too happy with me. I also don't want to invest for FOMO!
Goals for 2017: Queue up that broken record
My goals and strategy for 2017 will be no different from 2016 and no different from 2015, 2014, 2013, 2012 and so on so I’ll say it yet again. Despite my feelings that the stock market is ridiculously overpriced, I will still continue my discipline of working to identify opportunities to invest in great, well-managed companies that generate tangible economic profit and are being sold at a discount. One’s investment strategy and ideology should not change very much as deviation from the strategy is a recipe for trouble.
All the best for 2017. Now get out there and make some cash!