Is it me or has the past few years been truly exhausting? In 2016 we had the China stock market crash, Brexit, and the Mad King (aka The Donald). 2017 has been very much about the Mad King sucking the oxygen out of everything.
Despite the chaos and mayhem of the Mad King’s first year and the various consternations it is causing globally, stock prices around the world continued to surge in 2017.
One of the values I feel strongly about as an investment coach is that I practice what I teach…and be transparent about it…good AND bad. 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 (#trade2017) with you the investment decisions I’ve made throughout the year. Well it’s that time of the year where we set scroll down the page and see what I what I did right and more importantly what I did wrong…and did I gain any insights that will help me become a better investor?
2017: Stocks surged but…
Many of the investment decisions that I made in 2016 during the periods of great uncertainty bared fruit in 2017. When the Brexit vote went down, I bought more into my Europe ETF. Amazon was “disrupting” retail and when other retail stocks like Walmart and Costco were languishing I was buying them up and it paid off nicely. I was getting what I could from the markets, however one big shadow continued to hang over my portfolios.
Despite my continued dive into buying stocks, I started 2017 in the same position as in 2016 and 2015 which was in a heavily short position on the S&P 500. It’s been a very difficult investment decision and a very tough one to justify in 2017 as the markets were setting records on an almost daily basis. Heck by the end of the December the Dow Jones crashed past 24,000 mark and blasted by 25,000 a few weeks later. I made a lot of good decisions, however my decision to remain short the market has been a big time drag on the overall performance. By remaining short, I’ve violated one of my key exit strategy rules which is to sell a position when the loss level crosses 20 percent, no questions asked. My loss position is well above 20 percent, but I have decided to hold it and several times during 2017, I added to it. Why am I doing this?
I still remain very skeptical on the overall market. Despite all the uncertainties in the socio-business-economic world, investors have pretty much ignored it and pushed stock prices higher. The logical, analytical side is telling me the market is over valued, however the reality is the artistic, irrational, peer pressure side is pushing stock prices higher. I feel pretty strongly that there is something out there that is going to take this whole thing down a few notches. I have no idea what will be the catalyst and when that will be and it may not be in 2018. I tried to map out some scenarios in one of my podcasts. Maybe it’s interest rates and a flattening yield curve. Maybe it’s Trump imploding. Maybe it’s North Korea.
Having a short position continues to be a tough position and there were times especially after the election in November 2016 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
In 2017 I continued to manage a couple of other portfolios in my family. I setup and managed both my son’s RESP’s and a portfolio of another family member.
By the end of the 2017, my portfolios achieved the following returns (2016 returns in brackets):
Portfolio 1: -12.00% (1.75% )
Portfolio 2: 1.53 (+2.65%)
Portfolio 3: +7.30% (+7.92%)
RESP Portfolio 1: 21.1% (not including the Government Education Grant) (+2.7%)
RESP Portfolio 2: -13.8% (not including the Government Education Grant) (+12.99%)
Portfolio 1 contains my short position on the S&P500. RESP Portfolio 2 contained my position in General Electric which I sold at a loss and dragged the portfolio down.
RESP Portfolio 2 really was solid this year thanks to some great gains from owing Visa, Walmart and Costco.
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 a 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.
Feel free to jump off here
When you take the snapshots, the picture isn’t very good and at this level, it’s not impressive. So if you want to jump off this post right here because I didn’t deliver the goods, I’m giving you the off ramp right here. Bye!
If you want to take shots about how a passive, low cost index fund would have blown me away, then go for it in the comments.
If you want to say I should have invested in Bitcoin, well have at it then.
I have no excuses. Feel free to jump off here.
If you still are interested, I think there are some lessons I’ve gained from this that I would like to share with you.
Lesson 1: Tinkering with your investing plan/strategy/playbook is toxic
I’ve been pretty good in staying true to my entry and exit strategies on individual stocks and ETF’s. When I’m losing money past a certain amount, I’ve sold and I had to do that a few times in 2017 with Under Armour, General Electric, and NeuLion. But with the short position, I maybe felt that this decision was a more macro than micro decision and so maybe I had a willingness to let it ride longer because the S&P 500 cannot go up in a straight line forever although there have been times that I’ve wondered!
I’ve learned it is critical to not deviate away from your investing playbook as my experience shows it doesn’t take much to upend the apple cart. As we’ll see below, I made a lot of good successful decisions and I also made a few bad one’s, but because I stayed true to my playbook, those bad decisions were mitigated. This short position has enveloped and skewed my numbers in a bad direction.
Lesson 2: I haven’t lost any money
One of ideas that has kept me motivated to hold my short position is an article from Josh Brown’s blog where he cites a couple of cases of famous investors and how they have managed losses.
Case 1 is Warren Buffet
“Warren Buffett was down quite a bit that summer.
A very large sum of money, wouldn’t you say? Now what, you ask, does it represent?
It is roughly how much Warren Buffett’s personal shareholdings in his Berkshire Hathaway, Inc. declined in value between July 17 and August 31, 1998. And now for the six billion dollar question. During those forty-five days, how much money did Warren Buffett lose in the stock market?
The answer is, of course, that he didn’t lose anything. Why? That’s simple: he didn’t sell.
Berkshire Hathaway’s “A” shares had dropped in price from roughly $80,000 per share in June to $59,000 by the end of September. These same exact shares just hit a high of $229,000 this year. Buffett knew that while the price may have been changing for his company’s shares, the value that his companies were creating would not be permanently impaired. This allowed him to wait out the ’98 episode rather than reacting to it.”
The numbers on the short position are bad, but until I actually sell the position, I haven’t lost any money. It’s just a loss on paper. It’s a big one, but it’s not a loss. It maybe wishful thinking but if the market indeed corrects significantly, I can cut my losses significantly, maybe squeak out a small gain. Again as we sit here right now in January 2018, it’s wishful thinking.
Lesson 3: Learning how to lose money…to make money?
I believe it’s just as important to manage losses as it is profits. Josh Brown’s blog cited another case of a famous investor and how he dealt with a big loss.
“ David Tepper’s New York-based Appaloosa hedge fund was struggling with the same market environment. He had all the wrong trades on and it went against him severely. As Tepper himself related to us at the SALT Conference, it was a painful episode, despite how quickly things turned around for him:
Tepper tells us his fund has been down 20 percent or more on three different occasions. This includes the episode in 1998, where he was blown out because of the Asian Contagion and subsequent Russian currency devaluation. Tepper was heavily exposed to emerging markets and Russia, the combination crushed the fund. But then he made it all the way back to Appaloosa’s high water mark within 6 months.
“We did it two more times – people started flooding us with money whenever we were down big because counter-intuitively they knew it was good timing to get in.”
The lesson of 1998 for Tepper was that the massive market drawdowns are the biggest opportunities if you can stick it out. He (and his investors) learned to use these episodes to get even more aggressive. It was a tactic he would famously employ ten years later, during the even more difficult post-Lehman meltdown with Appaloosa down more than 20% from its high watermark.
There is an equity risk premium in the markets. Over the long term, stock investors can earn average annual returns that are close to 5% above what they’d be able to earn at the risk-free rate. That’s a huge number when compounded over decades.
But it must be earned the hard way – battling through the worst the markets can throw at us. And, as both Buffett and Tepper can attest, its when stocks are treating us the worst that this premium is right around the corner.
Both Warren Buffett and David Tepper know that volatility is where returns come from and the losses of today set up the outsized gains of tomorrow...
...They’ve “lost” some money on the way to earning tons of it.”
These behaviours reinforced my convictions about the overall market and led me to decide to stay with my short position and I’m determined to see this to its end.
One of the constants in life are death, taxes….and making bad investment decisions. It is a certain guarantee that we will all make investment decisions that don’t go the way we thought they would. We need to learn how to practice managing losses.
Cash continued to be king in 2017
I ended the year with my portfolios in about 2/3’s cash…again. If you look at it from a snapshot perspective the results were not great mainly because of my very high cash positions. My pessimism on the overall stock market and the difficulty in finding cheap quality 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. 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 succumb to FOMO (Fear of Missing Out) and invest in assets because of peer pressure.
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 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 made a good decision. In 2017 I made 17 selling decisions. Below are the realized returns from those decisions.
Under Armour (-37.7%)
General Electric (-27.4%)
Tyson Foods (+6.4%)
iShares India ETF (+28.3%)
Horizon Inverse Volatility ETF (-15.6%)
Vanguard Emerging Market ETF (+18.75%)
Whole Foods (+26.8%)
iShares Europe ETF (+22.5%)
Cal-Maine Foods (+16.5%)
Tyson Foods (2nd Portfolio) (23.0%)
I sold 13 out 17 stocks for a profit. I made tangible money. All 13 were sold at a double-digit gain (at least 10 percent return) and 9 of those gains were at least 20 percent return or greater.
Overall the realized return on these investments in 2017 was 9.42%. In 2016 it was 19.5%. In 2015 it was 7.7%. In 2014 was 20.6% and in 2013 it was 3.92%. 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. One of the disciplines I have continued to maintain is to instigate a check-in process of re-evaluating a stock and determine if I should sell when they cross at least a 20% return level. This tells me I appear to be disciplined in executing my strategy, short position not withstanding.
The next paragraph I wrote in my 2014, 2015, and 2016 reviews and sure enough 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
The way I make investment decisions now when it comes to buying and selling stocks is much different than when I started in 1996. It’s not totally about the quantitative side and the numbers game. I’ve become more mindful and aware of the qualitative, emotional, and behaviorial aspects of investing and that I think has helped me make better investment decisions. In my Everyday Investing courses I teach a module on how to manage our brains better.
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 over the past year, I can see these type of companies were well represented (Whole Foods, Costco, Walmart, Nike, Twitter, Cal-Maine Foods, Tyson Foods). 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: Snap Inc.). At some point I thought 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 was prepared to be patient and wait when I bought 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
In determining my costs, I try 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 (numbers in brackets are 2016 costs).
Portfolio 1: 0.609% (0.852%)
Portfolio 2: 0.152% (0.225%)
Portfolio 3: 0.259% (0.417%)
RESP Portfolio 1: 0.593% (0.372%)
RESP Portfolio 2: 0.481% (0.477%)
TOTAL ALL PORTFOLIOS: 0.368% (0.504%)
It’s not a surprise that Portfolio 1 carried the highest costs given it was 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 it was because I was much more conscious about keeping costs lower by using cheaper ETF’s and just trying to make fewer transactions.
Overall for the total cost of all portfolios that I managed to come in at about 0.36 percent which is very reasonable to me and much lower than in 2016.
This year I made more trades in previous years. In 2017 I made 58 trades while in 2016 I made 50 trades. In 2015 I made 28 trades and in 2014 I made 32 trades.
To put some perspective, I manage 5 portfolio so 58 trades over 5 portfolios comes out to about 1-2 trades/month which is not a lot and is definitely not going to get the brokerage companies giddy.
Goals for 2018: 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.
I'll be honest, this was a hard post to write. The short position really took the wind out of what I thought was a good year where I did make a lot of good decisions and I didn't want to use it as an excuse for what in the aggregate was somewhat blah performance. Investing is a very much bottom line game so I felt sharing my shortcomings can provide fodder for others to question my investing competency. I mean why pay money and learn from someone that makes bad decisions themselves? I felt like I was going to do more harm to my practice by showing my mistakes.
I think part of this guilt comes from just not wanting to lose. Even though the investment industry says 10, 20, 30 years is a long time, it really isn't. My older son is turning 6 next month. I swear I was swaddling him last week. 6 years has passed already. It's the same with investing, a 30-year investing time horizon looks like a lot but it isn't and unfortunately we get only one crack at this thing to do it right. The margin for error in our investment decisions is pretty low. If we make a lot of bad decisions and let them fester, it makes it harder to recover and move forward.
I had a big time hesitation to share my vulnerability...but at the end I decided to write this post anyway.
The big reason was that there are a lot of people, organizations in old media and new media that will share the good decisions and never their mistakes. You'll never see anyone go on CNBC or BNN and share their bad investing decisions. It's always the good stuff and if they do, it's followed up with endless excuses (the weather).
I've always said the foundation of my practice is to be honest with people I work and potentially work with and that means being sharing the victories as well as the defeats.
Investing is tough. It's an occupational hazard to make investing mistakes. It comes with the gig. No one is immune from it, even legends like Buffet and Tepper. All you can do is learn from your mistakes and try not to make them again or at best make them fewer times.
At the end I all I want to say to you is that as someone who teaches this stuff, I have and will make bad investing decisions and when I do make those bad decisions, I'll be right here writing about it...and owning it.
All the best for 2018. Now get out there and make some cash!