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What to do with your equity portfolio in 2016

During the holiday break, if you didn’t completely turn off from finance and investing, you may have read one, two or a dozen columns about where the markets are heading in 2016, ‘how to make money in 2016’ and where the best returns will come from in 2016.

Most are simply a waste of your time and you would have been better off ditching the articles and jumping in the water or heading down the slopes with your kids, partner or friends.

Forecasting doesn’t work

The sagest advice I have received on forecasting is that if I wanted to be successful at predicting markets, I should simply do it often. As investing professionals, we are regularly asked for insights that stem from our crystal ball gazing and for many it pays to participate. Those that get it right are lauded as if they have an omnipotent connection to the future, and such is the brevity of our memories, those who get it wrong are forgotten.

And such is the ability of some self-proclaimed prophets to spin their incorrect predictions into divine prophesy that they see no diminution in their monthly newsletter sales. I recall one magniloquent and high profile commentator stating with almost daily certainty that the Australian equity market would end 2016 above 6000 points. At the time the prediction was made the market was indeed close to that level. Of course, the market ended significantly below 6000 and traded below 5000 points after the prognostication was made. But in early 2016, the commentator slipped in that he got the call right (emphasis added):

“… the return of stock buyers whenever we hover around 5000 or just below tells us that the majority of stock players don’t see our market worthy of being at 6000, which we missed by five lousy points on March 23.”

Desist from forecasting altogether

Long-term investing success has nothing to do with forecasting share prices, politics or economics and everything to do with buying businesses whose intrinsic values rise over the long run. The share price will look after itself if the value of the business is rising steadily over the years. To offer any forecast of where the stock market will be, demonstrates a lack of understanding of this basic investing principle. A forecast tells you a great deal about the forecaster but nothing about what is to come.

Those who presume to understand the machinations of the economy and the markets and then offer their ‘insights’ simply haven’t learned that 1) they will never do better than 50/50 with their forecasts and 2) their forecasts aren’t required by you for you to be a successful investor.

There’s a constant temptation however to believe the facts one has collected amount to some undeniable insight about the future that one can bet the farm. To save ourselves at Montgomery from falling into this trap, with 50/50 outcomes, we developed a process. And much as one does when marrying - vowing to have and to hold for better or worse – we publicly committed to our investors, their advisers and the ratings houses to follow the process come what may.

At the beginning of 2015, I was asked whether I thought the market was expensive or cheap and I argued that the market seemed expensive because value did not abound, and that it would be difficult to generate meaningful returns.

It isn’t wise for fund managers to say such things because rather than appearing knowledgeable, it risks influencing investors to zip up their wallets. Of course, while we may have been right (50/50 remember!) with our prognostications – for the year to 31 December 2015 the Australian All Ordinaries Index declined by 0.8%, add in dividends and the return was just 2.8% – the Montgomery Fund returned significantly outperformed after all fees and expenses. If I had accurately predicted a 2.8% return for the market and decided the risks outweighed the benefits, so listening to myself, put all of my money into a term deposit, I would have missed the strong return.

Invest in strong businesses and be patient

And that’s the point. The stock market index is not where you should be investing (my piece on the problems of index investing is here). You should be investing at rational prices in businesses you are reasonably confident, if not virtually certain, will be materially larger and at least equally profitable in many years hence. General stock market and economic forecasts are largely irrelevant over the timeframe I am contemplating.

When we observed early in 2015 that the market was expensive, we also noted that banks and mining companies, at the highs, were unsafe investments, but this was not a prediction about the direction of the share prices of these stocks or what would happen next. What we simply observed is that investors were behaving dangerously and without regard to risk when they were chasing high yields and ignoring whether those dividends they were chasing were being supported by growth. We were simply saying that it was a mistake to chase yield at the expense of growth.

A business adds value by retaining profits and redeploying that incremental capital at attractive rates of return. It’s that simple. To maximize your returns, you have to fill your portfolio with companies able to retain large amounts of capital and generate large returns on that capital. The share prices of these companies will look after themselves over the long run.

The short run is merely the period over which stock prices for these companies overreact on both the upside and downside and therefore it is the period over which you can take advantage of the market’s manic moods.

Ignore everything else in 2016 and you should do well over the long run.


Roger Montgomery is the Founder and Chief Investment Officer at The Montgomery Fund, and author of the bestseller ‘’. This article is for general educational purposes and does not consider the specific needs of any individual.

February 02, 2016

Interesting comments here...

I guess like most things in life there's no right or wrong way to go about achieving a result, it just comes down to finding what method/approach/strategy works best for you.

From what I can gather, value investing takes time, effort and patience...3 traits which aren't really that common in today's society of wanting everything here and now and not having to do that much work to get it.

We hear a lot about the results the disciples of Ben Graham have achieved through adopting the value investing methodology, the greatest being Warren Buffett and Charlie Munger.

Who are the people that have achieved similar results to those two adopting an alternative approach?

Give me investing over speculating any day of the week and twice on Sunday.

January 30, 2016

The benefits of long term investing seem obvious,without picking the stars (CSL,FMG,etc).

A 6K investment in CBA not long after listing is approx. 320K now,dividends re-invested.The worst bank would be NAB,7K invested at the same time is now round 120K,still a reasonable return,far better than index or super returns.The NAB share price is still the same as 10 yrs ago.

Wesfarmers,woolies and such have also been good.The secret is always the same,reasonably predictable income streams and rising profits mean rising share prices.

The risk is the same,depends on the person.What are the chances that any of those banks go bust.Some people will say they are almost certain they will go bust.Others (myself) think the chance is small and it will not happen overnight should it occur,plenty of time to get out.

As Buffett said,despite world wars,crashes,minor skirmishes etc the DOW still went from 13 to 13000 over 100 yrs.The risk is being out of the market,not in it.

January 31, 2016

Kevin, do you know about survivorship and hindsight bias? How about naming companies that will perform well in the future rather than the past.
Yes long term investing is a great strategy , but yesterday's winners are seldom tomorrows.

February 05, 2016

I have no idea which will be the best performing companies in the future.Nobody can predict the future.
I did expect a reasonably predictable stream of income from them,which funds my retirement..I did expect that profits would rise thus share prices would rise.I expect the same in the future,time will prove if I am right or wrong.

When I bought them people all told me I was wrong,all these years later when time proves I got it right they still tell me I',m wrong.

I still hold them,I still live off the dividends.Ten years from today I still expect to hold them.If time proves I am right people will still tell me I am wrong.

I'm not looking for future stars now,I'm looking for a reasonably predictable stream of income.I think I have that.

I'm prepared to think that history could repeat,if it doesn't then I am wrong.As Roger says prices fall,CBA declare next wed,I'm expecting $1.95- $2 a share.The recent large price fall does not tell me how much profit they make,or how much they will make 10 yrs from today.

Jerome Lander
January 29, 2016

In response to Chris' comment, the great majority of investors do not have the skills to identify genuine and good active managers, to know when they should be in them and when they need to sell them, and nor do they have access to expert help who can do this for them. The reality is it is a highly skilled activity which is not readily available to all.

In the absence of the appropriate skill set, this majority of investors may not have much choice but to accept average or mediocre returns. There is no point in paying up for a mediocre risk/return result, hence if they are going to invest this way, doing so cheaply through an index fund is better than doing so expensively through a supposedly active manager who is anything but...

February 05, 2016

But that's the whole point - why I disagree with Roger's comment that “the stock market index is not where you should be investing”....easy for him to say, but near impossible for the average Joe to do.

January 29, 2016

I follow Roger Montgomery's blog and there's a lot of good stuff there, but the one thing I take umbrage to is that he says that "the stock market index is not where you should be investing".

To the average DIY investor (who has a full time job that is not being a fund manager), trying to get anywhere near the amount of information that the professionals do (let alone digest it or access to company directors) is almost impossible.

Why then, is the world's smartest investor (Mr Buffett) directing that most of his wealth be invested in the S&P500 after he passes on ? Is it because he doesn't believe anyone else can possibly or will pick stocks as well as he has, or is it because of his quote to Bogle that "a low-cost index fund is the most sensible equity investment for the great majority of investors"

Michael Howson
January 29, 2016

A well run company produces sustainable profits and these turn into dividends or are re invested into building the company's future which (depending on market sentiment will increase prices.)

Roger is a value based investor ;that is what he does . What market sentiment prices the company at is irrelevant.

Whether or not the price increases is almost irrelevant , I still own a good compan. A rising sustainable dividend flow is this retiree's dream. My share price going through the roof is almost an annoyance. Do I just let the price come down to normal or sell and try and find another equally good company .

These companies often do not require forecasts . A 5 year financials comparative chart (ROE, PEG, EBIT and cash flow) usually tells me everything I need to know

Jerome Lander
January 28, 2016

It would have been great if your investment counsel had have told you in December that 2016 is crisis prone: "Investors may need to reduce many passive and index like exposures to reduce their risk of large capital losses, as 2016 looks “crisis prone”..

Well, I did just that in December's Cuffelink's article "2015 asset class review and 2016 outlook" article. And this follows other prescient and accurate predictions in commentary I've provided to Cuffelink's and elsewhere, which have been quickly validated. Am I or anyone always right? Of course not, but nor does one need to be. Am I mostly right? Yes, so far, over an extensive period of time. And I know I'm not alone in this regard.

Does accurate forecasting matter? Of course, when you are getting it right most of the time. Particularly, when it saves one from being devastated by big bear markets, and large losses which are difficult to recover from. It matters a great deal to protect capital in at least a relative sense on the way down and to pick when risk is being rewarded - to ensure the strongest possible risk adjusted returns.

The mistake many people make is by thinking that just because they can't pick stocks, then that means an active manager can't pick stocks. Or just because they can't forecast markets, then that means nobody can. This is flawed thinking. The world is a big place with many people with different talents. There are many ways to build wealth; good bottom up research and stockpicking is one of them, but so is effective asset allocation and strategy.

There are some things we can't do that others can - such is the benefit of being able to cherry pick the best investment managers and combine them in a winning portfolio. Humility is being able to acknowledge that someone else can do it better, and know when we should give them the responsibility to do something in order to achieve a better result than we would alone.

Henry G
January 30, 2016

In reply to Jerome ... I think you've missed the point ...

January 31, 2016

Well said Jerome. Roger made many fine points in his article, but ruined it by attacking alternative approaches.
There are many paths to investing success. It's disappointing that many value investors are closed minded and think their path is the only path.
In promoting our own approaches there is no need to attack other approaches that we are not masters of.

Chris Smith
January 28, 2016

Roger says “Long-term investing success has nothing to do with forecasting share prices,” – but every investment decision is forecasting – stocks require forecasts of their share prices to beat the market index, etc. Otherwise just buy the index. But even that is forecasting – ie forecasting that the market index (or whatever portfolio they select) will achieve their investment goals, etc.
I think this article is more about better ways to forecast whether your investments will achieve your investment goals – or here are some ways to better forecast whether the companies you pick will do better than most, rather than not forecasting.


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High or low price, future returns will be low


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