November 2015

Behind every stock is a company. Find out what it’s doing.” – Peter Lynch, Fidelity Magellan Fund Manager (1977-1990)

If you kept abreast of the financial markets during Ronald Reagan’s presidency, then you undoubtedly have heard of, or possibly followed, Peter Lynch, the legendary investor who managed the Fidelity Magellan Fund. Mr. Lynch was emphatic about knowing the companies in which he invested and not overreacting to shorter-term moves in the market. His quote, referenced above holds as true today as it did 30-years ago.

At Talbot Financial, when we invest in companies and real estate projects, we study what we are getting into and why. We do not make decisions spontaneously. We do our due diligence to understand the company, its management, and products. Then, we ensure it fits into the overall investment portfolio and we invest with an infinite time horizon in mind. Simply put, we plan on owning our investments forever. If the fundamentals of the investment change, then we respond accordingly by adjusting or exiting the position and looking for more attractive opportunities. Regardless, it is critical to thoroughly understand the companies we own, and then routinely challenge our investment thesis to ensure we want to continue to hold the investment. If we do our job well, we will have a relatively low turnover, deep value portfolio that is built to last.

Consider that the S&P 500 Index is now up about 11% from its low of the year on August 24, 2015. The market in the late summer demonstrated some of the greatest volatility we have seen in recent years. We took this time to find out what the companies we own were doing by analyzing the noise and investigating concerns over global growth due to the modest slowdown in China, as well as some other foreign markets. In the final analysis, we made a deliberate decision to hold true to our investment philosophy during the market turmoil by staying invested in high-quality companies with strong balance sheets, sustainable profit margins and attractive dividend yields. It is important to remember that economic news is backward looking; and therefore, the data reflects historical conditions. Investors frequently neglect to connect the current news about economic data to the prior period of time that the figures measured. We evaluate the historical information, but our primary focus is to look forward. Count on us to go through the same analysis during the next, and subsequent, market cycles.    

The second factor we carefully consider to form our investment outlook is the state of both the business cycle and the economy. Fundamentally, we view the condition of the current business cycle and the United States economy as resilient and well positioned for continued growth in the coming year. Our analysis suggests that the U.S. economy and large, well-diversified U.S. based companies are equipped to continue to prosper. They may not boom, but they will prosper. Corporate earnings are healthy, the credit markets (i.e., bonds) are solid, the U.S dollar remains strong and consumer demand is high for the products and services of the companies we own in our investment portfolios. 

To further illustrate this point, the following is an economic indicators dashboard from Russell Investments that compares the current market and economy (as of Oct. 19, 2015) to historically typical conditions:

We track the indicators on this dashboard to help provide some relative perspective to short-term movements in the market. Importantly, almost every metric is currently in its “Typical” range, the exceptions being U.S. Treasury Yields and Inflation at historically low levels. The bottom line is we see little risk of recession over the next few years and favor large company U.S. equities and real estate as the preferred asset classes for reasonable returns at reasonable prices.

“Invest in what you know.” Lynch also shared this advice as a key for success. We follow this guide by not attempting to predict where the markets will be in six months or even one year from now. Instead, we trust our strategy, which is to do our homework to know the companies and the real estate assets we own. This will keep us positioned to perform through coming diverse business and economic cycles.

 

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