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What to do with your equity portfolio in 2016

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 2015 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 per cent, add in dividends and the return was just 2.8 per cent – the Montgomery Fund returned significantly outperformed after all fees and expenses. If I had accurately predicted a 2.8 per cent 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 of Montgomery Investment Management. To invest with Montgomery domestically and globally, find out more.


Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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  1. Some market commentators claim that only about 30-40 companies quoted on the ASX, can be considered “investment grade”
    If true, then too many investors (and investment funds) all end up chasing just a handful of these “quality” stocks which in turn drives up their P/E ratios to unreasonable levels. Ramsay, CSL and Sirtex spring to mind.
    For investors who didn’t buy when P/E ratios were at sensible levels, then it hardly makes sense to be chasing them now.
    Anyway Roger, your thought on this please.
    PS. am very happy with my investment in the Montgomery fund

    • Hi Ron, Our work leads us to conclude that the universe of acceptable companies is considerably larger than 30 or 40. It is the case however that the very highest quality companies, those also with the brightest of prospects, can be condensed into a smaller group. Having said that though it is not true that they are immune to falls. History will show you that even the very highest quality company shares can fall precipitously if participants are frightened enough.

  2. Hi Roger, is this why CSL has been such an outstandingly brilliant investment over many years? Instead of handing over massive dividends, it put many millions into research, many millions into buying competitors and many billions into compounding this success by buying back its own stock? I wonder if Freelancer, Xero and Dubber will succeed because as things stand now they appear to be building/inventing their future revenue base, like Facebook in the U.S.

    • I an, I think you’ve answered your own question. In the long run, the best performance in the stock market will be from companies able to retain large amounts of capital and generate very high returns on that incremental capital.

  3. “I recall one magniloquent and high profile commentator stating with almost daily certainty that the Australian equity market would end 2016 above 6000 points.”

    Did you mean 2015?

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