Happy New Year! What a good year 2019 was for investors! The stock market returned over 31%, the bond market over 9%. The stock market has returned of over 30% only eight times over the last 50 year, and in all cases but one, 1981, it continued its upward trend the following year. The trader's expression "Don't fight the tape!" (a reference to the thin role of paper, "ticker tape", that spooled out of the converted Morse-code wire system with abbreviated stock prices printed on it) comes to mind. However, by my reckoning, the broad U.S. stock market is roughly 15-20% overvalued even after accounting for low interest rates. If your setting aside money in your IRA, 401k, 403b or other tax advantaged account keep on dollar cost averaging into your favorite funds, but you may want to hold a bit more in cash, perhaps 5% or more of its total value. If you have a taxable account with bond exposure maybe hold a bit less bonds a bit more cash, perhaps 10% or more of its total value. The rationales for a slightly more conservative posture going forward are various, and I will discuss some of them below, along with ESG investing and a list of books you might like to read in 2020. One must always remember the first rule of investing in stocks: BUY! when the market is cheap and SELL! when the market is dear. That doesn't mean sell everything or even most, but perhaps it's wise to hold a bit less of the things that wiggle in value relative to cash.

Speaking of things that wiggle, have you checked out the price of gold lately? It is closing in on $1600/ounce. The SPDR gold shares (Ticker: GLD) was up 17.9% in 2019, and it looks to be on a parabolic run toward an all-time high. Gold traders will tell you that now that it has broken through the "resistance" price of $1375/ounce it is headed toward $1675, and if it breaks through that the sky's the limit. That said, if you've held gold for the past 10 years you're behind the market by roughly 50%. Even if gold catches up, gold shares will continue to be held down by storage and insurance costs. Stock market index ETF's cost nothing to store, insure, and kick off dividends. Admittedly, gold tends to be a good hedge against a currency's devaluation over vast swaths of time and tends to react to inflationary expectations short term. The current price movement seems to be driven by the U.S. Federal Reserves admitted desire to see significantly more inflation before pushing interest rates higher. Oil is a huge factor in the cost of mining gold. It has continued to stay above $60/bl., which is a signal of a cost push. Gold's primary price drivers are how much it costs to mine and its relative abundance (i.e. the cost to find places in the world where they will let you strip the ground and leach toxic run-off). There was a fall-off in production in the 1990's because its low-price lead to under-investment and miners left the business. A shortage ensued. The price rose, hitting a high of $1800 in 2012. At that price governments willing to disregard the ecological impact of mining and businesses able to make a profit started prospecting again. Now there is a renewed supply chain, and central banks are stockpile it. At a price above $1300/oz. gold miners can stay in business. Gold bugs are a unique breed. Recently I was told by one, a professional "gold investment" adviser, that gold is headed to $10K/oz. by 2030. His explanation was that there will be a meltdown in the relative value of the U.S. dollar because of large and unsustainable deficits and gold will come back into fashion as a world currency. News flash, the U.S. government is not unique among the world powers in its relatively large debt to GDP profile. Gold is a logistically difficult medium of exchange, and people have used everything from clam shells to tins of sardines as currency. Unless the U.S. populous elects a crazed leftist government that significantly increases taxes and slows or stops the growth of U.S. oil & gas production, gold will probably continue to average its historic rate of about 14 barrels of oil to the ounce of gold over the next ten years. Gold is nature's best conductor and it's pretty to look at, but in most of the world you can't use it as a medium of exchange to power a car, warm your home, or cook your food. Mark me as a skeptic of gold reaching $10k/oz in my lifetime. Even when the world runs on wind, solar, or fusion people will continue to value gold relative to how much energy must be consumed to dig it out of the ground. Fortunately, a lot of gold and oil come out of the ground in the U.S. Cheap oil & gas ~ cheap gold ~ strong dollar.

So, let us talk about things that come out of the ground and effect the environment. ESG (Environmental, Social, and Governance) investment is very topical. ESG funds have seriously taken off. The Vanguard FTSE Social index fund (ticker:VFTAX) has outperformed the broad market by nearly 11% over the last three years. With performance like that and a little margin leverage you too can become a hedge fund star. But why? Drilling down into the index's portfolio list of stocks you find a lot less energy, industrial, and utilities and a lot more financials, healthcare and technology than is reflected in a broad market index like the S&P 500. At the top of the list representing over 6% of the portfolio is Apple (ticker: AAPL), which doubled its price in 2019! As it turns out those segments of the market which are the most profitable (software) are also the most environmentally conscientious! No doubt the ESG trend wouldn't be such a hot topic if it were not so. However, the "E" does not mean you have to be entirely environmental conscious because if you scroll down the list of holdings far enough you'll find ConocoPhillips (ticker: COP), but not Exxon (ticker: XOM) or any gold miners for that matter. Why? It turns out a strictly "E" fund would have too little to choose from. Historically, an index only following that bucket of stocks has performed poorly. Necessarily, a companies "E" score only gets a 50% weighting in the index. The other 50%, the "SG", is what has made this a great index. Good governance tends to produce good corporate results, and good governance tends to recognize that "S" also adds value for shareholders. Good governance would have prevented XOM from overpaying for XTO Energy in 2010 at a price so high it hurt earnings for nearly a decade. Funds like the VFTAX will have to keep piling into AAPL, now paying a 50% premium to AAPL's historic value metrics partly because it has avoided mistakes like those made by XOM. It looks like the fund is stuck with AAPL and will have to hold on even if it sells for a 200% premium. To keep the fund diversified the index will be forced to sell some APPL as it goes higher, generating capital gains that will either get distributed and taxed or shoveled into overpaying for other companies held in the index. These are the whims of the market at work, investors looking to outsmart and outperform following the trends and bidding up price regardless of the soundness or long-term value prospects of a dollar of earning to generate future success for a company and its shareholders. The trend is your friend, until it isn't. But don't be fooled it isn't the "E" in ESG that has made the VFTAX a good investment, at some point the index would get cornered without its "SG" back door. Theoretically, if the APPL board starts overpaying to buy back its own shares or to acquire another software provider the "G" score will drop and so will its weighting in the index. VFTAX works because on the margin it is forced to pick well run companies that produce good returns for its shareholders.

Books to Read

As is my habit, once a year, I try to list some good books to read regarding things economic. In 2019, I was pleased and surprised to read and reread some insightful gems. A few worth mentioning: Red Notice by Bill Browder, Economics in One Lesson by Henry Hazlitt, and How Charts Lie by Alberto Cairo. Each of these books offers insights into how the economy works, how it is portrayed by the media, and they intersect in different ways on the stock market and points political. One can't read and understand these books without feeling a sense that the source of economic prosperity the U.S. citizenry has enjoyed for some 250+ years is under strain because of a general ignorance of the insights these books provide. I'll leave it for you to discern my meaning.

Best wishes in 2020,
Douglas A. McClennen