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The Independent Adviser for Vanguard Investors

January 2016

5

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800-211-7641

of where relative values lie between the

two major asset classes.

You might ask what happened dur-

ing the financial crisis. Yes, the gap nar-

rowed dramatically by the end of June

2007, and then rebounded to a high dur-

ing the first quarter of 2009. The only

time the gap has widened that far again

was during the third quarter of 2011,

when stocks were pummeled amidst

uncertainty over government budget

battles and the debt ceiling, and gold

was moving towards $1,900 per ounce.

Treasury yields flirted with sub-2%

levels, and investors were frightened.

Over the next four years, though, stocks

returned 84.4%, while the bond market

gained 9.6%.

So where are we today? Neither

hot, nor cold. The yield-earnings gap is

trending right around its average over

the past 30 years. If companies begin

earning a bit more money, the needle

will point more towards stocks, while

a rise in yields will tip the scale more

towards bonds. Given this scenario, I’m

neither pounding the table for stocks,

nor am I recommending retreat.

I’m a bit more optimistic about this

when I think about our portfolios than

when I think about investors who trust

their investments to the whims of the

stock and bond market indexes. Why?

Because you and I invest with some of

the smartest managers on the planet—

managers who will pick and choose

which stocks and bonds are cheaper

than normal and avoid those they think

are a bit too pricey. Even if these man-

agers are only successful on the mar-

gins—and we know from experience

that they do a whole lot better than that

(see page 16)—we’ll come out ahead

over the long haul.

One thing I don’t recommend, and

hope you won’t fall prey to, is the “buy

the beaten down” mantra that is cur-

rently making the rounds as pundits and

prophets gush about their “best” ideas

for the year ahead. The most popular

topic: Oil and energy stocks. As I read

the financial press, as well as analysts’

reports and even the letters to share-

holders fromVanguard’s managers, one

of the biggest themes I’m seeing again

and again is an unwavering belief that

oil prices are destined to rise in 2016,

and therefore, so are energy stocks.

Of course, there’s no question that this

is one of the most unloved sectors

Stock Earnings Yields

vs. Bond Yields

9/87

9/89

9/91

9/93

9/95

9/97

9/99

9/01

9/03

9/05

9/07

9/09

9/11

9/13

9/15

Earnings Yield

10-year Treasury Yield

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

>

if you were “Ready for $20 Oil,” though, of course, as the year ended oil

was trading closer to $37. He also called for the 10-year Treasury’s yield

to fall to 1.0%.

You have to love this one:

MarketWatch

’s Lawrence McMillan wrote

that 2015 would be bullish because “years ending in ‘5’ far outperform

any other year of a given decade.” Of course, that didn’t hold true for

2005, which was only the sixth best of the years from 2000 through 2009,

but nonetheless he was willing to get investors’ juices flowing with

this lovely, useless and wrong tidbit. In fact, with the Dow having fallen

2.2%, 2015 is, so far, the worst year of the current decade by a country

mile.

Chris Rupkey, the chief financial economist at Bank of Tokyo-Mitsubishi

UFJ, told

Bloomberg

that the 10-year Treasury yield would rise to 3.4% by

the end of 2015. He wasn’t far off…from his peers, at least. The median

forecast of 74 economists and strategists that

Bloomberg

surveyed was

3.01%. Now, just in case you weren’t keeping track, the 10-year ended

2015 at 2.27%.

Speaking of surveys, the

Wall Street Journal

’s survey of 70 economists

saw the average seer predicting oil rising over 2015 to a bit more than

$63 per barrel. While the forecasters’ average prediction for unemploy-

ment was 5.2%, a handful actually expected the rate to fall below 5% by

year-end.

Jeremy Siegel told

CNBC

that the Dow Jones Industrial Average could

hit 20000 in 2015, which sounds pretty wild. But that would have been

a rise of about 10.9% from where it stood when he made his prediction

around year-end. The author of

Stocks for the Long Run

and Wharton

professor is a perma-bull, and has often been right. But on this one, he

got gored.

Bond guru Jeffrey Gundlach said that the 10-year Treasury could see

its yield fall below its 1.38% low of 2012, particularly if oil prices fell to

$40. Well, oil did, but bonds didn’t.

Another bull, Brian Wesbury, chief economist for First Trust, predicted

oil stabilizing in the $55 to $70 range. It didn’t. He also said the fed funds

rate would end 2015 around 1%, and the 10-year Treasury’s yield would

rise to 3%, while the S&P 500 would rise 15%. Nope.

Oh, and so much for the famous

Dow Theory

. Its best-known practitio-

ner wrote that the “third phase” of the bull market was going to begin

in 2015 and “the stock market boom will envelope [sic] everything from

housing prices to precious metals to all commodities.” The envelope

please: Wrong.

I’m also quite wary of stock pickers and their top picks. Michael Farr of

Farr, Miller & Washington had 10 for

CNBC

followers at the end of 2014.

In fact, he said he would buy all of his picks on the afternoon of Dec.

31. How’d he do? Well, here’s the rub. If you had bought equal shares of

each of his 10 stocks, which were priced anywhere from under $48 per

share (PDCO) to over $530 (GOOG), you’d have seen your portfolio gain

12.0%. But had you bought equal dollar amounts of each stock, your

portfolio would have sunk 2.3%. Now, Google was a massively smart

purchase for 2015, though another stock, Qualcomm, was a pretty lousy

choice. Take those two out of the mix and, well, no matter how you

bought the other eight stocks, you lost money—lots of money.

The bottom line: To protect your own bottom line, tune out the pundits

and predictors who fill the airwaves with buys and sells. Build a strong,

diversified portfolio of some of the best stock and bond pickers in the

business (see page 2 if you’re having trouble identifying good ones), and

don’t be too smug as you laugh your way to the bank.