Trisha's Thoughts

I started my career in the late 1990s, during the early years of the internet revolution when phrases like “the new economy” were popular. At the time investors were flocking into stocks that were related to the web, often without doing much research on the fundamentals. Even some seasoned investors got into the trend, perhaps not paying much attention to the relative price they were paying for the stock(s). I remember specifically someone working for one of the largest investment firms who said to me, “buy Cisco at any price” because it was providing technology for the internet to work. Even as a young professional I remember thinking that didn’t seem prudent and it turned out that I was right.

After internet related technology stocks saw lofty performance for some time, reality set in suddenly, resulting in many of those stock prices falling quickly. Even established companies like Cisco were not immune. After seeing its price skyrocket from about $10 to over $80 in less than two years, Cisco’s stock fell as quickly as it rose, once again trading below $10 a share by late 2002. Today, over twenty years later, Cisco’s stock is trading at $54 – not a bad return if you bought it for $10 but not so great if you bought it at $80. It turns out that the price you pay for a stock really does matter.

I have been thinking a lot about history and stock valuations recently as investor money has flocked toward a handful of mega-cap technology stocks while largely ignoring quality companies in other industries. The newspaper article that I wrote and shared with you last quarter explained the difference between the S&P 500 Index, which counts bigger companies more when calculating performance, and the Equal Weight S&P 500 Index, which factors all 500 companies equally in its performance calculation. The large difference between them this year continues – as of September 30^th the S&P 500 Index had gained 13.07% for the year while the Equal Weighted S&P 500 Index was up 1.79%. Same companies, just different perspectives.

Not surprisingly, the 7 mega-cap stocks that have achieved outside performance this year are trading at a much higher average price to earnings ratio than the average of the remaining 493 companies in the S&P 500. They may be the best companies in the world – and some would argue that they are – but the price you pay for them still matters. Experience has taught me that remaining diversified is the prudent course even when all of the momentum seems to be in one area.

The investment markets experienced some fairly typical seasonal volatility during the third quarter, resulting in modest declines in both the stock and bond markets. The focus was largely on interest rates as the markets finally seemed to account for an expectation that interest rates are likely to remain near current levels for some time. The focus is now shifting to corporate earnings, which so far have largely been positively received. And while the markets will keep an eye on political issues and global conflicts they are viewed through the lens of potential economic impact, which so far has been viewed as manageable.

As we review and rebalance portfolios this quarter, we will continue to strive to balance risk and return.  In all economic environments we believe in the importance of diversification, the value of a regular strategy of rebalancing and the contribution of income toward total return.  We continue to view cash as a sensible piece of a diversified portfolio’s asset allocation, especially in accounts distributing income, but also appreciate the longer term opportunity that bonds can provide.

Please do not hesitate to call us if you have any questions or would like to discuss your account or the marketplace in general.  We are always happy to hear from you.

Trisha Arndt

Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties which are difficult to predict.  Past performance is not indicative of future results.  All indices are unmanaged, and investors cannot invest directly into an index.  Diversification does not ensure against market risk.