Please read Part 1 here; this blog post builds further on the lessons from that blog post.
In this blog I would like to address the question of whether Democracy is better or Communism? Are Democrats better or Republicans? Are men better or women?
Is Fundamental Analysis better or Technical Analysis?
All kidding aside, the analyst community and also the tools and metrics available do fall into these broad categories. There is the camp that swears by the Warren Buffet model: Pick the right stocks and stay with it. The other camp which looks at charts and swears by the logic or trading using moving averages, divergences etc.
Let us first look at Fundamentals…
The diagram below compares 3 portfolios.
Portfolio 1 is the Berkshire Hathaway / Warren Buffet performance from 2003 onwards.
Portfolio 2 is the S&P 500 for the same period
Portfolio 3 is the 60% S&P and 40% Bonds portfolio
What do you think about the relative performance of the portfolios? Keep in mind that the Warren Buffet portfolio actually did extremely well in the preceding decade and this performance is only from 2003 onwards
A 60:40 stocks and bonds portfolio actually did better than both the S&P 500 and Warren Buffet. Delivered around the same return but with half the drawdown.
Let those numbers be the reference point for any financial advisor you speak to. They need to be able to beat those numbers for them to get the 1-2% that you pay them for their advice.
Let us talk fundamentals from a different perspective now. Consider the diagram below.
Valuation Model is where you start adjusting the stocks to bonds allocation based on valuation multiples in the market.
Stock Portfolio is where you stay invested in the stock market
Balanced Portfolio is where you invest in a 60:40 stocks to bonds portfolio
Bond Portfolio is where you stay invested in the bond market
Now look at the results. The valuation model where you reduce the allocation to stocks when the valuations are high and increase the allocation to stocks when valuations are low has the best results!!
This is to show that valuations do matter; but not in the manner you think of “buying and holding”. When valuations are high; you need to have the courage to leave some money on the table and exit stocks and increase allocation to bonds. Buffet does that…so why shouldn’t you?
In the next blog; we will look at technical analysis….
The screen-shots you see above were taken from www.portfoliovisualizer.com; an excellent website and responsible for a lot of my initial learnings.
