The first half of 2016 was quite eventful.
By early February, the Standard & Poor's 500 was off more than 10%. Despite this, the index was back in positive territory by the end of the first quarter. The second quarter was range bound until Brexit, which drove markets lower globally. Those fears were short-lived (at least in the U.S.) with the S&P 500 quickly picking up the ground lost on the two trading days after the vote. When all was said and done, the S&P 500 increased roughly 2.5% for the first six months of the year (and nearly 4% including dividends).
At the end of the second quarter, the S&P 500 was at ~2,100, a level first touched in February 2015. Data from Yardeni Research (here) shows that consensus forecasts for S&P 500 operating (non-GAAP) earnings per share in 2016 are currently around $118 (it’s worth noting that this estimate has consistently trended lower for the two years or so that it’s been published). Based on those estimates, the S&P 500 currently trades at roughly 18x forward non-GAAP earnings.
Data from GuruFocus show that the Shiller P/E (also known as CAPE) is currently at ~26x, well above its historic average (the monthly average over the past 50 years has been ~20x). Here’s one contributing factor: the 10-year Treasury currently yields 1.4%, compared to 6.5% on average over the past 50 years. As Warren Buffett (Trades, Portfolio) noted at the 2016 Berkshire Hathaway (BRK.B) annual meeting, this has a material impact on valuations:
“If people ever really start thinking that something close to this is normal, that will have an enormous effect on asset values. It already has some effect.”
Everything should be viewed in terms of opportunity costs. I’ve been pretty vocal about my inability to find attractive equity investments over the past few years (against a hurdle rate in the double digits), which is why I hold a large percentage of my portfolio in cash (~20% currently). With that said, there’s one thing I’m quite sure of: I can find dozens of stocks I’d rather own instead of a 10-year Treasury bond. I'd much rather own a low-cost index fund than long-term U.S. government bonds. This speaks to the unattractive nature of long bonds, not the (absolute) appeal of equities.
Where I may differ from others is that I have no qualms about holding lots of cash (and putting it to work quickly, in size, if I think I find the right opportunity to do so). It’s unclear to me why every last dollar in my portfolio must be allocated to either stocks or bonds at all times (by which I mean long-term bonds, not short-term holdings that are essentially equivalent to cash). That statement carries additional weight in an environment where inflation is negligible.
If you're managing other people's money, cash might not be an easy default: clients aren’t happy paying an AUM fee while a large percentage of their portfolio sits idle on the sidelines. What many of them may find in the long run is there’s one thing they’ll hate more: sizable drawdowns.
Portfolio review
I was relatively inactive in the first half of the year; those who have read my articles for some time probably wouldn't expect any differently.
I made two purchases in the first half of 2016, both of which coincided with broad market volatility. I added to my position in Yelp (YELP) in early February and initiated a position in Moody’s (MCO) in late June. You can read about those investments here (Yelp) and here (Moody’s).
I wrote about Moody’s a few weeks ago and don’t have anything to add. On Yelp, the investment has been a pleasant surprise. My most recent purchase had the lucky timing of being within spitting distance of the market bottom. The stock has nearly doubled since February, which certainly isn’t what I was expecting. The company put up solid numbers in the most recent quarter. Obviously the higher valuation implies more optimism about the future than it did five months ago. While I continue to like YELP, I’ll probably cut the position size for portfolio management reasons (I like it a lot less at $30 than I did at $20 – and it’s a much larger percentage of my portfolio now). If we see it fall 30% or more from current levels, I’d like to be in a position to buy more.
I made a single sale in the first half of the year, which had an immaterial impact on my portfolio. If Mr. Market bids equities higher in the back half of the year, my activity will increase. I have a number of holdings near the point where I’m willing to sell (as was the case at the end of 2015).
Conclusion
Overall, my portfolio was up ~8% in the first half of the year. Berkshire Hathaway, my largest holding, increased nearly 10% in the first six months of 2016, providing a nice tailwind. Other large holdings like Johnson & Johnson (JNJ) and Walmart (WMT) helped as well, offsetting weakness in other (mostly smaller) portfolio positions.
I’m hoping we’ll see continued market volatility in the back half of the year. When Mr. Market jumps between bouts of euphoria and despair, I’m a happy camper.
As always, I’m interested in hearing your thoughts.
Disclosure: Long BRK.B, YELP, MCO, JNJ, WMT.
Start a free seven-day trial of Premium Membership to GuruFocus.
