Q1 observations, the drag of taxes, and our bull market's future

Q1 (the "first quarter") is closed, and emerging markets ran away with it, notching gains + dividends over 11.3% with international developed markets grabbing second place. There is a big debate in the investing world whether international exposure is needed, and Hans and I fall firmly in the camp of yes, it is. American investment portfolios tend to be underweighted in international exposure, and there is plentiful research that this is a non-trivial error. I'll devote a full future email to the topic.

Keep in mind that a quarter is an irrelevant time period. A slightly more interesting stat is that since the start of last year (15 months), emerging markets with dividends are up about 46% from their low point.

All kinds of bad news continues to pour out of many emerging market nations. Their governments are a mess (I'm looking at you Russia and Brazil), they have corruption problems (India), and rule of law is a joke (Venezuela, get your act together). But remember, the only friend you have in the investing world, other than Hans and me, is bad news. Bad news scared off other investors and allowed us to buy things on the cheap for you.


You're probably thinking, "will you stop going on about Ecuador when I can barely see my computer screen over my pile of tax forms." Yes, taxes are due Tuesday April 18. Investing-wise, we are hyper-focused on legal tax reduction. Remember that mutual funds, private equity firms, and hedge funds do not report their results after tax. They all tend to generate large tax bills for investors, but they let that flow onto your personal tax forms, conveniently pretending the expense is not real. The IRS isn't into make-believe, however.

The average mutual fund, with all of its trading, generates a tax headwind that costs investors roughly 1% of assets per year, by passing the recognized capital gains through to you. Just this tax bill will knock out about 25% of your net worth over your lifetime. I have personally owned certain index funds for 19 years that have never had a taxable distribution other than dividends (and yes, most of our clients now own them too).

But saving you that 1% / year is the minor league (if 25% of your net worth is the minor league, you can see why over a medium to long period of time this works so well). There are many other places that we look at for tax efficiency that are more significant. In this area we will keep improving, as we have many interesting ideas to research and test.

Additionally, we are going to lower your accounting bills or work by not trading your account so much. We don't like non-productive activity.

Cliff-notes style summary: we care about client returns on an after-fee, after-tax basis.


I get asked constantly where I think the markets are heading. The answer I don't know for a fact, and no one else does either. As Buffett says, "Forecasts of the future tell you more about the forecast than the future." But let me make one comment based on observation and experience.

If I were to guess, I would say we are not near the top of this bull market. I have invested through two of the largest bubbles that ever hit the United States, and two of the largest crashes (dot-com, sub-prime, and their related crashes). I've read a small bookcase full of books regarding the history of market euphorias and crashes, as I am weirdly fascinated by the topic.

Emotionally, markets don't tend to top when there is this much worry and fear in the environment. And despite 8 years of gang-buster returns, investors are worried, I see it every week. The scars from 2009 are still visible. For a certain type of person, much like the 1929 crash, they will never fade.

Markets top when people get the rose-color glasses stuck to their noses. They have been making lots and lots of money, they start to think the IQ test they failed at age 6 was the fault of the test, not them, and greed and more importantly, envy, dominate their subconscious.

John Templeton, the famous investor, had a maxim that "bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria." Along those lines, I'll end with a chart I like: Return to articles