Dear Clients,

I hope this letter finds you in good spirits as we embark on a New Year. With this letter I wanted share with you some of my thoughts, broken into two parts:

Part One: General Principles

• It will be worth restating, even in the context of a letter primarily focused on the year just past, my overall principle of investment advice. It is goal-focused and planning-driven, as sharply distinguished from an approach that is market-focused and current-events-driven. Long-term investment success comes from continuously acting on a plan. Investment failure proceeds from continually reacting to current events in the economy and the markets.

• You and I are long-term equity investors, working steadily toward the achievement of our most cherished lifetime goals. We make no attempt to forecast, much less time, the equity market; indeed we believe these to be fool’s errands.

• Since we accept that the equity market cannot be consistently timed by us or anyone, we believe that the only way to be sure of capturing the full premium return of equities is to ride out their frequent but ultimately temporary declines.

• By my count, there have been 15 “bear markets” in equities since the end of World War II — an average of one every five years or so. The average depth of these declines was something on the order of 30%. But in September 1945 the forerunner of the S&P 500-Stock Index was about 16; the Index ended this past year at 3,231. Thus, at least historically, the permanent advance has triumphed over the temporary declines.

• My essential principles of goal-focused portfolio management remain unchanged.

  • The performance of a portfolio relative to a benchmark is largely irrelevant to long-term financial success.
  • The only benchmark we should care about is the one that indicates whether we are on track to accomplish our financial goals.
  • Risk should be measured as the probability that we won’t achieve our goals.
  • Investing should have the exclusive goal of minimizing that risk.

Part Two: Current Observations

• Two thousand nineteen was, in important ways, the mirror image of the previous year. Two thousand eighteen was a dramatically outstanding one for the American economy — and for corporate earnings and dividends — despite which the equity market couldn’t get out of its own way, and ended on a terrific downbeat. This past year was the exact opposite: an exceptionally good year for the market - up 29% - even though the economy slowed somewhat, manufacturing appeared to be stalling out, and the S&P 500’s full-year earnings almost certainly trailed those of 2018.

• These three successive waves of new highs seem to me to have attended upon a slowly growing realization that widespread fears of major disaster — trade wars tipping the economy into recession, a significant year-over-year downtick in earnings, and a constitutional crisis regarding impeachment — were overblown.

• It is the way investors reacted to this relatively brief, relatively shallow drawdown which captured my attention, and which I commend to yours. Simply stated, net liquidations of U.S. equity mutual funds — absolutely, and especially contrasted with bond fund inflows—soared to levels not seen since the Great Panic of 2008.

• Set aside momentarily, if you can, the headline issues of the day: the trade situation, an aging economic expansion, impeachment/election uncertainty, and the like. These are not merely imponderable; they’re irrelevant to long-term, goal-focused investors like us.

• Instead, I would invite you to focus on what seems to be the default setting of the investing public, which I would describe as pessimism verging occasionally into sheer panic. All my reading and all my experience suggest that very meaningful market setbacks have not historically occurred during huge waves of public pessimism and fear. Quite the contrary.

• This is not to be taken as any sort of market forecast. (As I’ve always said to you, I’m a planner, not a prognosticator.) It is simply an invitation, as we look into the new year, to take some comfort from the rampant fear abroad in the land, even after a decade and more of stellar returns. There will be plenty of time to begin worrying when the stock market once again becomes cocktail party conversation, and everyone around us is excitedly bullish.

• Be of good cheer. It is overwhelmingly probable, as financial journalism has been shrieking of late, that 2020 will not match the returns of the past year. Few years ever do; that is both manifestly true, and wholly irrelevant. The fact — or, more properly, the truth — is that we goal-focused, planning driven investors had an exceptional year in 2019. We did so not by forecasting this year’s returns — nor by jumping into the market just in time to get them — but by patiently hewing to our long-term equity discipline. That, to me, is the great lesson of this genuinely great year.

Dear clients, please be invited, and indeed encouraged, to raise with me any questions prompted by this very brief summary. That’s what I’m here for.

—Michael Paulding Thomas

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