ARKK - The Stock Market Makes The Naughty List

Summary

• The unsavory prospects of a lengthy and agonizing bear market.
• The difference between investing and speculating, and between "the stock market" verses a value and quality-tilted portfolio.
• The two investment books that make the most sense today and for what may be coming next.

Do you want to know my emotional state every time I think about what the stock market may have in store for us for 2023 and beyond? To get a hint, simply take a look at the photograph above. And if you would like more than just a hint, then by all means, read on.

Few people look back wistfully to the stock market doldrums that commenced at the peak of the tech bubble in January of 2000 and then ground onwards and onwards and onwards, year in, year out, for the ensuing 13 years .

You and I aren't the only ones who see a few glimmers of similarity between the market today and the market back then. We can't help but to contemplate the fresh inflows of capital into funds like ARKK , the unshakeable devotion of some Tesla ( TSLA ) investors to their TSLA stock, and the continuing stream of hopeful articles touting cryptocurrencies as the next best thing since sliced bread. No. We cannot shake our unease because during our journey through that interminable valley between the years 2000 and 2013, we learned that bear markets rarely end in the stubborn optimism that we see all around us today.

I won't waste my time or your time prognosticating about what the stock market will or won't do next. No, I am grouchy today simply because I recognize that what COULD HAPPEN is a multiyear soggy slog through the yellowy grey slush of an agonizing, zero-to-negative-return stock market that poisons the souls of an entire generation of investors who, by the end, withdraw all of their capital in disgust and swear that they will never own a single share of stock ever again.

But then...

... a wan smile starts to creep across my face as my hands instinctively start to rub together. It must be ancient muscle memory because what I am remembering now is something that the S&P 500 charts from 2000 to 2013 won't show you.

But first, it's story time!

A Financial Odyssey

I mainly owned index funds, US Treasuries and money market funds when I first started investing in back in 1996, but as I gained interest and confidence I gradually started adding household name blue chip stocks (most of which I still own today). I bought shares of Johnson & Johnson (JNJ) based on a particularly sophisticated equity analysis that went like this: "everyone has heard of JNJ." I bought stocks like McDonald's ( MCD ), JPMorgan ( JPM ) and Canadian National Railways ( CNI ). I nibbled around the edges. I dabbled.

Most investors who have ever made money in the stock market probably have a story that is similar to my own: (1) get stupid lucky just once; and then (2) stay out of the way for as long as possible.

My wife and I sold our apartment in New York City in the Summer of 2002, which by pure chance happened to be very close to the bottom of the tech bubble bear market. It was our primary residence and thanks to a quirk in the US tax code, that meant a tax-exempt $500,000 windfall. We promptly invested a substantial amount into individual stocks - almost all of which we still own today. In a moment, I will tell you the names of most of the stocks that we bought but what matters even more are the criteria those stocks all shared (some of which we used in our selection process, others of which we stumbled upon accidentally). We bought shares of companies with the following characteristics: (1) blue chip, mega cap; (2) decades of consistent profits and positive cash flow (3) low debt; (4) occasional share buybacks; (5) dividends; (6) low price earnings ratios; (7) household name products and/ or services; (8) high and durable profit margins; (9) wide business moats; and (10) low obsolescence threats.

In the decade that followed, our index funds languished and had just started to make some fresh all-time highs just in time for the great financial crisis. Like most index fund investors, we didn't begin to see the light of day on our fund investments again until 2013.

But such was not the case with our individual stock investments!

According to PortfolioVisualizer.com, an equal-weight version of our early individual stock portfolio rose 10.44% per year from January 2000 through January 2013, compared to a 1.95% annual return for the Vanguard S&P 500 fund ( VFIAX ) - in both cases assuming that all dividends are reinvested. Better still, it was that bleak stretch of market history that set the stage for outperformance that continued to expand at a compound rate with each reinvested dividend.

You wisely ask "so what?" Here are the two lessons I take away from this waltz through my personal financial history.

First, a bear market does not mean a bear market for all stocks.

Second, the very best investment I ever made was reading two books - The Intelligent Investor by Benjamin Graham and The Future for Investors by Jeremy Siegel. T'was not I who invented those 10 criteria listed earlier in this article. I only wish that I had the conviction to place more of our capital into those individual stocks and less of our capital into index funds (had I done so, I'd be a very wealthy man today). But alas, I suppose that one must experience a few bear markets and at least one or two lost decades before one truly comes to appreciate the timeless investment lessons from those two books. Lacking that experience at the time, I nibbled when I should have gobbled.

Okay, I know what you're going to say next. Some people believe in the so-called "efficient markets" hypothesis. I understand why they do because I used to as well... but always with a gnawing sense of doubt. Why did I doubt? Because every single time somebody tells me that I can do just as well or better by doing no work, I know that I am being conned. Why should investing be the one and only exception to a rule that applies universally to all other aspects of the human experience?

Well, I say it isn't. Just think back to December of 2021, when the S&P 500 was heavily concentrated into astoundingly high-priced shares of companies like Tesla ( TSLA ) or Nvidia ( NVDA )? Doesn't it seem OBVIOUS now that any index that includes high-priced, heavily-indebted companies with scant (or even no) profit track records is going to suffer meaningful drag whenever the air comes out of the market? Of course it does! Of course it takes some work to screen those sorts of stocks out of your portfolio! Of course reasonably priced shares of consistently profitable companies outperform expensive shares of unprofitable and inconsistently profitable companies! Of course intelligently directed effort pays more than a complete lack of it! This is just common sense, and of course common sense eventually prevails - even in that howling absurdity that we call the stock market. To my mind, if our experience with 2022 confirms anything, it's that.

Not that I find any fault whatsoever with those who disagree. "Efficient markets" is like any other investment fad; the more widespread and stubborn the belief, the more rewarding it is for those who balk at it.

Conclusion

A 13 year "go nowhere" market can be fantastic news for value-oriented investors who seek out consistent cash flow to fuel the unrelenting power of compounding. Let me be perfectly clear. I have no idea if we are headed into a lost decade, but if so, you now know what my general plan is and will continue to be. Not only that, you now see a specific list of my portfolio positions and weightings.

According to Google Finance, our portfolio has outperformed the Vanguard Total US Stock Market ETF ( VTI ) by 8.33% over the past 5 years (including our 2.66% annual dividend yield minus the 1.66% dividend yield for ( VTI )).

Much of that extra performance simply comes in the form of losing less than the broader market, a fact that I attribute to my habit of avoiding stocks that don't fit squarely with the ten criteria listed earlier in this article.

You may note that some of our shares are plainly overvalued, but I have a plan for those little morsels as well. Continue to hold the stock but avoid buying more until the price drops.

And with that, let me extend my best holiday wishes to you and to the SeekingAlpha community, and my hopes for a very happy new year.

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