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Investors are faced with an unattractive array of investment options today, ranging from no return on short-term investments to a likely mid-single-digit long-term return on equities. Moreover, the equity markets have been characterized by unusually high correlations of returns for most stocks, with a handful of large companies producing double-digit returns to their shareholders. If the returns on these large companies are excluded from the S&P 500 total return in 2011, equity returns were negative.
If we are correct in projecting that equities will return only mid-single digits over the next 5-10 years, it is unlikely that “buy and hold” investing will produce satisfactory returns. Moreover, in today’s economy, there are very few companies whose securities are capable of producing 10+% returns for their shareholders on a sustained basis; either competitive pressure will erode returns, or the external environment will throw them a curve ball. Our approach in this environment is to be more willing to take short-term profits, especially if they appear to be largely macro-induced. In addition, we have an increasingly healthy respect for the option-value of cash.