Despite advancing by more than 12% (13% if you include dividends) in 2014, the U.S. stock market was not that friendly to most professional investment funds. Hedge funds, as a group, had a terrible year with an average return of just under 4%. Mutual funds were no different, with many of them failing to keep even with the market index.
The cause was simple. All the "smart" money forgot one market truism: investing in out-of favor-stocks over the long run beats investing in rosy, optimistic situations. Most funds abandoned names like Apple (AAPL) as it lost favor with the "growth" crowd. Shares advanced by over 30% in 2014. Other names that were seen as boring, unsexy stocks, like Micron Technology (MU), Microsoft (MSFT), and Intel (INTC) advanced 60%, 23%, and 40%, respectively. Yet most funds shunned these boring stalwarts and instead went after growth. Names like Amazon (AMZN) declined by over 20% in 2014.
Ironically, with oil starting 2014 in bullish mode, energy stocks were popular picks. Yet today, many of those same funds are shunning energy names. But guess what is boring and out of favor now? Murphy Oil (MUR), which peaked last year at $68, now trades for $46 and yields 3%. Apache (APA), which fetched $104 at one point in 2014, now trades for $60, and most funds are staying away from it. How is it that paying $40 billion for something is seen as more attractive than paying $22 billion? Isn't it more rewarding to buy things for less, not more?
As 2015 sets in, take heed of what works: buying unloved good businesses at points of maximum pessimism is perhaps the closest thing to a fail-proof investment philosophy. Of course, you still have to evaluate each opportunity and separate falling knives like RadioShack (RSH) from turnarounds like Best Buy (BBY). Remember Research in Motion, now known as Blackberry (BBRY)? Blackberry has been the perfect example of an out-of-favor stock that happened to appreciate by over 60% in 2014.
Buy good businesses when they are out of favor, and patiently wait for the crowd to turn. That's about the most sensible market guidance I feel smart enough to give.