2015: The year ahead

It's 6:30am on Saturday morning. The fridge is humming while I'm typing away on the couch and listening to my three-year old son play with his toys. They're the sounds of success. My New Year's resolution is to get up at 6am.

We'll see how it goes. Much will no doubt depend on the sleeping patterns of said three-year old and his siblings. Change inevitably involves launching into the unknown and that's the same with our new website.

Hopefully you'll be enjoying the much cleaner look, particularly on tablets and smartphones and the new site will feature a much improved search function, once it's property bedded down. This is among a number of teething issues, and you've been quick to let us know about the things you like and don't like. We're taking it all on board and working hard to make the changes necessary to give you the best possible experience (you'll receive an email with the details shortly).

We've also launched a couple of new services, including our Premium Service, which includes a range of additional benefits. For years members have been asking us to provide international coverage and more access to analysts and this product does this. It comes at a higher cost of course ($1,599 a year) so it won't be worthwhile for those not wanting the additional features. That will be the case for the majority of our members, in fact, and you can rest assured that you'll still be getting the same attention and research as before.

Our international coverage should also improve the quality of our research on the multitude of high-quality Australian businesses that operate in global industries. Graham Witcomb is currently based in Canada and will attend Berkshire Hathaway's 50th anniversary annual meeting in Omaha, Nebraska, and we're going to try to organise a field trip that could produce a special report; comparing CSL's US facilities with rival Baxter's is just one idea.

As with my late nights and late starts, not changing things was not an option. Our old website basically didn't work on smaller screens, the search function was lousy, it had a less intuitive structure and was gradually becoming obsolete. It's the nature of technology that if you don't move forward you'll end up not moving at all. As CS Lewis once wrote: 'It may be hard for an egg to turn into a bird: it would be a jolly sight harder for it to learn to fly while remaining an egg.'

Buying value

The idea of buying a dollar's worth of value for 50 cents, though, never changes, and it will continue to be the bedrock of our approach. Markets, however, can change quickly, so the location of our cheap dollars will continue to ebb and flow – we can't predict where they'll be, but we'll keep looking hard.

When I took over as Research Director in 2011, I wrote that I expected boom and bust market cycles to be shorter and more frequent after the GFC due to the amount of debt in the system; markets would be more volatile but we'd have plenty of opportunities to buy low and sell high.

Central bank money printing has put paid to that idea and – outside the resources sector at least – it's been much more boom than bust as interest rates have dropped. We responded by making sure we've been invested in great companies, with predictable cash flows, that benefited from low interest rates and a falling Aussie dollar as China's growth has slowed.

The results can be seen in the performance of our model portfolios, which have returned 13.1% and 13.2% per year respectively since I took over in 2011, compared to 7.4% for the All Ordinaries Accumulation Index. Last year was their best yet, with the Growth Portfolio returning 14.5% and the Income Portfolio 14.7%, compared to 5.0% for the index.

Resources

Gaurav Sodhi has done a great job steering you away from ticking time bombs, such as high cost iron ore producers and mining services companies, such as former market darlings Worley Parsons and Monadelphous. His Sell recommendation on Rio Tinto in 2010 at $83 was also a lonely call.

We're now slowly switching gears as prices have dropped. We assembled a 'mini-portfolio' of junior gold stocks on 6 Nov 2013 to profit should money printing eventually lead to rampant inflation. More recently we constructed a mini mining services portfolio on 26 May 2014 and we've reiterated our Buy recommendation on Santos. Origin Energy and Fleetwood have also joined the Buy list.

On the whole these recommendations haven't paid off, and we'd have been better off giving the resources and related sectors a wide berth. But this, along with the recent unscripted plunge in the oil price, serves to remind us that resources stocks should always represent only a small part of a well-diversified portfolio unless you have specialist knowledge. Our model portfolios have minimal resources exposure and that won't change.

We love that so many contrarian members are looking for bargains in the sector, as we should always be looking to profit from panic. Gaurav continues to scour the sector for opportunities and this year we're aiming to publish more short reviews to keep you updated, as events are changing quickly.

But the resources sector isn't a sector that you need to dive into. The decline in China's growth is just getting started and there's likely a lot more pain to come. The time to get really excited will be when we start seeing insolvencies and takeovers.

Bear in mind that the massive LNG projects underway aren't completed yet, and many mining services employees will be unable to find similar paying work, if they can find work at all. The world's largest oil services company, Schlumberger, just let 9,000 staff go in response to the falling oil price, as oil producers reduce spending on the development of new fields.

The situation reminds me of the A-REIT sector in 2008. Share prices had dropped dramatically and I upgraded GPT Group after its share price had nearly halved. It turned out that the falls had much farther to go and GPT was a classic case of premature accumulation. In summary, while we're getting more interested in the resources sector you can afford to be patient. The unprecedented 15-year credit experiment in China won't be cleansed in just a year or two.

Valuations

Which leads us to valuations. We currently have a bifurcated market like in 1999, when boring old industrial stocks in the US were being ignored by investors caught up in the dotcom boom. That allowed value investors to scoop up cheap, high quality stocks that performed wonderfully after the dotcom crash. Buffett responded to calls that he simply didn't get it by saying, 'a bubble market has allowed the creation of bubble companies, entities designed more with an eye to making money off investors rather than for them'.

Divided markets can be full of opportunity, but the current problem is that while high quality businesses like REA Group, Domino's Pizza and Ramsay Health Care trade on huge multiples, most of the companies that look cheap (think resources and related stocks) are indistinguishable from junk.

Our response is twofold. First, we're treading cautiously as market volatility is increasing, which could produce safer bargains. We've had a fairly benign environment since 2011 when markets thought the Euro would collapse. With valuations and US margin debt now much higher, expect Mr Market to be more temperamental.

Second, we've got cash to take advantage of opportunities. Only you can determine how much cash you should hold, but every year brings new opportunities, and having cash provides the financial and psychological resources to act quickly. It's never easy to sell a stock for another when you're fully invested.

Economic views

More broadly it still makes sense to diversify overseas even though the Aussie dollar has fallen substantially. The RBA has painted itself into a corner by lowering the official interest rate to a record low of 2.5% to support the economy, and increasing rates now could pull the rug from under the housing market.

We expect to see lower rates anyway as the resources boom deflates, which bodes well for income stocks, like Sydney Airport, even though valuations are already high. A question to ask yourself is what action would you take today if you though interest rates were going to zero. As always, our Income Portfolio contains our best income ideas, and it may be ok to buy some of our Hold recommendations if you have modest return expectations.

Just make sure you're not overexposed to companies that rely on a strong economy, such as the banks. In addition to their ordinary bank shareholdings, many investors own more bank shares in their super funds, hybrid securities (which we're steering clear of), their home and investment properties, and perhaps some shares in property developers or other stocks highly dependent on the strength of the Chinese and Australian economy.

That's been a great investment over the past 23 years, but it may not be the best bet now given China's pending move away from a fixed-asset investment economy toward a more consumer-oriented economy, not to mention Australia's high consumer debt levels. We'll buy most businesses if the share price is cheap enough, but make sure your portfolio is adequately diversified.

The strength of the US dollar could also cause some headaches. Investors are pulling money from emerging markets and adding to the pressure on their currencies, just when their incomes are falling because oil and other commodity prices are dropping. Other countries peg their exchange rate to the US dollar, and the last thing they need right now is a strong currency. We don't have any specific ideas on how to play this, but if it helps depress share prices more broadly then we'll be ready to add stocks to our Buy list and model portfolios.

Staying flexible

Humans are notoriously bad at judging probabilities. We might be able to imagine a wide range of scenarios, but handicapping each one is more difficult. The world is a chaotic place, so positioning your portfolio for a few different scenarios might leave you vulnerable to something you hadn't considered, or that turned out to be much more likely than you imagined. This time last year who thought we'd now be looking at a $50 oil price?

Legendary investor Peter Lynch wrote that 'far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in corrections themselves'. Over the long term we know it pays to be invested, but we're also conscious that we've had a great run since 2009 and that markets move in cycles.

Our approach is simple. Stay flexible, stick to your circle of competence and prepare for the unexpected. That way you're never surprised.