We hope everyone had a happy and healthy Holiday Season. As we end 2020 and begin 2021, I thought it would be a good time to reflect on the past year, the lessons we learned, and look ahead to the New Year.
2020 Lesson # 1 (The Stock Market)
For those that did not have a long-term outlook or game plan, the last 12 months were very difficult. Buying and holding a broadly diverse basket of stocks meant sitting through a very difficult March and April that saw the S&P 500 decline by 35% in a matter of weeks. The difficulty of holding stocks (or buying more) during this period was indescribable, as many of you are aware.
2020 was a litmus test for the long-term investor, as the markets rebounded dramatically from the March lows through the end of the year. Remember this for the next crisis. We believe, and as evidenced in 2020:
1. The financial news media, friends, or family do not know anything more than what is already priced into the market; and
2. Buy, hold, and rebalance is the worst form of investing, except all the others.
2020 Lesson #2 (The Economy)
Biggest question of 2020: How can the market recover so quickly when the economy is still so weak? It turns out that the market and the economy are different.
1. The economy’s largest sector is hospitality and entertainment. The stock market’s largest sector is information technology, which was in high demand during the Work from Home period.
2. The pandemic hurt small businesses the most. The stock market is made up of the world’s largest businesses. Those businesses got larger as small businesses were forced to close their doors.
3. The economy is backward looking. GDP numbers represent a historical view. The market is forward looking. Markets tend to recover before economies.
2020 Lesson #3 (Expect the Unexpected)
Ken Arrow, one of greatest economists of the last (and part of this) century, liked to tell the story of his time as a weather officer in the Army Air Force during World War II. He was asked to provide a long-range weather forecast. He objected that such forecasts were impossible and therefore useless. He was told to make it anyway, since it was necessary for planning purposes.
Chief Strategists at many of the world’s largest financial institutions have recently published their 2021 economic and financial market forecasts. How many of these strategists predicted a global pandemic and the worst GDP decline in 100 years at the start of 2020? In other words, we think it is pointless to act upon these “expert” forecasts.
As our friend Morgan Housel said in an interview with us earlier this year, expect the markets to blow up about once a decade and plan accordingly. Beyond that, any long-range forecasts are generally useless.
Those that maintained their discipline in 2020 were rewarded with a very solid year. Knowing that you have a game plan, are not reactionary, and have adequate liquid reserves allows you the luxury to tune out you much of the noise.
With market P/E multiples of greater than 20 times, history suggests the S&P 500 is on the expensive side. We would not be surprised by a pullback or a flat period to help earnings catch up to where price levels are currently. Trying to predict the timing of this, though, is impossible.
With 14 million people unemployed, there is a school of thought that says the markets will continue going higher as the vaccines kick in, government stimulus is expanded, and corporate earnings growth accelerates. Additionally, interest rates are at historic lows and stocks still offer an attractive risk premium as an alternative to bonds. Maybe the market is expensive for a reason?
What we can say with certainty is there will be market selloffs. There is always something out there to knock stocks off their tracks, even if its temporary. As per JP Morgan research, the markets have achieved a 9.0% compound annual growth rate since 1980. To achieve that rate of return, investors would have needed to withstand an average 14.3% intra-year decline each of the last 40 years. Expect volatility and don’t let it deter you.
Shifting the focus to bonds. With cash yields near zero and the 10-year Treasury around 1.1%, why would you own fixed income? In our view, bonds and cash have a place in our clients’ portfolios for a variety of reasons (diversification, defense, liquidity, cash flow, etc.). Most importantly, fixed income helps you maintain your equity exposure during volatile times without the impulse to act on negative emotion.
We want to thank all of you for your continued confidence. This year has taught us to be grateful for such a fantastic group of clients. Helping you reach your long-term goals is our mission. We enjoy coming to work every day.
As we continue to grow and reinvest in both people and technologies, we will always be available to each of you at any time for a meeting, review, or update. And know this, we are open for business and continue to grow. If you have someone that you think may be interested in our services, please let us know.
Have a happy and healthy 2021.