In 1985 we were introduced to Doc Brown, Marty McFly and their retrofitted DeLorean time machine in the movie Back to the Future. Two sequels followed to complete the trilogy that has since become embedded in pop culture lore. In the second film, the Grey’s Sports Almanac with 50 years of professional sports results was taken back in time. Obviously, anyone in possession of that book could earn a fortune gambling with tomorrow’s winners in their pocket. We would like to borrow the DeLorean and go back in time with our own almanac.
Assume Doc Brown’s time machine took us back specifically to December 31, 2019. The US economy was in the midst of its longest economic expansion ever, GDP was growing at a steady +2% pace, household net worth was at an all-time high and the unemployment rate was at an all-time low. While there were concerns about slowing growth, the economy was on solid ground. As we now know, everything changed as COVID-19 made its way across the U.S. in the first few months of the year. Here is what followed:
Officials forced the economy into a self-induced shutdown to battle the spread of the virus. Unemployment skyrocketed – for the ten years ending February 2020 there were 22.8 million jobs created. In the following two months 22.2 million jobs were lost. Demand in certain industries disappeared instantly – travel, dining out and entertainment were all massively impacted. The price of oil briefly went negative – someone literally paid another party to take barrels of oil off their hands in Cushing, OK. Our nation’s GDP fell an annualized 31% in a single quarter, kicking off a massive self-imposed recession. The Federal Reserve bought over $3.2 trillion in assets to stabilize market operations. These events are what we read in our almanac. Unfortunately, the section on market results is missing so the question is, how would one position their portfolio knowing all this was about to take place?
It is likely that anyone with our almanac in their back pocket would have decided to reduce risk. They would have sold stocks, bought gold and Treasury bonds or just stuffed cash under a mattress. A more aggressive approach might have been to bet against certain stocks or the entire market. But here is what happened:
Certain industries flourished and companies that could leverage technology to deliver goods and services to the home absolutely dominated. Ironically, many of these companies were already outperforming. Think of Facebook, Amazon, Apple, Netflix and Google, aka the FAANG stocks. A host of new “stay at home stocks” took off, tied to everything from home fitness to electronic payments. The housing market went through the roof (no pun intended). Few would have thought you could experience a massive economic recession and a housing boom simultaneously, but that is exactly what happened. The pandemic accelerated many trends that were already in place, and these are just a few.
Recall that in March the S&P 500 index fell 34% in the swiftest bear market ever recorded. By the end of the year, the S&P 500 had increased 16% (following the 29% return in 2019). Small stocks were even more resilient. At the lows in March, the Small Cap 600 index had fallen 42%! That index also finished the year +16%.
The takeaway here is that even with the gift of time travel it would have been extremely difficult to pick the winners of 2020. No one could have predicted how the market and certain industries would respond to a global pandemic. No one. But this is a critical concept for equity investors. Owning equities requires the confidence to not second guess yourself by trying to side-step market corrections, even when you think you know the future. Legendary investor Peter Lynch once said, “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” One of our core beliefs is that public equities offer the greatest returns for individual investors over the long run. The price for receiving those returns is the drawdown described above. Those with discipline experienced strong investment returns in 2020. Do you think you can earn the long-term market averages if you miss years like 2019 and 2020? You cannot. The discipline to stay invested through a year like 2020 paid handsomely, as it usually does. Simply put, you had to endure the losses in March to receive the gains later in the year. Timing these moves does not work.
A few months ago, a more predictable event had investors wringing their hands. Our conversations with clients and friends suggested investors thought the stock market would fall if Biden won the election and the House and Senate went blue. Conversations with prospective clients slowed almost to a halt. Some paused existing plans to put money into stocks. “Let’s wait and see what happens after the election” was common to hear. The results are in, and since the election we have experienced a very broad and encouraging market rally. It has included sectors and industries that were lagging even in the rise since March. Banks, foreign stocks, and small cap companies have all outperformed over the last sixty days. Again, this just confirms how difficult it is to make long-term investment decisions based on short-term events like elections.
At some point, maybe later this year or in 2022, we will see stocks go into a correction. They could dip 10% or flatten out for a while. They might even decline further for a period of time. Someone in the financial media, or maybe a neighbor at a backyard barbeque, will tell you that the reasons were obvious. “Because of blah blah blah stocks were bound to go down!” They might even say they knew when it would happen. They do not. We could write another ten pages with all the different reasons stocks might correct at some point. But the exercise is pointless. We would rather be researching companies or sectors of the market that will endure and thrive in the next decade. We recognize and accept there will be price volatility along the way. In fact, we welcome it so that we can have good entry points to add certain positions to portfolios.
Many investors in retirement think they can’t ride out any big stock market declines because they don’t have time to allow for recovery, relying instead on bonds for income production and price stability. This is another example of the changing world we live in. A client’s asset allocation is determined with their specific cash needs in mind, and we plan for multiple years of those needs. In past years living expenses could be met by increasing the allocation to fixed income. In today’s world, though, we are faced with a different scenario. Bond yields are at historic lows and returns are not going to be what they were over the past 20, 30 or 40 years. It is mathematically impossible. If someone retires today at age 65, we typically model for another 20-30 years of living needs. That is a long time to have a large part of one’s portfolio tied up in something earning 1%. A comfortable retirement is going to require more equity, which is appropriate given the longer time frame. We will be talking about this more in 2021 as we consider adjustments in portfolio construction over the next year or two.
While 2020 was challenging in many ways, we are very pleased with our results and grateful to work in an industry where we could still serve our clients through the pandemic. Many in our community and across the country were not so lucky. We wish you a healthy and prosperous new year and look forward to having more face time with clients in the coming year!
