December 22, 2020
Saying that 2020 was a challenging year is like saying World War I was a challenging conflict. I can’t remember a time in modern history when we were forced to confront two concurrent fears, each causing wide spread panic on their own:
1. The partial or complete loss of our income;
2. The existential threat of having to face our mortality or that of our friends and loved ones.
As a result, I witnessed anxiety run at among the highest levels I have seen in my 35 years as an investment advisor and my decade as a thought leader in the area of behavioral investment counseling (BIC). My role in BIC is to counsel investors on how to make rational money decisions under conditions of uncertainty – meaning rationality ALWAYS, since certainty, as a condition never exists anywhere in nature!
One would be less than human not to have experienced deeply all of the fears associated with the year’s events. The key is to NEVER reflect those fears in one’s portfolio decisions as that breaches Fusion’s credo. The credo: ALL successful investments are goal-focused and planning driven, while ALL failed investments are market focused and performance driven. As a corollary, all successful investors are continuously – always — ACTING on a plan, while all failed investors are continually — episodically — REACTING to current events, performance and the markets. Breaching the credo often leads to a permanent, and sometimes fatal, impairment of wealth.
At Fusion, we counsel that investor behavior (temperament or what one does) is the key determinant of investment success. The conventional wisdom thought leaders across the financial advice industry at firms like Goldman Sachs, JP Morgan and others all believe that intellect or what one knows is the dominant determinant. They employ countless analysts, economists, portfolio managers, and other highly educated and highly paid “experts” who suggest that their timing and selection proposition will enable investors to consistently enter and exit the most/least attractive economic sectors and asset classes/investments and always at the right time. Those things cannot be done consistently by anyone and they are irrelevant to an investor’s ability to retire comfortably, to stay comfortably retired and to create legacy. In fact, they reduce the likelihood of goal attainment as they encourage investors to always react to current events and the markets rather than to always act on and follow a plan. 2020 was a textbook example of why the conventional wisdom approach generally fails.
KEY STOCK MARKET LESSON OF 2020: BEWARE OF “EXPERT” OPINIONS
Let’s begin by recounting 2020’s market environment:
1. February 19 – S & P 500 reaches all-time closing high of 3,386.15
2. Gripped by the panic of COVID-19, the S & P falls into bear market territory (down 20%) just 16 days later. An event without historic precedent!
3. Just 33 days later, the market closes down 34% (from its February 19 high) at 2237.4. 34% down in 33 days is also without historic precedent!
4. What immediately followed was the best 50 days in the market’s history.
5. Following the deepest, fastest economic contraction in history, and the largest fastest increase in unemployment, there came on Friday, June 5th the monthly unemployment report. “Expert”
consensus was for a loss of 7.5 million jobs. In fact, there was a gain of 2.5 million jobs. The experts were off by a staggering 10 million jobs.
6. Six months and one day following the February 19 pre-COVID high of 3,386.15, the S & P completed the investor’s 2020 emotional round trip and on August 18 closed at a new all-time high of 3389.78.
7. As I write, the market closed near its recent all-time closing high on December 17 of 3,722.48. This was the 31st record high of 2020!
There must be tens of thousands of economists and market strategists globally. Each and all of the events cited above was forecast by exactly none of them! I receive countless emails inviting me to hear these same highly educated and highly compensated “experts” share — wait for it – their 2021 outlooks! Many advisors will listen to this pure guesswork, and worse, will actually pass it along to their defenseless clients. Investors don’t need to be provided with all of these near-term guesses; they need to be actively defended against them!
“If you spend more than 13 minutes analyzing economic and market forecasts, you wasted 10 minutes.”
~ Peter Lynch
THE SIREN SONG OF THE “EXPERTS” & THE FINANCIAL MEDIA
One of the wealthiest and most expensive/exclusive (annual dues of $30,000) investment clubs, TIGER21 amassed record levels of cash this year at the best times to add to stocks. The group increased cash levels from 12% to about 20% by the end of June, just in time to miss adding to the market in advance of its best August in 30 years and best November in history! Goldman Sachs called for a second major market decline on May 11 (the markets have gone straight up from 2,400 to 3,700 since). The experts, the financial media and the uber-wealthy littered the streets with myriad short-term economic and market forecasts that were invariably wrong. Worse, they enabled and even encouraged investors to fail by offering the illusion that REACTING to short-term current events is somehow relevant to an investor’s long-term, goal-focused, planning driven strategy. It is not. They fail to appreciate or even to recognize the entire history of market declines and advances. The advance is permanent and the declines temporary, such that both the values of the stocks in the S & P and the dividends that they pay both sit near all-time highs. The experts insist on timing the markets and advising others to do so, even though that is the only strategy that has ever caused a long-term investor to suffer a permanent loss. They believe one should engage in “strategies” to attempt to minimize the level of the next TEMPORARY decline even though doing so will almost always lead to minimizing their PERMANENT long-term gain.
Why do they do this? It is because the American investment culture has a deeply human and always fatal misperception of risk. Our culture believes volatility or up and down movements around the permanent long term uptrend is risk. Volatility is NOT risk any more than a temporary decline is a permanent loss. The only rational, practical definition of risk is the chance of a permanent loss of capital. Using this definition, one must accept that historically, the problem of building wealth has been most reliably resolved by owning the great companies of American and the world ( S & P 500 as an example) who have increased their dividend payouts by nearly twice the rate of inflation (6% per year, on average) for about the last 100 years. Stocks are one of the few investments that solve the “yield starvation” problem as they provide the right kind of income, one that increases at a greater trajectory than the cost of living (historically, twice as much). Investors always mistakenly worry about the LEVEL of income or yield currently available when what they need to worry about is its TRAJECTORY! Fusion views stocks, in this regard, as a peerless solution not only to the problem of protecting and growing wealth but to the investor’s income problem. We recognize that the problem is no longer one of understanding the financial markets, but one of psychology, in that investors have a deep belief in a myth (the “risk” of stocks). It is a myth because it can be overwhelmingly shown to not exist! A deep belief in something that cannot be shown to exist and that can overwhelmingly be shown to never have existed is not a financial problem. The real risk of stocks is that far too many investors are dramatically underexposed to them, impeding their battle against a lifetime and multi-generational period of 3% annual increases in their living costs.
WHERE DO WE GO FROM HERE?
At the risk of being repetitive – perhaps higher, even much, much higher! Why? We remain in the middle of the greatest secular bull market in history. This is only the third one in our lifetime. They last about two decades (this one turns 13 in 2021) and have only ended when the ONLY fear present among just about ALL investors is the fear of missing out (FOMO). Some posit that the market is in a bubble. How can we have a bubble when Investors have been net sellers of US stock mutual funds and index funds for all but 3 of the 12 years of this secular bull? We can’t!
This year investors sold US stock funds at a record level liquidating $206 billion through last Thursday. The previous liquidation record was set in 2019 when investors sold $167 billion of domestic equity funds in the second best performing year of the longest and strongest bull market in history when COVID was not a thought. Near the end of secular bull markets, we see investors chasing stocks, throwing record levels of money at them. The current scenario is the opposite and another indication that we are likely nowhere near the end of this bull.
All this leads me to believe that we may even go much higher than I believed when I wrote our June 22, 2017 newsletter, “Why the markets can’t go higher” and counseled that this bull market was likely in its second inning. The market was at about 2,400 then. At about 3,700 today, the market has annualized at about 16% which is nothing extraordinary during a secular bull. This bull has seen fewer 20%+ years than the previous ones and will likely experience a few more. For this reason and the reasons stated below, I would not be surprised to see 2021 globally diversified stock portfolio returns ranging between 15% and north of 20%. See Important Disclosure below.
THE ROARING 20s REDUX?
The uncertainties of 1919 were over – there seemed little doubt what was going to happen – America was going on the greatest spending spree in history…”
–F. Scott Fitzgerald, “Early Success.” 1937
Consumer demand arguably has not been this pent up in about 100 years. According to Bloomberg, there is an extra $1 trillion in excess savings stashed away for spending — primarily leftover from the $2.2 trillion CARES Act — as a result of the difference between the pre-COVID household savings rate trend of $1.2 trillion and the actual excess amount saved of $2.12 trillion. At the same time, household debt as a percentage of disposable income sits at record lows, leaving plenty of borrowing capacity as well. All this translates into households being able to spend $77.6 billion per month from this stash over the next year (roughly 10% of June wages and salaries). That’s real money!
Add to this fact, the roughly $18 trillion consumers have access to in cash equivalents via traditional (not an annual excess amount) savings deposits, demand deposits, checking and other components of US money supply as identified at the end of April by the Federal Reserve. All of this will likely supercharge growth and go a long way toward igniting the likely extended and powerful long-term return trajectory of equities ahead.
A FINAL THOUGHT ON VALUATION
In closing, many say that stocks are expensive at 22x earnings. Consider that the yield on the 10-year Treasury is .9%. It would take 111 years to get $100,000 in income by investing $100,000 in the bond today ($900 in annual income for 111 years). That is a price/earnings ratio of 111! Similarly, the dividend yield of the S & P 500 stands at about the same level of the income yield on a 30-year Treasury (which trades at 60 times earnings). Until 2020, this was a condition without precedent. Being able to buy the 500 best managed, best financed, most profitable companies in America and the world with an income yield (that historically grows by 6% annually) and that throws off about the same level of income as a 30 year bond is among the most compelling investment opportunities I have seen in my more than 3 decades as a wealth advisor. We get an income — currently 70% higher than that of 10 year bonds and equal to that of 30 year bonds — that grows, versus bond income which is fixed/frozen until maturity. Bonds cannot go up in value whereas any stock appreciation over 10-30 years will be essentially free!
On behalf of the entire Fusion team, I wish all of you and your families a happy Holiday season and a happy, healthy and prosperous New Year. We look forward to once again having the opportunity to see many of you in-person in 2021! Until then, please stay happy, healthy and hopeful!!!