During the past few years, many investors have responded to both the economy and their stock investments with fear, often beyond reason. Fusion’s intense focus was squarely on counseling to never suppress feelings of fear BUT to never reflect those feelings in portfolio strategy by abandoning the plan – selling stocks and going to cash – in response to short-term fear or pausing ongoing savings into their portfolios until the proverbial “dust settles.”
There was no shortage of fear-inspiring events confronting investors:
I am proud that our behavioral investment counseling enabled our clients to survive the chaos and successfully stay on plan.
As 2023 ended, it became clear to me that I was watching investors fear of catastrophe and financial Armageddon begin to evolve into the most insidious fear of all – the fear of missing out (FOMO).
“If we only wanted to be happy it would be easy; but we want to be happier than other people, which is always difficult since we think them happier than they are.”
~ Charles de Montesquie
TEMPTED TO PARTY LIKE IT’S 1999
The issues that so recently caused many investors to be tempted to abandon their investment plans are still present. So, why do so many of these formerly terrified investors seem to have newfound confidence to assume concentrated risks in pursuit of “easy money?”
Generally, due to market-driven optimism/pessimism bias, investors’ views of the world are influenced by the prevailing state of the stock market. The 25% decline in 2022 “confirmed” investor’s fears that all the world’s problems were surely about to lead to permanent personal financial ruin. Conversely, last year’s 25% rise in the S & P 500 led investors to assume the “all-clear” signal was sounded. The risks they feared for the past several years don’t merely still exist, they have amplified with a new war in the Middle East that exposes us to countless additional geopolitical and economic risks.
Investors’ new fear is that others who own more than they do of what has been doing the best, most recently (large-cap technology/artificial intelligence (AI) stocks), will get richer than them.
Today’s tech darlings are referred to in the financial media as the “Magnificent 7:” Nvidia, Meta (Facebook), Amazon, Tesla, Microsoft, Apple, and Alphabet (Google).
Early in my career (from 1996-2000) I experienced this same phenomenon. While the names of the companies were different (Lucent technologies, AOL, WorldCom, Cisco Systems, Intel), the investor response was the same. The Internet was the future, and everyone knew it, so why own anything but the largest US companies in that space? That period is now referred to as the dotcom bubble era. Its highest performing year (as measured by the increase in the NASDAQ technology index) was 1999 when it gained 86%. FOMO was raging, especially among investors with prudently diversified stock portfolios.
From 2000-2002, many wealthy investors watched as their “dotcom miracle” transformed into a wealth destruction nightmare, as the NASDAQ lost over 90% of its value. Worse, at the bubble’s height in 1999, yielding to FOMO, many investors liquidated important diversifying portfolio holdings (like small-cap and emerging markets) which rose between 75% - 100% over the next decade, while the S & P 500 lost 12%. Investors thought they were selling last decade’s losers to buy next decade’s winners while they unwittingly were doing exactly the opposite.
Investor’s memories are very short, indeed.
“Somebody will always be getting richer than you and that is not a tragedy.”
~Charlie Munger
CISCO SYSTEMS AND NVIDIA: A NARRATIVE OF TWO TECH TITANS AND THEIR STOCK TRAJECTORIES
In the late 1990s, Cisco was viewed as the key player in enabling internet connectivity to make the internet faster, more reliable, and more secure. It overtook Microsoft as the world’s most valuable company, reaching about $550 billion at its peak in 2000. Analysts were forecasting Cisco to reach $1 trillion. Today, about a quarter-century later, Cisco is valued at under $200 billion (still about 40% below its year 2000 peak) and its value is less than 7% of Microsoft’s, which recently surpassed Apple as the world’s most valuable company at $3 Trillion.
Nvidia is the world leader in artificial intelligence chip sales. The last 12 months saw its stock price rise from about $213 (valued at about $500 billion) to $726 (valued at about $1.8 trillion).
Analysts predict continued stellar growth for Nvidia, reminiscent of past expectations for Cisco.
"The only thing we learn from history is that we learn nothing from history.”
~ Georg Hegel
1999 and 2023: EERILY SIMILAR INVESMENT LANDSCAPES AND INVESTOR RESPONSE
In the ten years ending in 1999 and the recent ten-year period, investors saw Large US Growth stocks outperform value, small-cap, and international stocks. They must avoid responding today as they did then, by liquidating what was relatively inexpensive (and about to outperform for a decade) to buy what was at or near historic high valuation levels (and about to underperform for a decade). Past performance is never indicative of future performance.
Many investors mistakenly believe they are broadly diversified simply by investing in the S & P 500. They think that a $500 investment in the S & P 500 will result in having $1 invested in each of 500 companies (a broad, diversified exposure).
However, many don’t realize that the S & P is constructed by allocating more investment dollars to the companies selling at the highest valuations. For example, the value of all 500 companies in the S & P 500 is now about $42 trillion. Microsoft is the highest valued company ($3 trillion) and because of that it accounts for 8% of the S & P 500’s value. Consequently, $40 of a $500 total investment goes into Microsoft. Fully one third of the $500 investment ($150) goes to only 10 companies, mainly in the large-cap technology/AI space. Like in 1999, the S & P 500 today represents a large, concentrated speculation on the continuance of the leadership of one idea and is completely devoid of small-cap, value and international which, as they did in 1999, currently represent some of the historically most undervalued opportunities in the global investment markets.
According to Bespoke investment group, the technology sector’s weight in the S & P 500 recently crossed 30% for the first time since the dotcom bubble peak in 2000. According to Barron’s, it is far worse. Standard & Poor’s, in an effort to address the increasing index overweight in technology, stealthily reclassified Facebook (Meta), Amazon and Google (Alphabet) from the “technology” sector to the “communications” sector toward the end of 2018. Consequently, the actual technology weighting is about 40% (or a full 1/3) higher than in 2000.
Our message is not to avoid the Magnificent 7 stocks or the NASDAQ technology index. We cannot know if a bubble exists today and if it does when it will burst. Valuation (or anything else) is never a timing tool. In fact, although our portfolios are broadly diversified across nine stock exposures including small-cap, value, growth, developed and emerging international, our portfolios have about a 10% exposure to the Magnificent seven, so that approximately $100,000 of every million-dollar investment is in just those seven companies.
The message is to keep our eye on the prize (8% to 10%) long-term compounding in broadly diversified equity portfolios and not to blow up our plans by giving in to FOMO. Adhere to the behaviors that increase, rather than decrease, the odds of long-term success.
THE HANGOVER AND ITS LINGERING EFFECT
The anxiety from the gut-wrenching roller coaster ride of experiencing an annualized compound return of 42% from 1995-2000, followed by a 29% annualized loss from 2000-2002, is enough to turn investors off to stock investing. But our biases led to an even worse outcome.
We extrapolate recent patterns of past returns into the future and engage in performance chasing. This recency-bias causes us to sell the components of a portfolio that have recently underperformed to buy more of the components that recently outperformed (we sell low to buy high). This is the opposite of what must be done to maximize the odds of compounding investment returns at the likely highest average rate for the longest period. Remember, our expectation is to see broadly diversified global equity portfolios compound at an average annual rate of 8% -10% over an investment lifetime.
Many investors who engaged in this behavior in 1999-2000 lost twice by simultaneously causing overexposure to next decade’s laggards and underexposure to next decade’s leaders. Regret-aversion-bias, causes such investors to avoid taking an action (investing in stocks) in fear that the outcome will reflect their dotcom experience. That leads to status-quo-bias, where we simply leave the funds where they are (usually in cash/bonds) to avoid the regret of investing into another bubble.
The immeasurable wealth likely lost by such investors over the lost decade (1999-2009) often pales in comparison to their future opportunity cost, as they spend decades underexposed to stocks and compounding at subpar rates due to their past behaviors and regret aversion.
Human nature loves to invest for the past ten years instead of for the next 20 or 30. “Performance chasing” is one of the more costly mistakes that can destroy long-term compounding of wealth.
DON’T PLAY SOMEONE ELSE’S GAME
Remember the game you are playing. Others who call themselves investors may be playing the day trading game, seeking small, short-term profits, and selling out each day. We are also called investors, but we are playing the long-term, wealth compounding game. Those two investment games operate under very different sets of rules with very different objectives. Those who switched from the compounding game to the day trading game not only failed to win their game – they simultaneously lost both games.
A favorite story about this involves a young boy who plays a game each day with his dad. The dad shows him a dime and a nickel and asks him to pick one. The boy always picks the nickel. One day his older brother, who used to play this game with his dad, confronts him and asks why he always picks the nickel when he knows the dime is worth more. The younger brother tells him that if he picks the dime, dad will stop playing the game. The older brother’s objective was to get more money quickly and the younger brother’s objective was to keep playing as long as possible. They were really playing two different games with different objectives.
The objective of the long-term multigenerational investor must be to play the compounding game as long as possible.
CONCLUSION
Our portfolios are always broadly exposed to both the highest performing and lowest performing stock categories and the portfolio’s long-term objective is to capture global growth, after inflation. In the short run, the economy and the stock market are not connected. In the long run, the global economy cannot outgrow or undergrow the companies that comprise it.
The three variables that account for long-term stock returns are global economic growth/GDP (assume 4%), long-term dividend yield (assume 3%) and long-term inflation (assume 3%). That is where the long-term return for stocks comes from. Our approach simply attempts to gain exposure to a broad swath of companies to reflect the makeup of the global economy. Forecasting the economy, speculating on which industries will do better than others and when, and timing the markets are all exercises in futility that the broad investment industry engages in to appear to be adding value. Nobody can do those things consistently and they cause investors to react to short-term noise and to fail to maximize real life, long-term returns.
The period from 1999 to 2009 serves as a cautionary tale for investors. The urge to chase performance and the fear of past losses can lead to costly mistakes. To overcome these challenges, it's crucial to remain diversified, avoid comparing results with others, and focus on long-term wealth compounding rather than short-term gains. Understanding the game you're playing, staying disciplined with portfolio rebalancing, and maintaining a long-term perspective are keys to successful investing. Remember that chasing yesterday's winners does not guarantee tomorrow's success, and staying grounded in a diversified, long-term approach is essential for building wealth over time.
“Simplicity is the ultimate sophistication.”
~Leonardo DaVinci