New Decade, Same Optimism

Happy New Year! We welcome 2020 with great hope and expectation for the years ahead.

A decade ago, we were less than a year off the bottom after one of the worst bear markets in history as the global financial crisis unfolded in 2008 and 2009. Things didn’t feel so great at the time with the memories of recession and crisis fresh on everyone’s mind. Would you have guessed back then that in ten years’ time the S&P 500 (a broad index measure of the U.S. stock market) would be nearly 3x where it was? It was a good decade indeed for us and investors in general.

But did it really feel that good? Unfortunately, it’s a fact of human psychology that bad news sticks better than good. We’ve heard it said that our brains are like Velcro for bad news and Teflon for good news. Thankfully we’ve also heard we can be conditioned for optimism, but this psychological predisposition sure doesn’t help when popular media tends to skew negative in its reporting of global news and events. And it’s not just the market – significant improvements in the human condition can fly under the radar. For instance, we might not realize that the extreme poverty rate globally has fallen to less than 10% from 36% in 1990. Or that thanks to innovation, caring people, and organizations like the Gates Foundation (& many others), preventable diseases are being significantly reduced or even eradicated and many fewer kids are suffering from preventable disease. There are great advances happening every day!

You’ve heard us talk about how the 24/7 news cycle works against successful cool-headed investing. In an environment where information is literally everywhere, it’s often our job as advisors to cut through the noise and focus on what’s important. Yes, we’re sober about some harsh realities and risks to investing in the current environment but we’re also plenty optimistic. We’ll come back to that, but first it might be helpful to put a little context and color around where we’ve been. Let’s take a quick 50-year walk down memory lane by decade for some historical perspective. For time and simplicity’s sake we’ll keep our focus to the U.S. and use the S&P 500 as our proxy for the stock market and unless otherwise noted, we’ll be citing price returns (not including dividends) for the index.

The 1970s and 2000s, the “lost” decades. Let’s get the not so fun memories out of the way first. The 2000s were the only decade of the past five to post negative returns for the U.S. stock market. The new millennium (does the term “Y2K” still make your eye twitch?) started with the unwinding of the Internet bubble that inflated in the latter part of the 1990s and ended with a global financial crisis in 2008-2009 that was precipitated by an overzealous U.S. housing and mortgage market. There were two recessions during the period. While there were some good return years among the ten, the decade overall came to be known as a “lost decade” for stock returns as the S&P 500 fell 24% over the time period. Even including dividends, stocks returned a negative 1% per year in the 2000s. The 1970s weren’t quite that bad, eking out a modest 1.6% average annual return. Although the first couple years were good, the recession and bear market of 1973-1974 sapped returns for the decade. The U.S. stock market dropped 17% in 1973 and nearly 30% in 1974. This was compounded by oil crises (1973 & 1979; you may remember those lines at the gas station) and rampant inflation paired with modest economic growth leading to “stagflation.”

1980-1999, the golden investing years of the last 50. Happier times and we’re lumping two decades together here. Although plenty of distinction can be made between the two, they were generally characterized by similar and powerful forces that drove a spectacular stretch of strong investment returns. These forces included falling interest rates from their peak in the early 80s (30-year mortgages at 18+% anyone??), strong economic growth, and breakthroughs in technology including the personal computer revolution and the introduction of the Internet. Yes, this period started with a recession (1980-1981) and there were a few setbacks along the way: Black Monday on October 19th, 1987; excesses in commercial real estate leading to a banking crisis and recession in 1990-1991; and an emerging market debt crisis in 1998. However, in only three of 20 years in the 1980s and 90s did the U.S. stock market post negative returns and the average annual return was nearly 14%.

And the most recent, 2010-2019. Based on stock market returns, the past decade certainly qualifies for the “golden years” moniker and was the only one of the last five without a U.S. recession. Slow and steady economic growth defined the fundamental backdrop for the decade although growth in company profits per share were healthy and boosted by improving margins and share buybacks. Adding fuel to the fire for all financial assets (stocks, bonds, real estate, etc.) was the unprecedented monetary policy response from central banks around the world to the global financial crisis of 2008-2009, which pushed interest rates down throughout the period to very low levels today. Interest rates are a powerful force in determining the value of financial assets and lower rates tend to lead to higher valuations. These forces were a powerful and positive cocktail for U.S. stocks, which as we already mentioned rose 190% in price and 13.6% on average per year including dividends.

So how do we learn from our observations of the past, cut through today’s noise, and stay focused on the right things in the decade ahead? First, we avoid overanalyzing the things we can’t control. Watch the popular financial news or pick up any one of the hundreds of written market outlook pieces for 2020 and you will likely see predictions for: U.S. elections & politics; recession probability; China trade deal; Brexit; and escalating tensions in the Middle East & elsewhere. The list goes on. Please don’t misunderstand, this doesn’t mean we have our heads in the sand. We are aware of these developments and do our best to position portfolios considering the near-term environment.

But we think it best for our clients to maintain a common sense approach to investing for the long-term. We see this as an advantage in a market where many participants can’t or won’t do the same. Despite the crises, crashes, conflicts, elections, politics, recessions, bear markets, and even lost decades of the past fifty years, an investor in the stock market would have returned an estimated 10% per year over the period. Some of the biggest investor mistakes we’ve witnessed are self-inflicted by selling in scary times and near market bottoms when everything feels the worst and it’s easy to let our emotions get the best of us.

If we had to wager a guess at investment returns for the decade ahead, it would be for below average returns overall. Even if returns overall are challenged, there will without a doubt be good investment opportunities both in the U.S. and internationally. This is why we’ll continue to favor our approach of a carefully selected portfolio of targeted investments as opposed to broad index investing, which we believe will likely be more challenging in years ahead. In other words, we may be able to find faster growing pieces within the pie even if the size of the pie overall is growing more slowly or even shrinking.

A few specific things have our attention as we turn the page on a new decade. We continue to see top heaviness in major indexes—the top 5 companies (1% by number) in the S&P 500 represent 18% of market value of the index. In fact, Microsoft and Apple alone accounted for 15% of the S&P index returns in 2019 (thankfully we own both in our stock strategies). Energy was pummeled this year; the total value of all publicly traded U.S. energy companies is presently less than the market value of Apple! We were happily light in our energy exposure most of this year but we think there now may be an opportunities here amidst the carnage and we have carefully placed a couple of bets.

Overall, we’re pleased with how our investment strategies have performed. We’ve maintained our overall value discipline and it’s been a tough environment generally for value managers. Also, we have held and continue to maintain a strategic cash allocation as a tool for risk mitigation as we expect the market may become more challenging. This cash will serve as dry powder for buying on a pullback. Of course, and as always, we are doing our best with what we’ve invested to stay in reasonably valued companies even as the market pushes to new highs.

As we enter a new decade, even one where returns may be harder to come by than the last, we will continue to invest with optimism. We have immense conviction that a disciplined approach to investing in good assets at reasonable prices will produce a bright future of attractive returns over the long run. Though economic and market cycles are as sure to repeat as the rising and setting sun, we have supreme confidence in the creative and innovative human spirit, and our collective ability to find new ways to break through and achieve great progress.

It’s a privilege to do this work on behalf of our clients. So if this sounds like the kind of optimism that could give a boost to your investment and planning strategy, please let us know, we would love to hear from you.

Here’s to a great 2020 and coming decade for you and yours!