Broker Check

2020 -- A Brief Recap

December 30, 2020

A brief recap of the year that was as well as a look ahead to the coming year.

Obviously, as we leave the current year, it was dominated by two important occurrences, both of which had investment implications: the Covid19 pandemic and the 2020 U.S. election. While the election is past in most people’s minds (exception being the two GA senate seats to be determined on January 5th), the virus is still with us and has economic implications: more in some states, considerably less in others but nevertheless it will have an economic impact until the vaccines are fully distributed and implemented.

So what have we seen this year that perhaps we haven’t seen before – at least in terms of investments? Despite the media’s wailing to the contrary, in terms of investment returns, they have been pretty much within the parameters of the long-term historical ones. The exception being the dominance of the S&P 500 by the so-called FAANG+ stocks (Facebook, Apple, Amazon, Netflix, Google + Microsoft). When the returns of these few stocks are removed from the index the returns are far more ordinary for the rest of the equity universe. Actually, we have seen this before: think the late 90’s and the era and terminal bubble. There was also a well known investment lesson re-learned: you only incur a loss when you actually sell. Many who sold out in panic early in the year when the U.S. market dropped some 33% missed the recovery which not only made back the temporary loss but also delivered positive returns for the year. As usual, it is investor performance that rules the day, not investment performance!

While we know historically that over the long-term “value” stocks tend to generate 2%+ more returns than do growth stocks (see Fama/French model), over the last ten years this has not been the case. Thus, portfolios which were diversified and not heavily concentrated in large U.S. growth stocks (mostly as represented by the FAANG group) tended to trail the S&P in terms of performance. As noted above, we’ve seen this phenomenon before and as noted with the terminal bubble starting in 2000, “value” stocks considerably outperformed growth in the succeeding era. This was presaged by the media trumpeting such “interesting” catch phrases as “value is dead,” “growth at any price,” “clicks equal cash flow,” “cash is trash” and several more.  We were introduced to day trading and millionaires until their worlds came crashing down around them. Some were so severely “burned” to this day they still have not reentered the equity markets. Historically value and growth stocks have rotated periods of outperformance, but over the long-term, as noted, there is a value premium to be obtained – so long as one remains disciplined so they can be when that premium eventually emerges. The lesson, of course, for long-term investors is to remain disciplined and exposed to both asset classes.

This, of course is where the technique of rebalancing a portfolio comes in. For those who are not familiar with the technique or who have forgotten, when a portfolio is designed, it is broken down into multiple asset classes, each representing a percentage of the total portfolio. Studies have shown the asset allocation policy is responsible for 94% of a portfolio’s return – 100% of its positive return (Brinson, Hood and Beebower). Thus, to over-simplify, when one asset class appreciates more than another the portfolio gets out of balance and rebalancing requires selling some of the shares of the outperforming asset class and buying more of the underperforming one. This results in what all know is the secret of making money in the stock market: selling high and buying low!

For our investors it is important to acknowledge that our benchmark for performance (how well we are doing) is not the “market,” any index, anyone else’s portfolio or whatever the media is hyping but rather each investor’s own “investment policy statement” (IPS)which sets forth the performance,  risk objectives and time horizon for measurement of each individual portfolio. That is the only performance benchmark that matters and so long as you are within the parameters of that IPS you are doing well and on track for accomplishing your objective(s).

So what do we see in the coming year? If I had a crystal ball and knew for sure – particularly as it relates to investment performance, I’d not be writing this but be sitting on some Caribbean beach, tropical drink in hand, laptop handy, awaiting a brilliant investment insight to execute. But I don’t and neither does anyone else.

That said there are some certainties that will ultimately have some impact upon investments, both positive and negative. To what extent, who knows? For sure the virus will be with us for at least the first six months and possibly longer until we get a good handle on how well (or not) the vaccines and/or treatments are working.

  1. The stimulus bill. Ultimately, how much will be sent to the populace, what impact adding more to the debt which is already a record amount will have and the extent to which it will stimulate the economy.
  2. Tax policy. In part this will be substantially influenced by the outcome of the two Georgia senatorial races. The incoming administration has proposed substantial tax hikes, whether and to what extent they will be implemented will depend upon who controls the senate.
  3. Infrastructure spending. If this goes through then it should provide some stimulus to the economy.
  4. Green new deal – or portions of it. This will have an impact on living costs (transportation, heating, A/C, manufacturing costs, etc.) and that will affect how households spend their money and where it is actually spent. There are a lot of variables attached to this, thus difficult to predict.
  5. Is retail as we’ve always known it dead and will we see even more movement to E-commerce sales?
  6. The world. I see two major potential foreign issues facing us near term (although there will always be unforeseen issues that arise). The first is the potential reentry into the Iran agreement by the Biden administration; whether that will create any issues vis a vis the nascent peace agreements between Arab states and Israel and their posture toward the Iranians? To an extent this is dependent upon the terms with which the U.S. reenters the agreement. The second, of course, is China and its aggressiveness both commercially and militarily. I’ll be writing more on this in the coming days. However, both of these issues have similarities in the sense that our relationships with them are based upon an assumption (erroneously?) that as commercial ties bind us more closely together and their societies benefit economically they will bend more to the will and values of the west. I think we’ve seen how that’s played out with the Chinese. Whether that assumption will be realized with the Iranians is subject to speculation at this juncture.

In sum, as in most years, we are living according to the ancient Chinese curse: “may you live in interesting times!” This is why, when it comes to investing, given the future at best is unknowable and unpredictable it is best to have a long-term investment plan in place that takes into account all of the possible contingencies, both known and unknown that face portfolios over the course of time.

Our best wishes to you and your families for a very happy and healthy new year!