2020: The Year of….
…“unprecedented.” There’s been nothing like it in my investment lifetime, and I dare say in most of our lifetimes. Putting aside the obvious – virus, politics and shutdown – let’s instead examine the markets to see what lessons can be learned to benefit us for 2021.
Start with a few of the many, many market records that were set or broken:
1) Fastest bear market (a decline >20% from top to bottom) in history – S&P 500 index only took 16 trading days to decline 20% and 19 days to lose over 30%. What historically would take 9-18 months, took 2-3 weeks. This decline was, to borrow the phrase, “warp speed” and left long-time investors without words to describe both the velocity and volatility of the decline.
2) Fastest bear market in history was promptly followed by the fastest bull market in history. As measured by market watchers, the long running, ten-year bull market ended when the bear market started in late February. The bear was then broken in only 13 trading days as the market advanced over 20% from the March 23 low.
3) Market volatility reached its highest level since the peak of the 2009 financial meltdown. By some measures, it even exceeded 2009 volatility. More recently, election uncertainty, including anticipated post-election challenges, brought volatility insurance premiums to the highest level ever recorded. The number of days in which the market swung more than 5% in price was also record-breaking.
4) Referring to “the market” became both difficult and frustrating for investors, as dispersion among various sectors and indices reached record levels. Tech heavy NASDAQ returned 45.1%, while the S&P 500 was up 18.4% – both staggering, considering the uncertainty throughout the year. The Dow Jones Industrial Average only managed 9.7%, while dividend-focused Russell 1000 Value ended +2.8%. Shockingly, small stock index Russell 2000, underwater most of the year, had its biggest month, you guessed it – in history – during November. This propelled it to its best performing year in over a decade versus the S&P 500, advancing 19.9%. Most internationally based indices, although lagging the S&P 500, still managed double-digit returns.
5) Record levels of dispersion were evident as growth stocks continued their record level march ahead of value stocks, energy and financials faded in the shadows of technology (notably semiconductors and software) and large, mega U.S. companies dominated the investment discussion and returns for much of the year. Rarely have so few stocks contributed so much to the performance of the S&P 500 index.
Those of you who have read previous commentaries, or heard my recent webinar, already know that lack of market liquidity, along with quantitative, computerized trading, were responsible for much of the market’s exaggeration. During other pandemic periods, declines of 12-15% were normal, usually occurring over a year-long period. With today’s lightspeed trading technology also comes trillions of dollars dependent on these computers for their investment or trading strategy. These strategies, similar in approach and used by institutional investors worldwide, had the effect of a crowd running for the fire exit at the same time.
AWM&T was able to capitalize on what we felt were over-exaggerated declines and used this year’s environment to our clients’ advantage. Last spring, some of our key decisions were to eliminate most energy and financial sectors and add information technology. Growth was selected over value, and our security analysis indicated that some out-of-favor companies had become real bargains (aerospace, software and semiconductors, for example). Later in the year, we saw an opportunity to selectively reestablish positions in financials and industrials, along with our strong performing technology names. In short, it has been a great year to be with a firm that has the experience to navigate the most challenging of markets.
After all this, it benefits investors to take a look back – not so much “2020 hindsight,” but more like a “lessons learned” approach that will take us into next year.
Lesson 1 – “Experts,” when it comes to markets and economics, are usually wrong. How many predictions and forecasts were so far off the mark, and more so than usual, in 2020? If I only had a dollar for each one…
Lesson 2 – Human behavior has a greater impact on investment results than technical knowledge. The smartest people in this industry made the biggest mistakes, yet again. Brilliant financial engineers that developed computerized investment programs for large portfolios sold at the bottom of the decline, and many did not reinvest until over 20% of the advance had occurred. Clients were severely “whipsawed” by the best and brightest. Even many experienced investors were timid to invest, scared of the uncertainty surrounding the pandemic. AWM&T bought stocks and bonds at a time when, literally, the entire world was selling them.
Lesson 3 – Interest rates have a far greater impact on asset prices than politics or other external factors. The actions of the Federal Reserve, not the U.S. government, did more to calm and support the capital markets than anything else. When interest rates and inflation remain low, stock prices historically perform better than all other asset classes.
Lesson 4 – When markets are driven by either fear or greed, an investor must take the other side of the trade. Certainly, there are times when the herd will be correct, but when emotions start playing a prominent role in market direction – as it did from March through November – the correct course of action is to simply buy companies with sound, long-term operations. While this is easier said than done for many, an experienced investor should be equipped to make that move.
Lesson 5 – For the past eight years, AWM&T has always said, “Ignore the noise.” This advice is a combination of the above lessons, applied in an objective, unemotional manner. History has shown us that long-term investors are rewarded, over time, by owning a piece of the American economy and not panicking in the short run. This strategy, while not new or especially “brilliant,” very simply, works.
AWM&T has always believed that active management can add value. 2020 gave us a great opportunity to display that value to our clients, as many investment decisions took advantage of this unprecedented market volatility and chaos. Certainly, past performance cannot guarantee future results, but AWM&T has positioned its clients well for 2021. For example:
1) We continue to believe that a low interest, low inflation environment is the most favorable for equities. For that reason alone, we remain at the maximum allowable equity allocation.
2) Companies with earnings growth and earnings visibility will continue to outperform the overall market. Selecting those growth companies at a reasonable price (“GARP”) will serve our clients well in 2020.
3) U.S. markets, with all their innovation, capital and stability, will remain dominant in 2021. AWM&T remains overweight U.S. companies versus international.
4) Small cap companies, while having their time in the sun, remain underweighted in our portfolios. Capital market structure and regulation continue to favor mid-to-large companies with strong investor sponsorship. Additionally, special purpose acquisition companies (SPACs, a rising market phenomenon) are making it easier for private companies to skip the small cap phase and jump ahead as a larger company.
5) Fixed income allocations, very conservatively positioned coming into 2020, are now weighted significantly toward intermediate corporate bonds. We anticipate making some changes in current sector weightings throughout next year, as the bond market adjusts to an economic recovery.
For those of you that have been longtime clients, you know that AWM&T doesn’t make next year predictions. That said, there are some “predictions'' that you can count on to be correct: there will be volatility in the equity market. There will be periods of uncertainty, either in politics, markets or foreign affairs. There will be hand-wringing by so-called market experts. There may even be another short-term market panic. How do we know this? Because human nature does not change. When these things inevitably occur, AWM&T will carefully analyze, then act on behalf of our clients in an objective fashion. That’s a “prediction” you can depend on.