January 2022 Newsletter
The markets have had a rough start to 2022. The culprit seems to be the release last Wednesday of the Federal Reserve’s minutes from their December meeting. In a nutshell, the meeting notes indicated the Fed may be looking to speed up their forecasted increases in interest rates AND perhaps increase the speed of their balance sheet runoff. What does this all mean? Tighter monetary policy…less free money...less monetary stimulation. All positives for the long-term, but maybe not so for the short-term because as we’ve said for a long time-the markets have been addicted to this sugar. Weaning the markets off of this addiction may cause some short-term pain. But even if so, it’s well needed- at the least the Fed should not be buying billions of bonds still every month.
But remember all of this is just talk so far. Let’s see how far they go….or how far they CAN go? We still think the Fed’s game plan is more about talk than action. There is so much debt in the world that quite frankly if rates go up sharply for lack of better words…I think the whole world may go bankrupt. The increased cost in debt service on a 1% rise in rates just for the government debt alone is astronomical. Let’s not even talk about the record amounts of student debt, auto debt, credit card debt, etc., etc. Gone are the days of “living within your means” -especially for the government! The bottom line is let’s see how far the Fed can actually go with all of this (we are doubtful they can go too far without causing a greater than wanted economic slowdown), BUT at least some monetary policy normalization is a long-term positive.
Nonetheless, the markets have begun to make bets that rates will rise significantly in the future; bonds (whose prices move inversely to interest rates) have been the obvious victim, while in equities, there continues to be a significant rotation away from those assets which are deemed “expensive” (that is, those stocks with a high market valuation relative to their earnings….or lack thereof!) towards more value-based companies with strong current earnings, dividends, etc.
The result has been—as we have repeatedly reported in past newsletters—that many of the popular highfliers have seen their stock prices come well off their highs. It is important to note that these may be fine companies with exciting technologies, but the valuations just got too extended. For example, as of this writing, Zoom is now trading at $173/share (down from $450); Peloton is at $35 (down from $171); Teledoc is $81 (down from $300)…and Robin Hood which was a huge IPO last year is now at $15 (down from $85.) 40% of the stocks trading on the Nasdaq are down 50% from their highs and 2/3rds are in bear market (down 20%). Finally, some of the froth has been taken out of the market. Too many of today’s investors in these types of companies probably were little babies during the tech bubble of the late 90’s and have not learned the lesson that valuation does matter.
Meanwhile, value sectors, such as financials, healthcare and energy are other sectors that have done quite well over this period of time and have greatly outperformed on a relative basis. As always, the lesson is to not hold one group or the other exclusively, but instead a combination of both and remain diversified. Once again, high quality dividend paying companies are proving their worth in times of turbulence. Slow and steady always wins the race. Even if we go into a correction or bear market, the companies that produce real earnings, cash flow, and dividends will come out on the other side just fine whereas many of these speculative stocks may never reach their highs again.
The 60/40 Portfolio
The traditional 60/40 portfolio continues to be questioned in light of elevated valuations in stocks and very low yields in the bond market. Just using the Vanguard total bond market as a proxy for bonds, this fund last year was DOWN 1.67% and already this year (…although we of course never want to read too much into YTD numbers on January 11th!) is down another 1.5%. When you are getting such miniscule yields on your bonds even little changes in bond prices can impact your total return.
Wall Street consensus on the role for bonds in a client portfolio is all over the map. Investors are getting bombarded with ideas for supposedly better places for their money than bonds. As we’ve said numerous times in prior letters, everyone has a private fund to sell nowadays. Private Credit, Private Real estate, hedge funds, and on and on. Add annuities, structured notes, life insurance, and cryptos to the mix! What do all of these have in common? High fees, illiquid, and complicated investments. But they sure do pay the seller pretty well.
Our view continues to be that bonds absolutely still play a role in a retiree’s portfolio, but we can certainly make a case that they do not for someone 10 years plus away from retirement. But in either case, probably not up to as much as 40% anymore.
So where do those extra dollars go then? We still come back to what we think is one of the most misunderstood types of investments, such as option-based strategies. Such strategies as selling calls against a stock position that is already held can create small, but additional monthly income that helps overall returns.
And yes, although they are more complicated than a traditional stock or bond fund, these types of strategies are low cost and liquid and they allow you to hold a greater number of higher returning stocks in a portfolio while limiting the risk. We continue to use these types of vehicles to help our clients plan for and achieve financial independence.
You and Mr. Market
In a recent article, “Who You Should Know”, the author Charles Ellis makes an important point that there are many components of investing that individuals need to consider. However, perhaps the most important is to understand who you are as an investor….AND realize that the market (“Mr. Market” as he calls it…) does not always have your best interest at heart.
As investors, we all have different personalities and traits. And, of course, our financial situations are all unique. This is why it is paramount that individuals first understand themselves, their risk profile and how they react to adverse market conditions. Only with a realistic and honest assessment of themselves, can they plan around for their own situation.
Alternatively, the market (…or Mr. Market) has its owns plans. For example, the market will do its best to convince investors to sell…and buy…at the wrong times. And at times as a reaction to news or an event, the market will decline too far; while in other instances, it will rise too quickly, by too much. In both cases, the market can distort valuations and test investors’ discipline.
In fact, this underscores one of the biggest and most common investor behavioral mistakes: buying at the top and selling at the bottom. Time and time again, investors react impulsively-- buying at peaks and finally relenting (i.e., selling) when prices have bottomed. This is exactly why most investors do not achieve returns that are comparable to the markets: they make wrong decisions at the wrong times.
As an example, we can look at the return history of a very well-known exchange-traded fund (ETF). This highly volatile, largely tech stock ETF had an annual return of 152.5% in 2020 and was ranked the top in the mid-cap growth Morningstar Category. But last year the fund was actually DOWN 24%....(In 2022, the fund is down already down another 14%.) A wild ride, for sure.
However, what is interesting—if not disappointing—is the fact that despite the stellar performance in 2020, most investors of that fund probably are looking at huge losses. The reason? According to Morningstar, 90% of all cumulative inflows since inception came in late 2020 and early 2021….EXACTLY when the fund’s performance peaked. I had to read this article 3 times to make sure I didn’t misread it. That’s a startling number and just shows how dangerous and pervasive performance chasing is. For those who invested early, they are still enjoying positive gains. But for those who bought in at the highs, they are facing big losses. Most investors got in to this fund too late and did not enjoy the early spectacular gains. This fund has been a spectacular success, but yet, the average dollar invested in the fund has lost money.
The lesson, of course, is to be true to yourself. Realize how you react in weak markets and understand your propensity for risk. If necessary, it can be helpful to write down your investing strategy and review it during challenging market periods. But what is absolutely necessary is to NOT make decisions that are based on emotions and contrary to your investment plan. Changing paths—merely due to Mr. Market—is exactly what the market wants you to do and will nearly always result in greater difficulty in reaching your financial goals.
In summary, to achieve financial independence investors must look themselves in the mirror and admit their strengths and weaknesses when it comes to investing. Good advice may seem expensive, but bad advice or no advice costs a fortune.
Assured Misery
Morgan Housel wrote a great piece with this title recently. His opening line, “People tend to know what makes them angry with more certainty than what might make them happy. Happiness is complicated because you keep moving the goalposts. Misery is more durable.” What a quote-Housel is such a talented writer.
He made 5 points around this, but I will just focus on the one that relates most to financial planning and investing. “Expectations rise equal or faster than results, leading to constant disappointment no matter how much you’ve accomplished.” All wealth, Housel says, is a two-part equation. A result relative to expectations. Managing expectations and getting the goalpost to stop moving is one of the hardest tricks in life, he says. Agree.
But it’s so essential, especially with the goal of achieving financial independence. After all, what is the purpose of money? Many would say the purpose of money is to make a better life. Again, from Housel, “It’s just realizing that an insatiable appetite for more will always push you to the point of disappointment and regret-always, every single time. So having some ability to deny an extra dollar of work, or a potential opportunity, a bigger house, or a nicer car, is essential.” From an investment perspective, did all those investors who piled into that hot ETF too late really need to buy in? Did it make sense to buy that ETF for their financial or investment plan? Was that a consideration first? Probably not. They bought it more likely because they allowed the goalpost to move. They heard about this hot ETF in the media or somewhere and just couldn’t resist jumping in.
Another example, today everyone wants to know how their investments are doing relative to the S&P 500. Why? Because it’s been the best performer for several years. Did investors want to be compared to the S&P 500 in 2010? I’ll guarantee the answer was no for anyone. Why? Because the S&P returned 0 for the previous 10 years. But now the goalposts are moving again. And the next time the S&P declines by 50% the goalpost will move again.
All the best,
Nick
DISCLOSURE: This newsletter contains general information that may not apply to everyone. The information above should not be construed as personalized investment advice and should not be considered as a solicitation to buy or sell any security. Past performance is no guarantee for future results. There is no guarantee that the opinions expressed in this newsletter will occur.
Investment advisory services are offered through NCM Capital Management, LLC, an SEC-registered wealth advisory firm domiciled in New Jersey. This communication is not to be construed or interpreted as a solicitation or offer to sell investment advisory services to any residents of any state other than the State of New Jersey, the State of New York, the State of Texas, or where otherwise legally permitted. For additional information about NCM Capital Management, LLC, you may request a copy of our disclosure statement as set forth on Form ADV.