“We make money the old-fashioned way. We earn it.”
– Smith Barney tagline, circa the 1980s
In last month’s article, in honor of Thanksgiving, we pondered the things we can be grateful for. This month, we reflect on the year that was in hopes of learning something.
The Year In Review (Kinda)
It is customary in the investment industry for firms to publish an annual letter, which includes their analysis of the “Year in Review” for the global investment markets and their investing outlook for the coming year. We are breaking tradition just a bit this month in two ways:
First, typically these letters hit investors’ inboxes in January, but we decided not to wait. We thought it might be nice to beat the rush so that we don’t get lost in the flood of Annual Review content that will be published by money managers, analysts, and investment pundits all over the world next month.
Second, we couldn’t resist the temptation to extend our review just a little. Instead of reviewing the last 365 days, we would like to comment on the period from February 19, 2020, which was the equity market top that came just before the COVID shutdown, to today. In our view, the market developments which occurred since that historic day provide us with an incredibly valuable opportunity to learn some important lessons as investors. So, we thought it might be useful to comment on those lessons.
Lesson #1: Do Nothing
The first observation to be made about this important stretch of market history is that the U.S. stock market was astonishingly resilient over this period, which should come as no surprise to anyone who understands the long-term history of American financial markets. As we study the shares of the S&P 500 companies during this time, we find that the S&P 500 ended 2019 at a level of just about $3,200, it stands at just about $4,000 today, and its dividend has increased from $59 in 2019 to an expected $65 this year.
Many investors may find these numbers surprising because, thanks to a series of classic behavioral mistakes, they did not capture anything close to the returns implied here. Indeed, these last three years have been a case study on how the equity market will seduce us into making emotional investing mistakes.
However, for the lucky few who owned a broadly diversified portfolio of equities and didn’t change their portfolio because their investing goals had not changed, this period was not so bad from an investing standpoint. Our equities increased by close to 24%, while our dividends increased by about 10%, which helped offset the increase in the cost of living brought on by the rising inflation we are dealing with today.
On the whole, the average annual compound return of the S&P 500 over this time was just a little better than 7% per year. Although this return did not measure up to the long-term historical average equity return of 10% per year, it was not so bad considering all of the difficult economic and geopolitical events that transpired in the world during these years.
Back in the early 1980s, the investment firm Smith Barney ran a series of TV commercials featuring a crusty old actor named John Houseman, in which they announced that “At Smith Barney, we make money the old-fashioned way: We EARN it.” So how did these lucky few investors “earn” this wonderful 24% increase in their wealth over this period of chaos? They did the one thing that is almost impossible for an investor during such a volatile and scary time: They did nothing.
If history has taught us anything, it has certainly made clear that the ultimate way to earn your investing success over time is that when things get volatile and scary, do nothing.
Lesson #2: If it’s in a Super Bowl Commercial, Don’t Buy It
Between March 2009 and January of this year, the world’s equity markets experienced an incredible recovery from the financial crisis of 2008. For this period of 13 years, all one had to do was passively hold the S&P 500, which increased by about seven times during this period and produced an average annual compound return of 17.6% per year. It would be difficult to imagine a time when one could be handsomely rewarded for Doing Nothing with their investments.
Sadly, it is also true that the average American investor spent most of that period liquidating their equities and did not enjoy these returns. Thanks to the existential hatred of the stock market that had been hammered into their psyche during the 2007-08 bear market, most American investors adopted the mantra that their capital must be invested into “Anything but Equities” and that they must instead seek non-equity, “Alternative Investments” as a place to store their hard-earned capital.
Of course, the most highly publicized of these new “Alternative Investments” was cryptocurrency.
We can clearly remember watching the commercials during the Super Bowl back in January of 2000 when it seemed every other commercial was for a fledgling dot.com company, pointing out how badly we were missing out for not placing 100% of our investment assets into New Economy stocks. Although we didn’t know it then, those Super Bowl commercials were the way of the “market gods” telling the world that the dot.com investing euphoria was about to end.
We had the same feeling during the 2022 Super Bowl when all those celebrities and athletes came on TV to tell us how we were missing out. When actor Matt Damon lectured us that “Fortune Favors the Brave” who are willing to dive headfirst into the next chapter of history by investing in cryptocurrency, it seemed clear that the jig was up for crypto.
This month it came as no surprise when a celebrity crypto “genius,” who was touted by Fortune magazine as “The Next Warren Buffett,” watched his net worth dwindle from an estimated $26 Billion to $0.00, and that he now faces spending time in jail for a variety of charges.
In our view, cryptocurrency was never an investment; it was always simply speculation. An investment is something that produces an economic result, thereby producing an economic return. Stocks, bonds, real estate, and your local Starbucks franchise are investments. Crypto was never an investment in this way; it was never anything but speculation.
For some reason, the more comical the speculation became, the more people wanted in on it. It seems almost too obvious that this mania would end in disgrace when one considers that people were investing real money in tokens with pictures of dogs on them and virtual real estate that only existed in the “Metaverse.”
Cryptocurrency may ultimately disappear altogether, but then again, it may not – it could rise from the ashes in a more grown-up way, just as dot.com did. In the meantime, it’s a good bet that the investor who listened to Matt Damon and “bravely” put money in Bitcoin will be underwater for quite some time. All the while, us equity market fossils will plod along, earning our returns by Doing Nothing.
Lesson #3: Beware of Investing Fads
Cryptocurrency wasn’t the only investing fad that turned to disaster over this period. There were other “sure-fire” investment trends that everyone knew would grow to the sky as society was revolutionized – until they didn’t.
Facebook, Amazon, Apple, Netflix, and Google were a handful of gigantic technology companies that investors loved so much that they earned their own acronym: the FAANGs. These stocks were regarded as immune from the pandemic’s economic shutdown, they could only go up, and there was no price too high to pay for them. Until their stocks got crushed this year.
Then there were the “Work from Home” stocks, which became popular when everyone began to assume a permanent state in which we would all be in Zoom meetings all day forever while peddling furiously on our Peloton cycles and getting all our food and groceries delivered by Amazon and Door Dash. The pandemic ended, and these stocks have likewise been crushed.
Then there is ARK Invest, the new age investment fund which achieved national celebrity by chasing every investing fad of these last five years and calling that investing in “innovation,” or “disruption,” or whatever buzzword was currently in fashion. Although the fund is down as much as 80% peak-to-trough, its founder still gets quoted every day in the financial media.
The fallout of these fads gives serious investors yet another reason to double down on the boring yet effective practice of investing in a diverse portfolio of great American companies and doing nothing over a long period of time. Of course, fads will inevitably break out again someday, thanks to the American Investor’s fascination with the next “shiny ball.” When they do, we recommend not believing the hype.
Lesson #4: Turn off the TV
It is helpful to understand the true nature of the financial media to gain a proper perspective on how it will affect your investing success. The financial media is in the business of advertising, pure and simple. Financial media companies make more money when they sell more advertising, and they sell more advertising when someone watches or clicks on their content.
More importantly, we must always understand that the financial media has no incentive to help us invest better or more successfully.
These companies sell more advertising when they produce content covering the exact kind of investing fads we just discussed and the “celebrities” who appear to be riding them. The average American investor loves to read the latest story about the “30-year-old crypto billionaire” who is about to dethrone Warren Buffett as the world’s greatest investor.
They also sell more advertising when they frighten people into watching their portfolios every minute of the day and convince them that they need to “Do Something” to avoid the next leg down in equity prices. In a decline such as this year’s, not a day goes by without CNBC quoting some pundit as saying the market has still lower to go, and you better act now before it is too late.
The financial media cannot allow you, even for a moment, to take a long-term perspective. Because if you do, you may stop watching/clicking on it.
Lately, it does seem that journalism’s most devious features — fad idolatry alternating with hysterical fearmongering — have become even worse since the pandemic began. The financial media has always been the most dangerous enemy of your long-term investing success, and in our opinion, there has never been a period in your investing life when you must be more wary of your enemy’s seductive siren songs.
An Outlook for the New Year
Most money managers and investing pundits typically include a “New Year Outlook” as part of their year-end letter to investors, in which they make predictions about how the markets will behave in the coming year. We find this exercise to be a waste of time and a great way to make a fool of oneself. As we have suggested before, there are no facts about the future, and we regard it as arrogant to suggest otherwise.
However, we do think it is worthwhile to make the following observations about the current situation.
Just before the S&P 500 bottomed out in March 2009, a famous investor named Jeremy Grantham was quoted as saying, “Be aware that the market does not turn when it sees the light at the end of the tunnel. It turns when all looks black, but just a shade less black than the day before.”
On Thursday morning, October 13th, the S&P 500 opened trading on a down note, declining to its lowest level of 2020. Then suddenly, the market experienced a massive rally and ended trading up 2.6% for the day. This “Intra Day Reversal” was the 5th largest such rally in the history of the S&P 500. The reason for this big day for equities is that there was an inflation report published that appeared to be just a tiny bit better than expected. In fact, it was just “a shade less black.”
Since that day, the S&P 500 has continued to rise and is up roughly another 9%.
That’s how a turn in equity prices always happens – when things still look bad but just a tiny bit better than they looked yesterday. And the worse things looked yesterday, and the more widespread investor pessimism was just prior to the “shade less black” day, the more explosive the turn will be.
We are, of course, not predicting that this market rally was the inflection point that would signify the beginning of a new bull market. Only time will tell, and we will only know that in retrospect. However, that also means that by the time we can be sure, the market will already have gone up much more than it has so far.
Maybe a recession is still looming out there and will cause another serious decline in equity prices. And maybe that means that the bottom, when it inevitably comes, will be from even lower lows. But when the bottom comes, this period of October 13 to today is what it will look like. Keep in mind that back in March of 2009, when it seemed only faintly possible that green shoots were developing in the world economy, the equity market doubled in a year and never again looked back.
Equity prices tend to behave like a rubber band: the deeper the market declines, the more violently it will snap back. Thus, the long-term investor holding a meaningful cash position in the hope of investing at lower prices is taking a risk that we could never accept. We are much too conservative to make a big bet like that.