The more things stay the same, the more they change
January 17, 2020
Market Summary – 4th Quarter, 2019
“That men do not learn very much from the lessons of history is the most important of all the lessons of history.”
– Aldous Huxley, author, Brave New World
It is said that history is written by the winners. This may be true of traditional, geopolitical history, but with investment markets, history tends to be aligned with objective data and is less subject to interpretation. Nevertheless, investors make their own judgments based on their own understanding of the past. Those judgments often influence future investment decisions.
There is a tendency among some investors to conclude that the experiences of recent years will carry forward for an indefinite period of time. Yet it can be a mistake to consider short-term performance characteristics to be a reliable guide to long-term investment strategies. Just as we counsel investors to be patient and maintain a long-term view, the same is true when interpreting the lessons of investment history. Markets aren’t static. Just when you are convinced things are going to “stay the same,” a significant change in the environment may be just around the corner.
The bad habits of the 2010s
The end of a decade is a time to look back at what has transpired. Many will see it as an opportunity to reflect upon their long-term expectations of equities.
Before drawing any conclusions, let’s remember that the 2010s were the first decade in history that the U.S. economy expanded without suffering through a recession1. Investors can’t be blamed if they feel like most of the past ten years played like a broken record. The bull market continued throughout the decade, interest rates started low and generally stayed that way, and the biggest and most popular stocks just kept getting bigger and more popular.
In this kind of environment, investors could get away with many bad habits that have historically proven to be costly. While it was certainly a prosperous decade, the markets positively reinforced bad habits over this 10 year period.
How likely is it that the success experienced will persist going forward despite practicing these bad habits? Count us among the skeptical. History, as we explain below, tells us that the dominant themes of one decade typically fail to carry over to the next.
The Perceived “Lessons”/Bad Habits from 2010s:
- Assume that interest rates always go lower
- Take comfort in popularity and follow the crowd
- Invest only in big, dominant companies. The bigger, the better
- Pay more attention to future earnings rather than current debt
- Give more credence to headlines rather than fundamentals
- Make life simple and invest in an index
- Don’t overthink. Judgment is overrated as part of the investment process
Extrapolate experiences of the recent past into the indefinite future
- Instead of buy low and sell high, focus on buying high and selling higher
- Expect double-digit returns from the stock market year-after-year
We’re reminded of a quote from President John F. Kennedy that seems particularly appropriate given the track record of the last ten years. While promoting his proposed tax cuts designed to boost the economy, Kennedy stated, “a rising tide lifts all boats.” That theme applied to equity investors in the past decade, regardless of their capabilities.
But a word of warning – the “rising tide” that allowed judgment-free investing to succeed over much of the 2010s may soon be a thing of the past. We’re of the belief that the dominant investment trends of recent years will prove to be transient in nature. Markets tend to be “un-kindred” spirits moving across decades, and may be poised for a more discriminating era.
History shows that certain strategies that were popular in one decade can turn around and destroy wealth in the next. Investors are most susceptible when the exuberance of a particular stretch in the stock market overshadows the increasing risk that lies just under the surface. This is a lesson we hope you never have to experience in order to appreciate.
Consider what we’ve learned from previous decades:
On the heels of a “guns and butter” fiscal policy of the 1960s (significant spending on both the Vietnam War and expensive domestic programs) and the emergence of OPEC as a controller of oil flows, inflation reared its ugly head in a big way. The American economy was in turmoil for much of the decade. Newsweek magazine ran its famous cover story, “The Death of Equities.”
The Perceived “Lessons”: Invest in real assets that can keep pace with inflation and put money into money market accounts that benefit from high interest rates. Stocks are “dead.”
The Actual Aftermath: Tangible assets like real estate took a dive by the mid-1980s. Interest rates, after peaking in the early 1980s, began a downturn that lasted 35+ years. In the meantime, stocks were on the verge of a more than 400%2 gain in the 1980s.
After the late Paul Volcker, as Chairman of the Federal Reserve, helped lick inflation, tax cuts and deregulation from the Reagan administration gave stocks a boost, with mid-caps performing particularly well. But the record-setting stock market crash of 1987 left a lasting impression on many. Japan seemed on course to own a good chunk of America and emerge as the top economic power in the world.
The Perceived “Lessons”: Don’t trust the stock market just yet. Remember October 1987. Be especially fearful of what might happen at that time of year. America is losing ground to Japan and the economic future looks cloudy.
The Actual Aftermath: The U.S. economy was on the verge of one of its biggest boom periods in history. In the 1990s, the U.S. economy grew rapidly, with median GDP growth of 4 percent per year from 1994-19993. The Dow Jones grew by four times. Over the decade the once red hot (and popular), Japan Nikkei 225 Index lost half of its value.
After a brief recession in the early part of the decade, the economy took off. The emergence of the Internet fueled a boom in technology stocks. Markets soared, with large-cap stocks dominating.
The Perceived “Lessons”: “Everything has changed,” was the mantra, with a belief that the economy had become recession-proof. Valuation didn’t matter. It was all about “eyeballs” and “clicks” on Internet websites that represented real value. Just buy the hottest stocks and ride the wave upward. And by the way, home prices will never go down.
The Actual Aftermath: America was drunk on the “irrational exuberance” of the 1990s. The hangover began quickly, as by early 2000 the economy began the first of two recessions it would experience in the “oughts.” From 2000-2002 and again from 2007-2009, the stock market suffered declines in the 50% range. The S&P 500 lost ground over the next ten years, and didn’t sustainably exceed its all-time highs for until early 2013.
America suffered through two recessions and two significant market downturns, each close to a 50% drop. The housing market crashed. Before the decade was over, some feared that capitalism, as we knew it, was on its last legs.
The Perceived “Lessons”: Stocks may be too risky, particularly for older investors. Expect only modest returns on stocks going forward. The future of the U.S. economy seems shaky. All of this represents the “new normal.”
The Actual Aftermath: It turned into another big decade for stocks, as a bull market and recession-free economy persisted throughout the period.
As the track records of past decades prove, the more immediate “lessons” of the market do not provide reliable guidance for long-term investors. The reality is that most of the trends that drove previous decades have come and gone. Any investment lessons derived from those trends potentially sent investors in the wrong direction. The reason is simple – in most cases, what worked so well over a period of years ultimately became overvalued, regardless of the type of asset that benefited from favorable trends over the short term.
While we shouldn’t ignore the experience of recent years, we also realize that markets move in cycles, and underlying fundamental factors ultimately rule the day.
Successful investors appreciate that long-term wealth creation involves not just achieving gains, but more importantly, avoiding large losses. The fact that many investors today are dismissing the second part of this equation should give astute investors a reason to pause.
In some ways, our newsletters over the past year accurately reflected the kind of trends we saw dominating the market in the past decade:
1st Quarter – “March Madness and the Dow”
We took on the distorted performance of the major market indices. As money flowed into index funds and the biggest stocks, these indices became top-heavy (a trend that continues to this day). We noted at that time that the top 10 stocks in the S&P 500, just 1/50th of the index in terms of the number of stocks, represented fully 20% of its value. That was in March. By year’s end, their value had grown to 22.7%4. While the big stocks kept getting bigger, their inflated prices also made them riskier. We pointed out that value stocks may have experienced lagging performance by comparison, but still generated substantial returns. Value stocks rewarded investors without burdening them with the risk carried by the popular stocks of the day. We believe that value investors were better prepared to preserve wealth at a point when the market changes, as it inevitably will.
2nd Quarter – “Be Wary When Everyone is on the Same Side of the Boat”
One of the big stories of the past decade was the incredible popularity (and performance) of the so-called FAANG stocks (Facebook, Amazon, Apple, Netflix, Google). Add Microsoft to that list, and a large part of the overall market’s success can be attributed to these six stocks. As a result, we saw this as a crowded trade. We noted that in the past, other successful companies reached price levels that were unrealistic, and ultimately investors paid the price. Cisco was a prime example. It’s a business that has grown tremendously since it reached its peak stock price in 2000. But Cisco’s stock price remains far below its peak nearly 20 years later. Its experience demonstrated how the top-heavy nature of the market created compelling and overlooked opportunities away from the high-flying stocks of the day. Valuations matter (a beneficial, long-term lesson) and crowded trades can flip quickly. Things don’t stay the same forever. Overvalued stocks almost always decline, setting investors up for significant and permanent losses.
3rd Quarter – “How Do You Sleep at Night?”
We focused on how headline-driven events could impact stocks, for good or for bad. Fundamentals are easily overwhelmed by flashy headlines, particularly those of a negative nature. We pointed out how many investors feel comfortable because the indices and popular stocks in which they choose to invest continue to rise. Unfortunately, we also noted that many investors have been lulled into thinking that there is little risk in these investments.
We’ve learned time-and-again that certain sectors or stocks can’t rise indefinitely without earnings to match those gains. A prime example we noted was that three of the four largest stocks in the year 2000, the most popular stocks of their day (Citigroup, GE, Pfizer), proceeded to lose significant value in the next two decades. Investors should not find comfort in owning what’s popular, but by investing in tremendous, sustainable businesses with great growth prospects. The “unpopularity” of stocks like these make them incredibly inexpensive and, in our judgment, less risky than the broader market.
Fortunes will be made over the next decade, but not by all
We at MPMG are as excited about what the next decade holds for investors as we have ever been. Given the technological advancements we’ve seen in recent years and those on the horizon, life in 2030 may be dramatically better than it is today.
Human innovation will respond to critical challenges, such as clean energy solutions to address environmental concerns, or health care advancements to meet the needs of an aging population. Stories like the recent report of a dramatic drop in the death rate from cancer5 are a sign of things to come. We can expect numerous new developments stemming from 5G technology for communications, and the preponderance of smart devices that enhance many of the basic functions of daily living.
As these and other new developments on our radar emerge, fortunes will be made by savvy investors. There is every opportunity for investors to succeed going forward, but it will likely require more diligent scrutiny than the previous decade.
As we noted earlier, the most prominent beneficiaries of the market’s return in 2019 were a narrow group of stocks. Close to half of the S&P 500’s 30%+ return was generated by just two mega-cap stocks – Apple and Microsoft.6 The remaining 498 stocks are responsible for the other half of the return. Apple and Microsoft won’t be the only companies to benefit from future growth, and they are clearly among the more expensive and popular stocks to own at current levels. Investors who continue to chase the same “winners” will take on significantly more risk by doing so, and we believe will ultimately be disappointed by the results.
Successful investing isn’t about capturing momentum and looking to make a quick buck. If that were our approach, our logo would not be the plodding, but determined, tortoise. Rather, it would be the cheetah, the fastest land animal over short distances, but one that relies on a quick strike and isn’t made to come out victorious if the chase drags out.
The simple, but flawed, strategies that worked in recent years (as outlined above) are not likely to enjoy a repeat performance. Investors who continue to practice the bad habits of the recent past, rather than focus on proven fundamental investment principals that have worked across decades, and navigated good and bad market cycles, could easily miss out on the tremendous opportunities that lie in our future. Despite the wonderful innovations that will unveil themselves over the next decade, investors’ success or failure will largely be dependent upon the lessons they choose to follow.
The point of investing is to both accumulate and preserve wealth. This is a long-term proposition that can often be obscured by decade long fads. If history is going to be a guide to your investment approach (as it should) we vote to base our decisions on investment lessons that have stood the test of time. The fundamentals of investing and long-term wealth creation that have existed for decades remain applicable today. Those are at the core of our investment philosophy and process, and we have every confidence that this approach will continue to reward our investors.
While it may appear as if the rules for successful investing will stay the same from the last decade to the next, the reality is they will most likely change.
1 Source: cnbc.com, “For the first time in history, the US economy has started and ended a decade without a recession,” Dec. 19, 2019.
2 S&P 500 Total Return
3 Bureau of Economic Analysis, Gross Domestic Product Percent Change from Preceding Period
4 Source: Standard & Poor’s, S&P 500 Fact Sheet, Dec. 31, 2019.
5 Sheikh, Knvul, “Cancer Death Rate in U.S. Sees Sharpest One-Year Drop,” New York Times, Jan. 8, 2020.
6 Li, Yun, “Apple and Microsoft contributed the most to the market’s big year and no other stocks were close,” CNBC.com, Dec. 31, 2019.
Established in 1995, Minneapolis Portfolio Management Group, LLC actively manages separate accounts for individuals, families, trusts, retirement funds, and institutions. Our proven value-oriented investment philosophy has created long-term wealth for our clients.
Visit our website at: www.MPMGLLC.com
Although the information in this document has been carefully prepared and is believed to be accurate as of the date of publication, it has not been independently verified as to its accuracy or completeness. Information and data included in this document are subject to change based on market and other condition. All prices mentioned above are as of the close of business on the last day of the quarter unless otherwise noted. Market returns discussed in this letter are total returns (including reinvestment of dividends) unless otherwise noted.
The information in this document should not be considered a recommendation to purchase any particular security. There is no assurance that any of the securities noted will be in, or remain in, an account portfolio at the time you receive this document. It should not be assumed that any of the holdings discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable. The past performance of investments made by MPMG does not guarantee the success of MPMG’s future investments. As with any investment, there can be no assurance that MPMG’s investment objective will be achieved or that an investor will not lose a portion or all of its investment.