2020 was certainly a year to remember. One popular meme on New Years said, “I’m going to stay up on New Year’s Eve this year. Not to see the new year in, but to make sure this one leaves.” Like the writer, many are breathing a sigh of relief that 2020 is over. We will all have stories for years to come.
2020 Hindsights
I spent much of the year trying to prevent investors from destroying their portfolios by bailing out when things looked bleak. I have to say that I am proud of our clients. As a group, they stayed disciplined and remembered the education we brought them through.
Despite what you’re hearing about market returns, money bled out of stocks at the market lows—and many missed the recovery. You have to be in the market to experience the returns.
Dangers Ahead
Still, I think some of the greatest dangers could be ahead for investors. It’s very tempting at times like this to abandon diversification, but these are the worst times to focus on a single area of the market.
You will hear from the media that “the market” had a great year. While nearly every asset class is up, only one class was up nearly 20%—and that was large US stocks (the S&P 500). A few other market segments went up over 10%. Many “only” went up in single digits for the year and just two went down. It’s almost amazing to me that anything went up at all after a year like this.
The temptation for investors to chase the returns of those big companies is two-fold. First, they just had a good run in recent years and second, they are also the most recognizable stocks out there. That is why big investment firms and their sales force tend to overweight them in their mixes.
You need to be careful that large US stocks are not over-weighted in your portfolio. In fact, the numbers right now are eye-opening.
While the S&P 500 went up 18.4%, a diversified portfolio of stocks was up a little over 3%.
After the S&P 500 and Small US stocks, most asset classes that a diversified portfolio should own didn’t have amazing returns. Most were under 5% and international value was even negative on the year.
Big US stocks benefited from a global pandemic since many people had to work from home, shop from home, avoid crowds, etc. As you’ve heard me say, no doubt, the biggest winners were tech companies (Microsoft, Apple, Amazon, Google (Alphabet, Inc.), Facebook…).
However, since the vaccine and election confirmation (November 11th), there has been a big change:
Here’s the 4th quarter returns for the major asset classes:
| Index | Market Area | 2020 Q4 |
| S&P 500 | Large US | 12.1 |
| Russell 1000 Value | Large US value | 16.2 |
| Russell 2000 | Small US | 31.3 |
| Russell 2000 Value | Small US value | 33.3 |
| MSCI EAFE | Large International | 16.0 |
| MSCI EAFE small | Small international | 17.3 |
| MSCI EAFE Small Value | Small international value | 19.8 |
| MSCI EAFE Value | Large International value | 19.2 |
And if you look at just November and December, it’s an even bigger difference. The S&P 500 was up 7% while small value was up 22% and international large value up 18%, for instance.
As you can see, large US stocks are the lowest performing area of the market for the end of the year.
Don’t let market moves move you. We invest for the long haul. If you look at twenty-year returns, large US stocks are tenth out of twelve asset classes.
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Market Prices
What should also catch your attention is the price data on these market segments.
In our initial workshop we teach about value stocks. While growth has outperformed value recently, keep in mind that the research shows that value outperforms growth in 95% of twenty-year periods in history.
Value stocks are things like “we buy ugly houses.” Ugly houses can make good investments because you can buy them cheaply and sell them for a profit. Of course, there is more risk involved in this strategy. The same is true for “ugly companies.” Value companies are ugly companies because they are seen as weaker than other companies and therefore sell for a lower price.
Because of their lower price, research has shown that value companies have historically had higher long-term returns. Adding value stocks also tends to reduce long term risk since they don’t move in lock-step with growth stocks.
Lesson? The recent dissimilar returns of growth and value stocks is completely normal and even desirable. If two investments always move together, then one isn’t needed.
Okay back to current prices.
According to our Direct Investment tracking software, the S&P 500 is selling for over two times the price of the next highest priced asset class (small US) and over five times the price of small international value stocks in terms of their price to book ratio.
Is that a guarantee that it will continue to underperform in the future? You know that we don’t try to predict the future. If we knew that, we wouldn’t hold any large US stocks right now. However, it should give investors some pause.
We analyze a lot of portfolios and see a tremendous concentration in those big US stocks right now. It reminds me too much of the late 90s tech bubble. In fact, I’ve been hearing that from many other market commentators. If those numbers aren’t shocking enough, the Vanguard Growth Index fund holds stocks that average over double the price of the S&P 500.
We wouldn’t dream of running to a store to buy clothing because the retailer just recently raised prices. So why do we do that with stocks?
Again, we know past performance isn’t helpful in choosing our investments, but it instinctively feels so good. Our job is to help you overcome the instincts and emotions (greed and fear being the big ones) that can cause investors to make bad decisions.
If you have a 401(k) or similar work plan, it is a good time to reallocate it. Employer plans often don’t have very good value or small company options, but we need to make sure they aren’t overly concentrated in those bigger companies. As I always say, “trees don’t grow to heaven.”
Don’t Ignore Risk
As investors, it’s easy to get overly focused on short term returns and forget about risks. While I talked about market risk above, another type of risk shows its ugly head when taking an income from an investment portfolio. It’s called “sequence of returns risk.”
Remember there are two stages in life: first, you work for money, then money works for you. You save income today so that you can live off those dollars in the future. A properly designed investment portfolio can create a replacement for your work income with income and returns generated by your investments.
When you take an income from investments that include stocks, you have to be conscious of the fact that stock markets go up and down. When they go up, everything is fine. When they go down, you might be forced to sell some stock at lower prices. We can protect against this by holding some high-quality bonds (see my book, Confident Investing), but we also have to think about better diversification with stocks. If all of the funds move together, you could end up with far less income—even with a portfolio with higher returns.
This is another reason why it’s critical to be diversified right now. If you’re not a client of ours yet and you’re not sure if you’re diversified, schedule a call with an advisor and they can talk you through how to check your diversification and how to get on the right track.
May you have a happy and prosperous 2021!!
By Paul Winkler
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*Advisory services offered through Paul Winkler, Inc. (‘PWI’), an investment advisor registered with the State of Tennessee. PWI does not provide tax or legal advice: please consult your tax or legal advisor regarding your particular situation. This information is provided for informational purposes only and should not be construed to be a solicitation for the purchase of sale of any securities. Information we provide on our website, and in our publications and social media, does not constitute a solicitation or offer to sell securities or investment advisory services, or a solicitation to buy or an offer to sell a security to any person in any jurisdiction where such offer, solicitation, purchase, or sale would be unlawful under the securities laws of such jurisdiction.
References:
MSCI EAFE NR USD
This Europe, Australasia, and Far East index is a market-capitalization-weighted index of 21 non-U.S., industrialized country indexes. This disclosure applies to all MSCI indices: Certain information included herein is derived by Morningstar in part from MSCI’s Index Constituents (the “Index Data”). However, MSCI has not reviewed any information contained herein and does not endorse or express any opinion such information or analysis. MSCI does not make any express or implied warranties, representations or guarantees concerning the Index Data or any information or data derived therefrom, and in no event will MSCI have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) relating to any use of this information.
Russell 2000 TR USD
Consists of the 2000 smallest companies in the Russell 3000 Index. The constituents displayed for this index are from the following proxy: iShares Russell 2000 ETF.
Russell 1000 Value TR USD
Tracks the companies within the Russell 1000 with lower price-to-book ratios and lower forecasted growth values. The constituents displayed for this index are from the following proxy: iShares Russell 1000 Value ETF.
MSCI EAFE Value GR USD
The constituents displayed for this index are from the following proxy: iShares MSCI EAFE Value ETF.
S&P 500 TR USD
A market capitalization-weighted index composed of the 500 most widely held stocks whose assets and/or revenues are based in the US; it’s often used as a proxy for the U.S. stock market. TR (Total Return) indexes include daily reinvestment of dividends. The constituents displayed for this index are from the following proxy: SPDR® S&P 500 ETF Trust
Source: Morningstar
Fee and Expense Information
1. Market Indices – Investors cannot invest in a market index directly, the performance of an index does not represent any actual transactions and its performance does not reflect the deduction of any fees or expenses associated with actual investing. Market performance information is included in this presentation solely to demonstrate the potential benefits historically associated with diversification of asset classes and does not represent or suggest results Paul Winkler, Inc. would or may have achieved when managing client portfolios.
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS
All investing involves risk and costs. Your adviser can provide you with more information about the risks and costs associated with specific programs. No investment strategy (including asset allocation and diversification strategies) can ensure peace of mind, guarantee profit, or protect against loss.
