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2020 Annual Letter from Brad Thumbnail

2020 Annual Letter from Brad

This time of the year often brings nostalgia as I prepare for holiday celebrations with family and friends and reminisce about events over the past year.  It also gets me thinking forward to my goals and aspirations for the new year.  Feeling nostalgic and celebratory does not seem fitting this year because it was a year with many trials and tribulations, sorrow and sadness and uncertainty for many.  But, this should not stop us from taking the opportunity to look back at all that has transpired to validate our beliefs and gather some life-long learning lessons that can significantly benefit all of us moving forward if we can apply them correctly. Some of these lessons can be applied to investing and, if we apply all that we learned in 2020 we will be very successful as investors for the rest of our lives.

Let’s begin by taking a walk down Memory Lane.

On February 19, 2020, the S&P 500 closed at a record $3,386.15. Gripped suddenly by the uncertainty of the COVID-19 virus, the S&P 500 fell from its all-time high to close in bear market territory in just 16 trading days on March 12th. This was the fastest decline into bear market territory in history!  The S&P 500 continued its downward spiral until March 23rd when it hit the bottom at $2,237.40, down 34%.  In just 33 days the S&P 500 went from peak-to-trough.

This decline was immediately followed by the best 50 days in the history of the U.S. equity market. Ever. On June 8th 2020, the S&P 500 closed in positive territory for the year. Meanwhile, a globally diversified portfolio continued to post negative returns year to date leading people to ask the great question “should I just put all of my money in the S&P 500?”  This inquiry led us to want to understand why the S&P 500 was performing so well while the uncertainty surrounding the Coronavirus remained and the rest of the market indices continued to post negative returns.

As we unpacked the remarkable journey of the S&P 500, we discovered that a few large companies were driving all the performance in that index. The “Big 5”, as they were affectionately named, consist of Apple, Amazon, Microsoft, Facebook and Alphabet/Google were thriving during the pandemic. Driven by worldwide stay at home orders to fight the spread of Coronavirus, people found themselves at the mercy of the tech giants in their “new normal” work from home (WFH) circumstance.  Because the S&P 500 is a market cap weighted index, the “Big 5” companies now made up 25% of the S&P 500 index.  More importantly, these 5 companies posted a +49% return collectively!  These are eye popping numbers!  Meanwhile, the remaining 495 companies in the index had negative returns for the year.  The pandemic caused a real chasm between winners and losers and created the very real temptation to go “chasing” after this year’s hot performers.

As summer waned and the fall approached the winds of change were blowing and a rotation began to happen. Since early September there have been a series of rotations into other areas of the market outside of the “Big 5”.  We’ve seen shifts from growth stocks to value stocks, from large-cap to small-cap, from defensives to cyclicals, from stay-at-home stocks to get-out-and-about stocks, and from leaders to laggards. Looking ahead, we expect rotations will continue to come in fits and starts, largely driven by virus-related news about economic activity.

We headed into November with the nation focused on the Presidential election.  People from both sides of the political spectrum were weighing in on the effects on the market if the person of the opposite political party won.  Once again, fear and uncertainty gripped the nation and the markets as November 3rd approached.  The election was very unusual for many reasons. After a bitter battle followed by more uncertainty and an outcome that just now officially concluded, one might think this would negatively affect the equity markets. But not so!  November turned out to be the third best November in the history of stock market investing!! Had someone gone to cash in late October to prepare or protect against the election results, they would have missed an incredible month of growth.  This would have had devastating consequences on one’s long-term financial planning and investing. As we shared earlier this year, if an investor misses the best 25 days in a 30-year period, their long term returns are slashed in half and their chances of not outliving their money are significantly reduced.  Trying to time the market doesn’t work and we watched that play out multiple times in 2020.

Looking ahead to 2021

We see several important trends playing out now and into next year.  Small cap stocks (small companies) just had the best November in history, up 18.4%.  Typically, small caps lead coming out of recession so their performance in November should not come as a surprise, although it exceeded expectations.  Historically, small cap stocks have outperformed their large cap counterparts, however, over the last three to five years small caps have lagged, especially small cap value.  Extended periods of underperformance can often be followed by similar periods of outperformance.

The same can be said for value stocks which have underperformed for a decade against the high- flying growth companies.  Historically, value companies tend to outperform growth companies.  The last decade has been frustrating for the patient, disciplined value investors out there.  We may be seeing that trend reverse as well. While it’s too early to make a definitive call, value companies have outperformed growth companies for the last three months.  At some point this trend will intensify as growth and value continue the rotation.

Lessons Learned from 2020

I would like to summarize by recapping the most important lessons learned from 2020 that, if applied correctly, will lead to a long term, superior investment experience:

  • You can’t predict the future or even pretend to know what is going to happen down the road.  Nobody would have predicted the Covid-19 virus would take the world by storm this time last year.  Trying to make investment policy out of predictions is a fool’s game.
  • You can’t time the markets.  They move too fast. Information changes hands at such a fast rate that it is impossible to try and time the markets. Anyone who went to cash in the first half of the year is seriously regretting it today.  We will never, ever go to cash and you shouldn’t either. It’s a recipe for disaster! You have to get it right twice! When do you get out and when do you get back in?  Nobody has proven to be able to consistently time the markets.
  • Presidential election cycles don’t matter as much as we would like to think they do on our investments.  The market and the economy are bigger than one person and one party.  Trying to make investment decisions based on political outcomes is not a good investment strategy.  Trying to time the market based on political cycles is even worse!
  • Don’t try and pick individual stocks. Trying to pick individual stocks is dangerous, risky and not worth attempting. If we were to ask you which 5 stocks would have a cumulative return of 49% midway through the year and your financial well-being came down to your ability to choose the 5 “winners” this is akin to Russian Roulette with your retirement savings at stake.  You are far better simply owning the entire index knowing that somewhere in your basket of securities you will own the serious winners who will perform well enough to make the entire index meet and exceed the returns you need to make your financial plan come to life.
  • Make sure you have enough money in reserve for emergencies.  It’s important to have enough money in safe investments so you can maintain your lifestyle during times of market declines, preventing you from selling shares of wonderful investments at fire sale prices. In other words, have enough money in cash in the bank or high-quality bonds in your investment portfolio to be able to withdraw from the asset classes during times of market volatility and decline.  This will give you enough time to allow your wonderful equity investments to recover and thus weather the storm.
  • Volatility is your friend!  Plan on the stock market going down temporarily about 14% per year and 30% every 5 years.  This is normal and in fact, this is exactly what the stock market has done for about the last 80 years.  If you uncomfortable with this type of behavior you probably shouldn’t invest. Or at least, make sure to hire a competent advisor as your guide to help you navigate through the uncertainty and scariness of it all.  It’s because of this volatility that equity investors enjoy the wonderful returns that we do.  We demand good, long-term returns in exchange for the volatility and uncertainty in the short-term.
  • Have faith in the future.  If I were to tell you on March 23rd (the market bottom) to invest all your cash into the stock market you probably would have thought I was crazy!  But, keep in mind that you are investing in wonderful companies, run by very smart people who make it their business to figure out how to get through any situation and return a profit to their shareholders.  History has shown us that mankind is very resilient and full of ingenuity. We continue to solve some of the most daunting problems thrown at us and this will not change in the future.  Have some faith!
  • Make sure to be disciplined about your rebalancing. If I were to tell you to go “all in” on the stock market on March 23rd, you would have thought I was crazy again!  It was at that moment in time where our stock to bond ratio was out of balance enough to warrant selling out of bonds (they had gone up during the stock market decline and thus you were “selling high”) and buying into stocks (they had gone down and enabled you to “buy low”).  It’s funny, but stock market investing is the only place in the world where a wonderful thing goes on a 30%-40% discount and people actually want to sell rather than buy! If I had offered you a home to purchase in North County San Diego at a 35% discount I would have people knocking down my door to purchase it.  It’s time to reframe the way we look at volatility and rebalancing.

As in anything in life, some of these lessons have been learned the hard way through blood, sweat and tears.  If you have succumbed to some of the temptations that 2020 presented, please don’t feel bad. You are not alone.  Whether it was trying to time the market, buying individual stocks, chasing the hot performers, investing with your politics, or trying to read the tea leaves from Fed and Washington policy- it’s okay.  The good news is we can learn from all of this and apply it towards the actions we take (or don’t take) in the future.  All of this will make us better investors and people. 

The end of the year is a time to pause, reflect and give thanks for all that we are grateful for.  I am grateful for my family, the excellent team that I get to work with everyday and the wonderful people I am privileged to guide and serve on their life journey.  And yes- I am even grateful for the wild and crazy year that 2020 was because I plan to harness these lessons to help many people have a wonderful future.  Thank you for your business and for the trust that you place in our team at Seaside.  Here’s to an outstanding and prosperous 2021!