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First Quarter 2021 Newsletter

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First Quarter 2021 Newsletter

By: Sarah K. Charles, CSRIC™, AIF® / Director and Bill Laird, CFA®, CFP® / Co-Chief Investment Officer

A 21st Century Siren Song - Sarah K. Charles

In 1720, London’s stock market was roaring – and South Sea Company was the name everyone was talking about. Sir Isaac Newton, who was modestly wealthy at the time, and normally a cautious investor who preferred the safety of government bonds, decided to invest.   The story goes that after realizing some early gains, Newton cashed out. But shares in South Sea continued to climb, increasing eightfold in eight months, and so Newton sold most of his bonds and re-invested heavily in South Sea Company in the hopes of making even more money than he had already made. The story does not end well. Newton re-invested towards the very top and within several months South Sea Company crashed and Newton’s fortune was wiped out.

The thrill of big returns and getting rich quick is nothing new, and frankly – it can be tempting. 

Between December 2020 and February 2021 Bitcoin doubled in value.  Imagine doubling your money in three months. Or what about the day trader who turned a $50,000 investment in GameStop into $40 million?  Then there is Beeple’s non-fungible token (NFT) which sold for a record-setting $69.3 million. (By the way if you don’t understand NFTs – you’re not alone. Although Saturday Night Live tries to explain them here). And how could we leave out SPACs? The blank check company craze is generating plenty of buzzy headlines with celebrities like Colin Kapernick, A-Rod and Ciara jumping on board. I can invest like a celebrity? Sign me up.

Stories like these seem to be everywhere these days. But the problem, is they aren’t investment strategies designed to build long-term wealth.  They are 21st Sirens enchanting investors to veer off their long-term course with the lure of short-term, sky-high gains.  And there’s no doubt it can be a tantalizing tune. But according to Greek mythology, it did not end well for the sailors who fell prey to the sweet song of the Sirens. And as we saw with the South Sea Company, it didn’t work out so well for the man who discovered gravity either.

In 1970, psychologist Walter Mischel and his colleagues conducted one of the most famous social science experiments of all time: the Stanford Marshmallow Experiment.   A group of pre-school age children were each presented with one marshmallow. They then had two options.  If a child wanted to eat their marshmallow, they could ring a bell at any time, and one of the doctors conducting the experiment would come in and the child could then eat the marshmallow. However, if a child could wait until one of the scientists returned on their own (usually every 15 minutes), they were given an additional marshmallow. 

The Stanford Marshmallow Experiment was a study in delayed gratification, and in subsequent studies conducted in the decades following the original research, Mischel found that those children who had been willing to delay eating the marshmallow, grew up to have better life outcomes including higher SAT scores, lower body mass indexes, greater self-esteem, and a greater capacity to cope with stress as adults.  

The results are not that surprising. Instant gratification is rooted in our tendency to seek pleasure while avoiding pain – or what Sigmund Freud labeled “the Pleasure Principle.” It’s what drives us to grab a handful of potato chips instead of a handful of carrot sticks. Or to hit snooze instead of getting in that early morning workout.  Or to buy a lottery ticket with the hope of quitting our job and retiring to a private island.

If you go on a crash diet and lose 15 pounds in 3 days (instant gratification), you’re probably not going to keep it off long-term.  In fact, people who take that approach to weight loss often gain it all back and then some, and they can find themselves in the ongoing cycle of yo-yo dieting. But if you approach weight loss with a plan and take a long-term (delayed gratification) disciplined approach, you may not see immediate results, but over time, you will be more likely to achieve your goal – and be able to maintain it. 

Delaying gratification can also be a good tactic for growing and sustaining long-term wealth because wealth in the capital markets builds incrementally and slowly over time.

EXHIBIT 1

Source: Dimensional Fund Advisors

Performance data shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Average annual total returns include reinvestment of dividends and capital gains. Indices are not available for direct investment. All investments may lose money.

As seen in Exhibit 1, over the last 42 years the Russell 3000 has had an average monthly return of 1.07% or an average daily return of 3.5 basis points (0.035%). That’s not headline worthy. No one writes stories when the market is up 3.5 basis points because it’s BORING. The GameStop saga is much more entertaining (and will sell a lot more advertising). And yet, $10,000 invested in the Russell 3000 on January 1st, 1979 would be worth over $1.3mm today. 

That’s not boring. That’s meaningful. It’s also not magic.  It’s common sense.  Over time, successful companies are generating cash flow, growing earnings per share, paying dividends – in short, they are building intrinsic value that will accrue to investors over the long-term. 

Paul Samuelson, who is considered the father of modern economics, famously said: "Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”   But as investors – it can feel like Las Vegas every single day thanks to the media.  Daily headlines are akin to the flashing lights of the slot machines– distracting us and enticing us to play. But I am inclined to agree with Dr. Samuelsson.  When it comes to saving for the future and ensuring that clients have the financial resources they need to live their best life, boring is better in my opinion because it’s not just about the returns. Managing risk is an important part of our role as your advisor. 

Cryptocurrencies have been through 4 price cycles since 2010. And while each one has led to an increase in overall market capitalization, the volatility has been intense.   Back in 2017 Bitcoin skyrocketed from $963 to $19,497 before losing ~ 80% in value the following year. Eighty percent in one year. Ouch.  Now imagine your 401(k) or your kid’s college fund or the money you were saving to buy a new house losing 80% in a single year. In some ways it doesn’t take much.  During last year’s rapid market sell-off the S&P 500 lost over 30% in 30 days and many investors were afraid that the elevator down had no floor. Do you remember how you felt a year ago as an investor?

These days Bitcoin is hovering close to ~ $60,000 after another phenomenal run-up but who knows what comes next. Maybe it keeps going up. Or maybe the price cycle comes to a close. Either way, be aware that historically Bitcoin has been 5x more volatile than gold and 9x more volatile than the S&P 500.  Talk about a roller coaster.  There’s a reason why long-term investors in Bitcoin are called HODLers. Hold On for Dear Life indeed.

Meanwhile GameStop ended the first quarter with astonishing gains of over 900%. 900% in 90 days makes the South Sea company’s “8x in 8 months” look like chump change.   But did you know that shares of the headline generating “meme stock,” whose meteoric rise was powered by an online army of day traders and retail investors, have been nearly 6x more volatile than Bitcoin?  Over the last ~ 2 months daily price moves in GameStop stock have been in the range of +/- 21%. Once again let’s rewind to March 2020 which was the most volatile month in the history of the S&P 500. It was a painful month for investors everywhere and almost no one would ever want to live through it again.  During that period, the S&P 500 experienced daily price moves of on average +/- 5.3% daily. Which means investors in GameStop just lived through quadruple that level of volatility during the first quarter of 2021. Was it worth it? And how many people were able to sustain through all the extreme ups and extreme downs to realize the overall return? And how many people jumped off the roller coaster in the middle of the ride when the news was bad, and the future looked bleak?

Our advice?

Continue to take a prudent and proven approach to building long-term wealth by investing in a low-cost globally diversified portfolio which is based on financial science – not headlines.  And if you are intrigued by a headline generating trade – be it crypto, meme, SPAC or whatever comes next – treat these opportunities the same way you would a trip to Vegas: set limits for what you bring to the table and be prepared to lose it all.

Most importantly, remember Odysseus. He successfully avoided the demise of many a sailor before him by having his crew stuff their ears with wax so they wouldn’t hear the Sirens singing. He himself wanted to hear their song, so he strapped himself to the mast of the ship so that he wouldn’t be seduced to steer off course. Translation for 2021: tune out the noise, and anchor yourself to your Strategic Life Plan which guides the financial ship on which you sail.

Q121 Market Perspective - Bill Laird

As we have highlighted before, markets were led higher by technology and other growth-oriented sectors in the months following the March 2020 downturn, the same sectors that had led prior to the economic interruption caused by the pandemic.  But, as illustrated below in Exhibit 2, the first quarter of 2021 saw the continuation of what is now a 5-month-old broadening of the stock market advance that began in November 2020.

EXHIBIT 2

Another sign that the current recovery is widespread in nature is the 200-day moving average, which is often used as a gauge of market movement.  If a stock’s price remains above the 200-day moving average, that is seen as an indicator that the stock’s price will likely continue to go up. According to Bloomberg, 94% of the S&P 500 is currently trading above its 200-day moving average. That is a high number.  In fact, its highest measure since 2013.

Reasons for this broadening of markets include:  

  1. Vaccines:  Industries that suffered major interruptions due to the pandemic may see a light at the end of the tunnel with the widespread rollout of vaccines. 
  2. Valuations:  After a long advance, a pause or correction may be due for sectors with historically high valuations and an advance due for those who did not previously participate as much.
  3. Inflation: higher interest rates may provide tailwinds for inflation sensitive sectors involved with assets like commodities or those that lend money, like banks.  Those factors were not present in the early days following the pandemic.

At DHG Wealth Advisors, we invest in a diversified manner across multiple asset classes, styles, and geography which means our clients benefit from broad market advances.  All of the reasons above are interesting points to consider and provide some context when reviewing sectors or funds that you own in the short and medium term.  But they are not reasons to change your allocation to chase the latest group of stock market leading companies or the alluring Siren songs mentioned previously.  By being diversified, you are positioned to participate in those market leaders when they arise.   As we’ve seen over long periods of time, sector or asset class leadership changes frequently, often when least expected. 

The question of “Have we come too far too quickly?” has also cropped up given large advances (100%+) for certain asset classes, such as U.S. Small Value, since the market low twelve months ago.   The math of large losses requires these big returns to get back to breakeven after a large decline.  For example, you need a 100% return to recover from a 50% loss, while a 33% loss needs a 50% advance to heal itself.   Most asset classes reached their previous high within 6-8 months of the low; typically, a recovery from a bear market lasts 22 months, so we’re just not used to seeing returns this large over a 12-month period.   

However, it’s interesting what a one month change in your starting point does for perspective as shown in Exhibit 3.

EXHIBIT 3

Source: JP Morgan

The advances past the previous market high 13 months ago look more like returns that we’re used to seeing for stocks in good times for the economy i.e. the S&P 500 is up 19.6% from the February 2020 high.

*   *   *   *   *

Markets aren’t the only thing popping.  Spring has sprung and there’s a sense of hope and optimism as both the flowers, and the world, begin to open back up after a long, cold winter. Enjoy this season of rejuvenation and revitalization!

Stay safe. Stay healthy. Take Care.

The information in this article should not be considered investment advice to you, nor an offer to buy or sell any securities or financial instruments. The services, or investment strategies mentioned above may not be available to, or suitable, for you. Consult a financial advisor or tax professional before implementing any investment, tax or other strategy mentioned herein. The information herein is believed accurate as of the time it is presented, and it may become inaccurate or outdated with the passage of time. Past performance does not guarantee future performance. All investments may lose money.

Attachments

  1. FirstQuarter2021_DHGWealthAdvisorNewsletter.pdf 4/13/2021 2:25:02 PM