By: Sarah K. Charles, CSRIC™, AIF® / Director of Business Strategy and Bill Laird, CFA®, CFP® / Chief Investment Officer
A Look Back (Because Hindsight is 20/20)
Sarah K. Charles, CSRIC™, AIF®
The new fall season of TV boasts 25 reboots. Imagine. Twenty-five TV shows that have come and gone and are now back again – revived or reimagined; and while I love Frasier Crane as much as anyone, it seems as if we have run out of ideas for new content and find ourselves with no other option but to recycle the characters and storylines of the past.
It’s not just the fall TV line-up where stories are being recycled.
Each quarter, when I sit down to write this newsletter, I have one primary objective: find the story that’s been garnering the most headlines in the financial media – and explain it by looking through the lens of financial science instead of what will sell the most advertising. For the last 18 months, there has been no shortage of content. However, as I sat down to begin this newsletter, it was clear that the main themes over the last 90 days were much like the fall TV season: the same old storylines recycled and rebooted. So, because hindsight is 20/20, I thought I’d look back at some of the themes we’ve written about over the last 5 quarters and see where they stood today.
Making Sense of The Market (2nd Quarter 2020)
Last spring, after experiencing the fastest, steepest sell-off in market history, we were whipsawed in the other direction with an equally quick and robust recovery that left investors everywhere scratching their heads. The news was grim. We were in a recession. A pandemic. And yet the S&P 500 was booming. In fact, the index experienced its best 3-month period in two decades during the second quarter of 2020. As I wrote then, the market made as much sense as the friendship between Martha Stewart and Snoop Dogg.
Eighteen months later people are still asking: why does the market keep going up? And really what they are wondering is why does the market keep going up when the news is so bad? The withdrawal from Afghanistan. Labor shortages. Supply chain issues. New variants of Covid. Wildfires. Hurricanes. North Korea launching a hypersonic missile. There’s little cause for optimism with headlines like those. But here’s the thing – bad news is nothing new.
EXHIBIT 1: Growth of a dollar—MSCI World Index (net dividends), 1970–2020
Source: Dimensional Fund Advisors
As is illustrated in Exhibit 1, there is a history of markets moving upwards despite constant negative headlines. And those are just the highlights! Think about everything that’s happened in the last 50 years that’s not listed on that chart. And then go a step further and think about everything we lived through before 1970. In case you need some help, Morgan Housel offers this summary in The Psychology of Money:
“Here’s how the U.S. economy performed over the last 170 years: 1.3 million Americans died while fighting nine major wars. Roughly 99.9% of all companies that were created went out of business. Four U.S. presidents were assassinated. 675,000 Americans died in a single year from a flu pandemic. 30 separate natural disasters killed at least 400 Americans each. 33 recessions lasted a cumulative 48 years. The number of forecasters who predicted any of those recessions rounds to zero. The stock market fell more than 10% from a recent high at least 102 times. Stocks lost a third of their value at least 12 times. Annual inflation exceeded 7% in 20 separate years. The words “economic pessimism” appeared in newspapers at least 29,000 times, according to Google. Our standard of living increased 20-fold in these 170 years, but barely a day went by that lacked tangible reasons for pessimism.”
We have looked through the lens of bad news – and not just bad news but depressing, frightening, and nerve-wracking news – for nearly two centuries. And yet, markets have thrived. Why? Because they reflect our inherent optimism and resilience. They reflect our ability to solve problems, get beyond the crisis of the day, and innovate. And they reflect our expectations for the future.
I suspect that the news will continue to be bad for most of my lifetime and beyond. But I also suspect that humans – and by extension capital markets - will find a way to grow and prosper despite it all.
Beware the Narrative Fallacy (3rd Quarter 2020)
There is a lot that I find maddening about the financial media, but the thing that I find to be the most maddening is their tendency to try and connect dots that shouldn’t necessarily be connected. Nassim Nicholas Taleb calls this phenomenon the narrative fallacy and he describes it as “our limited ability to look at sequences of facts without weaving an explanation into them.”
We like a good story. But the financial media goes above and beyond when it comes to world events and market activity, and they often try to reduce what’s happening in the stock market to a single factor. Just look at September 20th when news broke about Evergrande – a large Chinese real estate developer poised to default on a staggering debt load (~ $300 billion). The media wasted no time conjuring up a juicy drama with headlines like:
- Stocks Tumble as Wall Street's Fears Turn to China1
- Global Equity Markets Fall Over China Evergrande Fears2
- Dow Books Worst Day in 9 Weeks as Debt Woes for China’s Evergrande Rattle Stock Market3
The last one is my favorite simply due to the arbitrary timeframe of “worst day in 9 weeks” as I don’t know anything special about the 9-week window between July 19th and September 20th other than the fact that my birthday is in there, and the reporter felt it was an important reference point.
Yet for all the “Henny Penny the Sky is Falling” headlines, market losses weren’t exactly jaw-dropping. The Dow’s “worst day in 9 weeks” equated to a loss of 1.4%, while the S&P 500 responded with an intra-day drawdown of ~ 2% before paring its losses to ~ 1%. Hardly a bloodbath.
All week long the financial media kept trying to tell the same story, including comparisons between Evergrande and Lehman Brothers, and suggestions that this could be the beginning of a new global financial crisis. The problem was investors weren’t nearly as rattled by Evergrande as the media suggested they were.
Here’s the real story: Investors got some bad news about one company (albeit a very large one), took stock of the information available, decided that we weren’t at the dawn of a new global financial crisis (for now), and moved on with a forward-looking sense of optimism which is why the Dow, the S&P 500, and the Russell 2000 all ended the week higher.
Here’s something else to consider: when it comes to the global investable universe, China is smaller than you might realize.
Information provided by Dimensional Fund Advisors LP.
In USD. Market cap data is free-float adjusted and meets minimum liquidity and listing requirements. Dimensional makes case-by-case determinations about the suitability of investing in each emerging market, making considerations that include local market accessibility, government stability, and property rights before making investments. China A-Shares that are available for foreign investors through the Hong Kong Stock Connect program are included in China. 30% foreign ownership limit and 25% inclusion factor are applied to China A-Shares. Many nations not displayed. Totals may not equal 100% due to rounding. For educational purposes; should not be used as investment advice. Data provided by Bloomberg.
While China is a large country, with a large population and a powerful economy, it only accounts for 5% of the total global stock market. That’s an important perspective to remember given that it dominates a much larger percentage of headlines.
A 21st Century Siren Song (1st Quarter 2021)
Earlier this year we acknowledged how easy it can be to get sucked into the “get rich quick” allure of cryptocurrency compared to the unsexy, slow and steady path of building wealth incrementally over time by investing in global markets. We cautioned against the temptation and advised that if you do feel compelled to invest, treat it like a trip to Las Vegas i.e., be prepared to lose it all.
While I continue to stand by that viewpoint, I also believe that there is more to cryptocurrency than just a get rich quick scheme. In fact, I believe that cryptocurrency is here to stay, as is the blockchain technology behind it. In fact, we will likely begin to see more and more applications as blockchain evolves. How this translates for investors is still unclear, so as we continue to learn more, here are 3 additional crypto considerations:
- Right after we last wrote about Bitcoin, it peaked at an all-time high, before losing nearly half its value in ~ 6 weeks. That was followed by a day in May – one, single day – where Bitcoin dropped as much as 30% intra-day (it ultimately closed down 12%). And June saw Bitcoin’s price volatility reach a 14-month high reflecting average daily moves of 5 – 7%. With volatility like that, all I can say is if you’re going to ride the rodeo, be prepared to get bucked around.
- Betamax, launched by Sony in 1975, revolutionized at home TV viewing for consumers everywhere. Yet despite being a pioneer in the field, and despite having better technology, Betamax lost the “videotape format war” to VHS and quickly became obsolete. Of course, VHS technology is also archaic having been replaced by Laser Discs (briefly), DVDs, Blue-rays, and DVRs. And now you don’t even need a special device: all you need is an internet connection, and you can stream content just about anywhere.
What started as a groundbreaking idea – You can watch a movie in your home! You can record your favorite TV show! – has evolved over the course of nearly 50 years and has introduced us to multiple iterations and innovations of the technology. It also left a technology graveyard in its wake (anyone else have a rewinding machine for your VCR tapes?).
What does this have to do with cryptocurrency? Cryptocurrency is in its infancy. Bitcoin, the original crypto, was developed in 2009. A few years later, several more joined the field. Today, there are over 6,500 cryptocurrencies in existence.
Will Bitcoin be the Betamax of crypto? Who knows? But going from one iteration of crypto to 6,500 in 11 years reflects an explosive pace of innovation – one that likely can’t be sustained. So, I suggest waiting for the pace of innovation to slow significantly before determining if/how cryptocurrency fits into a long-term investment strategy.
- Mr. Goxx has been trading cryptocurrency since June and year to date he’s up almost 20%. Since he’s been outperforming many of his peers, Mr. Goxx has leveraged social media to let people know when he’s trading and what he’s trading. Oh. Did I mention that Mr. Goxx is a hamster?
The stock-picking monkey throwing darts at the dart board has evolved to a crypto trading hamster with a Twitter page, and I am not sure whether to rejoice at the implications that there are broader opportunities in crypto or weep that this is actually a real thing.
While not everything should be recycled, plenty of things should be. Like the plastic water bottles and ocean bound marine plastic which companies like Allbirds and Rothy’s use in their fashion-forward footwear. Or good financial advice including:
- Staying focused on the progress you’re making personally, not the progress of the markets.
- Letting financial science serve as the foundation of your investment strategy.
- Relying on your DHGWA Strategic Life Plan to help you navigate your financial decisions – not headlines.
An ESG Primer & Intro to SMAs
Bill Laird, CFA, CFP®
Environmental, Social, and Governance (ESG) investing has allowed investors to invest in a way that aligns closely with their personal values. If you’re not familiar with ESG investing, it is an investment strategy that considers environmental, social, and governance factors alongside financial factors in the investment decision making process.
- Environmental criteria consider how a company performs as a steward of nature.
- Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates.
- Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.
While DHG Wealth Advisors has offered these solutions to our clients for over a decade, we wanted to re-introduce our enhanced suite of solutions in this space.
ESG has grown as an investment category due to investor demand. Measured at the beginning of 2020, there are $17 trillion invested in ESG mandates, up from $12 trillion, just two years prior. As growth has occurred more specific offerings have become available as increased interest has made introducing these strategies financially viable for the investment managers offering them.
Many offerings are broad and employ screens over E, S, and G. Others are much more specific in the screens they employ, such as focusing on Sustainability only or even one aspect of Sustainability. How they approach the screening process can even be different. Examples of different approaches to the screening process are below.
In the early days, fees were very high for ESG portfolios with the sponsors noting that they had to employ additional staff or pay a consultant to help screen their portfolio. Over time, fees have become very similar to investment strategies that do not utilize screens as interest in the investing category has helped create economies of scale. For example, funds offered by Dimensional Fund Advisors employing an ESG focused mandate, have very similar costs to their non-ESG counterparts:
With efficiencies in technology and the reduction of transaction costs, some investment managers now have the ability to screen out very specifically the industries that individual investors do not want to participate in. Dimensional Fund Advisors (DFA) has recently introduced their Separately Managed Account (SMA) platform at a $500,000 minimum. SMAs provide some very specific features that investors may find valuable. With regards to designing a portfolio that aligns very specifically with your personal views, SMAs are well-suited for this purpose. Instead of employing broad screens, SMAs allow you to specifically avoid investing in companies or industries that do not align with your values. Examples of the very specific criteria that can be employed in designing your portfolio are the avoidance of securities involved in the gambling, tobacco, or weapons industries. These are just three of the dozens of criteria that can be employed to design a portfolio very specific to you.
In addition to being able to avoid investing in companies that do not align with your values, SMAs allow for other specific criteria to be employed in managing your portfolio. Criteria related to tax efficiency can be specified such as employing a capital gains budget you’d like to stay under due to gains in other areas of your financial life, or a loss-harvesting strategy where the manager sells securities at a loss from time to time to shield future gains from taxation. You can also use SMAs to avoid adding to industries that you may be overexposed to personally through your employer or by other means.
At DHG Wealth Advisors, we seek to build a plan that is customized to you and your needs and are thrilled to be able to offer additional ways to tailor your portfolio. Please reach out to your advisor for additional information regarding these solutions.
Q321 Market Perspective
Source: Morningstar Direct
Both U.S. and global equity markets were relatively flat for the quarter while Emerging Markets suffered meaningful losses – largely a reflection of concerns around Evergrande and China. Year to date, U.S. Small Cap stocks are continuing to have an incredible run and are up 47.6% compared to 30% for U.S. Large Cap stocks.
Last quarter the financial media focused on the seasonality story including the fact that September has historically been the worst month for stocks, while some of the worst stock market crashes in history (1929, 1987, 2008) have happened in October.
As Mark Twain once wrote: “October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.”
Don’t let the financial media spook you this month with news about seasonality. Tune out the noise, stay focused on your goals, stick to your plan and we’ll see you next year!
1CNN Markets Now, September 20th, 2021
2Investopedia, September 20th, 2021
3Marketwatch, September 20th, 2021
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.