Happy Thanksgiving to you and your family. We all have much to be thankful for. Twenty-one months after COVID-19 led to lockdowns across the United States, vaccines are now widely available. Additionally, new highly effective treatments are coming to market, which could minimize the risks associated with virus. Entrepreneurs and businesses of all sizes squeezed about 10 years’ worth of innovation into one year to overcome both COVID-19 and the shutdown of the economy. Couple that with $4 trillion of money creation by the Federal Reserve (“FED”) and $5 trillion of government borrowing and support, the stock market has consistently made new highs this past year.
The ValueAligned Model portfolio is up +18.8% year to date as of Monday, November 22, 2021, while the S&P 500 Index is up +26.3%. We still have about 12% in cash waiting for better prices. But still, I don’t think this financial windfall is a reason to celebrate. I think this comment from economist, investment commentator and Ferris Bueller’s Day Off actor, Ben Stein sums up my attitude on gratitude:
So I cannot tell you anything that, in a few minutes, will tell you how to be rich. But I can tell you how to feel rich, which is far better, let me tell you firsthand, than being rich. Be grateful.
While this fourth quarter rebound is encouraging, let me remind you to be grateful for the current windfall and stay focused on our longer-term goals. Stocks have historically had a long-term upward bias, but they don’t move in a straight line, no matter how positive the economic fundamentals may be. Be that as it may, 2021 has been a very good year for stock investors like us. Many of your plans call for an +8% or so after-tax annual return on your portfolios, and this year’s returns are so far more than double what is necessary. That’s helpful because we can bank that good performance for the inevitable temporary interruption of the permanent uptrend, or better known as a decline of -20% or more.
Aren’t we still in a pandemic? Isn’t inflation a concern?
For the many, viewing the multiple highs we’ve seen this year can spark questions. One may ask, “Why are stocks performing so well? Aren’t we still in a pandemic? Isn’t inflation a concern? Aren’t we facing economic and political challenges that should derail the rally?” All are good questions. All are fair questions. But various metrics that investors collectively follow vary from what the casual observer might be more attuned to. And by investors, I mean the millions of large and small investors that buy and sell stocks on a regular basis. Let’s look at three variables that have played an outsized role in this year’s rally:
- economic growth
- profit growth
- interest rates
They have all been strong tailwinds for stocks. Economic growth slowed in the third quarter, but overall, it has been strong this year, as the economy continues to open up after the severe lockdowns of 2020. Economic growth by itself might not be an important variable, but economic growth powers profit growth. And profits power the stock market. The pandemic has created enormous economic distortions that have benefited some sectors at the expense of others. I get that. Overall, however, the economic rebound has fueled a substantial increase in earnings this year, according to Refinitiv, and that has aided stocks. Notably, October’s strong performance was closely tied to another quarter of much-better-than projected Q3 profits (Refinitiv). Think of it like this. If you find a small business that you might want to purchase, you’d examine many aspects, but current profits and expected future profits would play the biggest role in the final purchase price. The same line of thinking holds true for shares of publicly traded companies. Let’s add one more variable to our recipe: interest rates. Interest rates and bond yields are at very low levels. Without jumping deep into the weeds of time-tested academic research, low interest rates leave savers with fewer options. In turn, that makes stocks more attractive to savers.
Experts Warn of the Risk of -20% Market Decline
This month’s Client’s Corner asks; how would a -20% pullback in the stock market affect you? “Yes, it’s certainly possible that, at any given time, the equity market may pull back more than a little, or more than momentarily—say 20%. How would that affect me, in terms of my ability to pursue my long-term investment/financial plan?“ Of course, most of you know that the temporary interruptions of the permanent uptrend or “pullbacks” are opportunities to accumulate shares of great companies at prices that are below their values, resulting in extra returns. And we need the extra returns of stocks because, as Nick Murray explains in this little essay,
Your mortal enemy in retirement isn’t the occasional equity “volatility.” It’s the relentless, grinding, inexorable increase in your cost of living over decades in retirement. Inflation is the enemy and stock returns over time will beat the enemy.
Time, not timing, is key to building wealth.
We’re due for a correction. Obviously, that did not happen in October, as favorable economic fundamentals countered September’s volatility. Yet, risks never completely abate, even if they are overshadowed by favorable developments.
Inflation is still a big worry, and investors now expect a faster pace of rate hikes from the Fed, according to a recent CNBC survey. Even if the Fed were to go ahead with one or two quarter-percent rate hikes next year, the fed funds rate would remain near historic lows.
I’ll leave you with this excerpt from Bill Miller’s final market commentary ever. Bill Miller, CFA is the founder of Miller Value Partners, and currently serves as the Chairman and Chief Investment Officer. He is ceding his market commentary responsibilities to two of his colleagues. Has he given up? No. He just realizes that he says the same thing every time. Check this out:
Over the past decade or so my letters have been focused mostly on saying the same thing: we are in a bull market that began in March of 2009 and continues, accompanied by the typical and inevitable pullbacks and corrections. Its end will come either when stocks get too expensive relative to bonds or when earnings decline, neither of which is the case now. There have been a few other themes: since no one has privileged access to the future, forecasting the market is a waste of time. It is more useful to try and understand what is happening now and give up trying to predict what is going to happen. In the post-war period the US stock market has gone up in around 70% of the years because the US economy grows most of the time. Odds much less favorable than that have made casino owners very rich, yet most investors try to guess the 30% of the time stocks decline, or even worse spend time trying to surf, to no avail, the quarterly up and down waves in the market. Most of the returns in stocks are concentrated in sharp bursts beginning in periods of great pessimism or fear, as we saw most recently in the 2020 pandemic decline. We believe time, not timing, is key to building wealth in the stock market.
I trust you’ve found this review to be educational and informative. Let me emphasize that it is my job to assist you. If you have any questions or would like to discuss anything, please feel free to give me a call. My cell number is 732-284-1267. Please know that we are grateful every day to have a chance to serve you and your family. Thank you. Happy Thanksgiving.