Dorato News, July 2020
Updated: Jan 4, 2021
If you were ever looking for a good example of why market timing is extremely difficult to pull off successfully, the last several months is a pretty good time period to review.
From February 19 to March 23, about four and a half weeks, the S&P500 dropped about 35%. Now perhaps you saw the severity of the coronavirus, that most of the world would shut down their economies, and that world stock markets weren't properly reflecting that. So perhaps you think you might have sold all your stocks before the sell-off.
Then, from March 23 to the middle of June, the S&P500 rallied about 40%. By March 23, many governors had shut down their states, using emergency powers to keep people at home. New York was the center of the crisis in the US, with the daily death count rising steadily. The news was universally bad, and some market experts predicted an economic depression and a further fall in the stock market.
My guess is that even if you were one of the ones to get out of stocks and into cash at the start of all this, you didn't invest that cash on March 23. And I doubt you invested any time after that, either, because many people have been saying this rally is unjustified.
One more thing: what do you do now?
With market timing, you are implicitly saying that you think you're smarter than the rest of the investors out there, that you will know when to get in and when to get out, and end up making a better return than if you had just stayed invested throughout. As you can guess, I think market timing is a hopeless exercise. At best, your return is less than the market over time. At worst, you end up losing money.
If you fell asleep for the past several months, and woke up and looked at the stock market indices, you could be forgiven for thinking that not much had happened during your slumber. The US equity markets are not too far off where they started the year. Of course, then you'd notice everyone wearing masks, people giving you a wide berth, and your favorite restaurant is closed, and you'd start to wonder what you'd missed. So after all that's happened over the last several months, are stock prices expensive or reasonable? The answer, I think, is both.
As of mid-June, roughly three-quarters of the stocks in the S&P500 are down for the year. Yet all five of the largest companies in the index are up for the year. The divergence of stock performance between growth and value companies has reached historic proportions. Growth stocks have outperformed value stocks for the last five years by more than 10% per year. But in 2020, the difference has reached absurd levels. Vanguard's large growth company index is up 20% for the year; the large value company index is down 20%. The last time we had that sort of performance difference? 1999. That rubber band is stretched extremely tight, and it will snap back. Whatever you do, do not run out and buy an index of growth companies. You will not be happy with that investment.
Indeed, the current period is reminiscent of the late 1990s in many ways. Back then, the Silicon Valley types said anyone who didn't own their stocks just didn't get it. People thought Warren Buffet was washed up. And if a company put dot-com in it's name, the stock price jumped. Today, if I had to pick one theme, I'd say it's e-commerce. Companies such as Shopify sell for 15 times revenues (Walmart sells for less than one times revenue), and 900 times cash flow. Facebook announced a plan to get into e-commerce and the stock jumped 10%. Facebook doesn't currently have any revenue from e-commerce; it was just a plan.
And of course I have to mention Amazon, the king of e-commerce, which trades at about 80 times 2020 earnings, pretty expensive for a very large company. In early 2000, Cisco, the king of the internet, traded at $80, 100 times earnings. Today, twenty years later, it trades at $45.
Why would investors press repeat on a period that happened only twenty years ago, and that didn't end well? Are investors that thick? My theory is that the coronavirus-induced lockdowns and recession have created a lot of uncertainty, in a similar way that the rise of the internet created uncertainty in the late 1990s. When the world seems to be in flux, investors are more likely to grasp onto whatever seems to be working at the moment. And at this moment, the theme is e-commerce.
So when I say that stocks are both expensive and reasonable, I mean that growth stocks look expensive — particularly the large technology stocks — and value stocks look reasonable — particularly high-quality stocks in the financial sector and in the consumer-facing sectors. The current performance difference between growth and value will not last much longer. Either growth stocks will take a tumble, value stocks will play catch-up, or some combination of the two. In just about any scenario, you should expect some volatility. The transition is rarely smooth.
A ten-year US Treasury note pays interest of about 0.7% per year, not much to get excited about. Cash pays nothing. But you own bonds and cash to deal with the volatility in stocks, to keep the fluctuations in your portfolio to manageable levels.
I don't expect volatility to be as high in the next several months as it has been from February to June, as the virus and its consequences are now much less of a surprise. But we should expect more volatility than normal. Keep your wits about you and stick to your long-term plan, and you'll come out fine.
Sources: Economist, Wall Street Journal, Value Line, Vanguard, Morningstar, Business Insider