Dorato News - December 2022
Portfolio Issues - Timing
2022 was a year most investors want to forget. After a year like this, some variation of, “I know you can’t time the market, but…” comes up pretty frequently. Since we have heard more of that recently, we want to highlight the differences in returns that can arise if you are trying to move in and out of the market.
If you remove the five days with the best performance in the S&P 500 for the year, your return drops drastically, from -19.4% to a loss of more than 37%. Conversely, if you remove the five worst days for the year, your return was very flat - .09%.
This isn’t a phenomenon unique to this year. Over a 30 year period, the S&P 500 has averaged a 7.8% annual return. If you remove the 50 best days over that time period your average annual return would be approximately –1%. There were more than 7,500 trading days in that 30 year time period, so 50 days represents less than 1% of the total trading days. There are many other statistics that display the absurdity of market timing, but you get the point.
Cash might look enticing with interest rates where they are today. If you have a near term need for cash, then there are some valuable options out there. However, if you are looking at a retirement period of 10-20 years or are planning on passing along wealth to family, when do you switch back from those investments?
High interest rates look attractive now, but they will not stay at this level over a long period of time. Trying to forecast when to buy back in to the market is akin to betting and we don’t advise gambling with your investments.
“I don’t think I’ll ever be a long-term investor. I can’t think past my next meal.”
Market View - Navigating the New Year
2022 has been a crummy year for most investments: stocks down 19%, bonds down 13%, even inflation-protected bonds down 12%. Higher-quality, dividend-paying stocks were one of the few bright spots, and that helped portfolio performance.
Think back to the end of 2021. You might have thought stocks and bonds were expensive, as we did. But you also knew that cash is a terrible long-term investment, and that cash paid an interest rate of nearly zero percent. If we had told you to sell all your stocks and bonds and put your money in zero-percent cash, you would have questioned our sanity, and rightly so. Yes, in hindsight, that seems like the best choice, but hindsight is as useful as a roof made of yesterday’s newspaper.
Now think about today. US stocks, at these lower prices, have decent return potential, in line with historical averages. International stocks might have even more potential. Bonds, too, are much more reasonably priced. Finally, there’s cash, with cash interest rates now closer to 4% in money market funds and CDs. Some of you may be tempted by those cash rates. After all, you’ve just witnessed losses for stocks and bonds in 2022, a year when zero-percent cash was the best option. But we reiterate: cash is a terrible long-term investment. You will always lose to inflation. You did in 2022, and you will in the future. Stocks and bonds, from here, offer a better return.
The key to investing is not to look at the recent past or the present, but to look to the future. We think of it as similar to driving. If you look two feet in front of your car or in the rearview mirror, you’re always going to be surprised, and often in a bad way. If you look down the road, you’re more likely to navigate safely.
Cash rates will likely not stay this high for long. They will peak sometime in 2023, probably late in the year, and then start to come down. As the economy slows, inflation drifts downward, and everyone starts to worry more about recession than inflation, the Federal Reserve will have room to lower short-term interest rates, and cash interest rates will follow.
We don’t expect inflation to get all the way down to the 0-2% range. Once inflation drops to the 3-4% range, the Federal Reserve can probably declare victory. Getting below 2% would require too much pain. Investors currently seem to expect inflation in the 2-3% range. Given our higher estimate for inflation, we recommend inflation-protected bonds over standard US Treasuries.
For stocks, the risk is of recession, and of droopy earnings. Much of the hot air has come out of the stock market, particularly the large technology companies and the profit-less, growth-at-any-cost companies. But probably not all of the hot air, so we continue to advise caution on those stocks. With a recession, we expect earnings to take a hit, even for solid companies. But recessions, if we have one, are temporary. Long-term investors should always be looking past any temporary impediments.
We mention international markets because international stocks are trading at a large discount relative to US stocks. People have been saying this for the last several years, and the gap has only grown wider, so who knows if 2023 will be the year that we see a change; but having some exposure to international stocks seems like a good idea.
When stocks are down, we typically hear ideas about all sorts of other things we could do with our money. Perhaps we will be saved from those ideas this time because the price of almost everything went down. Don’t mess with Bitcoin, options, or any other idea that’s more of a gamble than an investment. That’s a path to destroy wealth rather than build it.
Sources: Economist, Wall Street Journal, Value Line, Vanguard, Applied Finance Group, Schwab, Bloomberg