Portfolio Issues - Predictions
2023 was a decent year for the US economy by most accounts, but that was not the prediction last year around this time. A recession was considered inevitable, the discussion centered on when this proverbial storm would arrive. The combination of higher rates for cash and poor economic forecasts enticed some investors to change their allocation. That was a mistake.
The “Magnificent Seven” propelled the S&P 500 to a return of close to 25% for the year. We think the hype surrounding those specific stocks is excessive, but the equal weighted index still returned close to 12% for the year. A benefit of looking at the equal weighted index is that it is not distorted by the performance of the largest companies. Either way you look at it, keeping your money in the stock market instead of switching to cash was the better option.
We think 2023 provided a helpful reminder of the importance of sticking with an investment plan. Trying to predict future events is a fool’s errand and economic forecasts are notoriously unreliable. Investors who maintain their allocation generally come out in a better position than those who alter course based on predictions. Choosing the correct balance of stocks and bonds and adhering to it throughout different investing environments is the simplest way to reach long-term goals.
That doesn’t mean we never recommend modifying your plan, but those adjustments should be made when personal circumstances change, not when trying to guess the future.
Sources: Economist, Wall Street Journal, Value Line, Vanguard, Applied Finance Group, Schwab
“I don’t like these prices. I’m waiting to see if they change.”
Market View - Price versus Value
We read all the time, both for business and for pleasure. In one of the pieces we recently read, finance professor Aswath Damodaran, talked about the difference between price and value. Price is what we see everyday, and what gets talked about endlessly in the media. It’s a bit like the weather—you can’t change it, but that doesn’t stop people from talking about it. Value is different. Value derives from the cash flow of an investment today and in the future, and the certainty of that cash flow. Sometimes price and value are the same thing, but often they’re not. It’s good to be clear with yourself which one you’re talking about.
Benjamin Graham, a famous investor, said that in the short term, the markets are a popularity contest. In the long term, they are pretty good weighing machines. We think Damodaran and Graham are saying similar things. As you might guess, we think popularity and price are not necessarily helpful items to focus on. Value is.
In today’s context, the top seven stocks in the S&P 500 index are the popularity winners, and everyone talks about their prices, and which way those prices are headed. Wall Street has even coined a name for them: the Magnificent Seven. But here’s an investment tip: if the financial media coins a name for a group of popular stocks, it’s often best to walk quickly in the other direction. Remember the Nifty Fifty of the 1970s, or BRICS (Brazil, Russia, India, China, South Africa) of the early 2000s? Those investments fared poorly after they acquired their catchy monikers.
So what does all this mean for the S&P 500? Probably not great things, since these Magnificent Seven stocks comprise 30% of the index. However, for those of us not following the popularity parade down Wall Street, the future doesn’t seem quite so bleak. There are quite a few good companies selling at reasonable prices and that pay solid dividends. We think the stocks of such companies represent good value, and we are happy to have you own them, and to own them ourselves.
Interest rates have been quite the story for some time, ever since inflation took off and the Federal Reserve raced to catch up. Currently, short-term interest rates sit at about 5%. Long-term interest rates are a bit below that, at about 4%. We want to stress the difference between short-term and long-term rates. If the Federal Reserve raises or lowers rates, that directly affects short-term rates. They are not raising or lowering long-term rates. If investors think inflation is still a problem, long-term rates will remain high. If investors think inflation is licked, then long-term rates should come down.
People seem to think that both short-term and long-term rates will come down in 2024, spurred by the Federal Reserve cutting rates. Maybe, but the Federal Reserve has been saying that rates will have to stay higher for longer. And even if they cut short-term rates next year, that doesn’t mean that long-term rates will follow.
Given the trade tensions with China, the hefty deficit spending of the federal government, and the federal government’s large debt, we think the risk of inflation running above 2% is still quite high. That’s why we continue to have inflation-protected bonds in most portfolios.
With the concentration of the S&P 500 in large technology stocks, and with a Treasury market that we think is overly optimistic about inflation, 2024 could bring a few fireworks. But those fireworks will mostly be about fluctuating prices, not about fluctuating value. We think you don’t need to ignore price fluctuations, but keep them in perspective. Value doesn't fluctuate nearly as much as prices do.
Sources: Economist, Wall Street Journal, Value Line, Vanguard, Applied Finance Group, Schwab