WOW, just WOW! Did that really happen?

Once in a very great while, there comes a year in the economy and the markets that may serve as a tutorial—in effect, a master class in the principles of successful long-term, goal-focused invest­ing. Last year was just such a year.

On December 31, 2019, the S&P 500-Stock index closed at 3,230.78. This past New Year’s Eve, it closed at 3756.07 some 16% higher. World indices were also up almost 12% based on the MCSI World Price Index.  The average actively managed International/Global fund that we use and track was up 17.24%.  In Canada, the TSX was less exciting but nonetheless started the year at 17 063 and closed it out at 17 433 which is only 2.1% but add reinvested dividends and we get closer to 5%.  5% seems quite pale in comparison to 16% but it is most peoples’ target annual return.  This is in a year where oil prices were actually negative for a short time.  Also, equally weighted, Canadian bank share prices were slightly negative in 2020.  And then the economic shutdown with awful economic numbers.  And so on and so on… 

From these bare facts, you might infer that the equity market had, in 2020, quite a good year. As indeed it did. What should be so phenomenally instructive to the long-term investor is how it got there.

We saw new all-time highs mid-February, then the markets reacted to the onset of the greatest public health crisis in a century by going down roughly a third in five weeks. In the U.S.,the Federal Reserve and Con­gress responded with massive intervention, the economy learned to work around the lockdowns—and the result was that the S&P 500 regained its February high by mid-August.  The TSX took a bit longer and was back to all-time highs at year end. 

I was in the office March 17 (which was March break, by the way) and started my “two week” work from home March 18.  Bad news was all around me.  Turn on the TV and it appeared the end of world was nigh and yet the markets bottomed days later.  March 23, to be exact.  From there, the market wasn’t looking at that day’s news but rather 6-12 months out.  We started to put money to work in earnest and it worked out well yet every headline would lead you to believe this should not be the case.  Why did we think adding to investments made sense?  There was a sale going on.  Some of the best companies in the World were at very compelling valuations and priced for worse than worst case scenario so the risk / reward told us we were making the right moves.  Dividends would also reward us handsomely while we waited.  And, no one that we were adding equity exposure needed the money in the next 6-12 months.  Any money needed for ongoing cash flow needs was not in equities anyway. 

So…

The lifetime lesson here: At their most dramatic turning points, the economy can’t be forecast, and the market cannot be timed. Instead, having a long-term plan and sticking to it—acting as opposed to reacting, which is your and my investment policy in a nutshell—once again demonstrated its enduring value.  Don’t get me wrong, as active managers, we were doing things in February and March but panicking wasn’t one of them.  We acted – we did not react and make moves with potential for long term devastating consequences.  (Two corollary lessons are worth noting in this regard. (1) The velocity and trajectory of the equity market recovery essentially mir­rored the violence of the February/March decline. (2) The market went into new high ground in midsummer, even as the pandemic and its economic devastations were still raging. Both outcomes were consistent with historical norms. “Waiting for the pullback” once a market recovery gets under way, and/or waiting for the economic picture to clear before investing, turned out to be formulas for sig­nificant underperformance, as is most often the case.)  I’ve read stories of great numbers of retirees (none that deal with us, I can thankfully clarify) pulling out of the market entirely in March and still out.  They took what was arguably a temporary decline and possibly derailed their retirement plans.

In the U.S., the American economy—and its leading companies—contin­ued to demonstrate their fundamental resilience through the bal­ance of the year, such that all three major stock indexes made mul­tiple new highs. Even cash dividends appear on track to exceed those paid in 2019, which was the previous record year.  Meanwhile, at least two vaccines were developed and approved in record time, and were going into distribution as the year ended. There seems to be good hope that the most vulnerable segments of the pop­ulation could get the vaccines by spring, and that everyone who wants to be vaccinated can do so by the end of the year, if not sooner.

The second great lifetime lesson of this hugely educational year had to do with the American presidential election cycle. To say that it was the most hyper-partisan in living memory wouldn’t adequately express it: adherents to both candidates were genuinely convinced that the other would, if elected/reelected, precipitate the end of American democracy.  In the event, everyone who exited the market in anticipation of the election got thoroughly (and almost immediately) skunked. The enduring historical lesson: never get your politics mixed up with your investment policy.  The markets started a huge rise the day before the election and were up every day that week.  This in spite of us not knowing who actually won the election which was, we were told, the worst possible outcome.  Throughout this, November’s market performance ended up being the second best on record.

As we look ahead to 2021, there remains far more than enough uncertainty to go around. Is it possible that the economic recovery—and that of corporate earnings—have been largely discounted in soar­ing stock prices, particularly those of the largest growth companies? If so, might the coming year be a lackluster or even a somewhat declin­ing year for the equity market, even as earnings surge?  Yes, of course it’s possible. Now, how do you and I—as long-term, goal-focused investors—make investment policy out of that possibility? We don’t, because one can’t. Our strategy, as 2021 dawns, is entirely driven by the same steadfast principles as it was a year ago—and will be a year from now.

Rates will stay low and probably near current levels until such time as the economy is functioning at something close to full capacity—per­haps as long as two or three more years.  For investors like us, this makes it difficult to see how we can pursue our long-term goals with fixed income investments. Fixed income is used to ensure cash that is needed in short term is available.  For longer term needs, equi­ties, with their potential for long-term growth of capital—and especially their long-term growth of dividends—seem to be the more rational approach. I would even argue safer as being negative after inflation and tax doesn’t sound too safe.  We therefore tune out volatility.  I have never once seen a headline that says “Back up the truck, it’s time to load up as everything is on sale”.  We act; we do not react. This was the most effective approach to the last year and will be this year and the year after.

I look forward to discussing this further with you further over the next month or two.