“The world is full of foolish gamblers and they will not do as well as the patient
investors.” – Charlie Munger
As many of us attempt to adjust focus away from our busy life routines into the year-end
holiday season, I thought it made sense to pass along the below note written by Mellody
Hobson and John W. Rogers Jr. of Ariel Investments. Their message is one of long term
optimism as it relates to investments and financial markets.
Although I am taking a more cautious approach to investing client assets as the
economy decelerates, it is an undeniable fact that in the long run, betting against the
U.S. economy and our financial markets has been a mugs game.
*****
What the Stock Market Taught Us This Year: Don’t Fall for These Investing Traps
By Mellody Hobson and John W. Rogers Jr.
The Wall Street Journal
December 5, 2023
The uncertainty around near-term interest rates has dominated the story of the stock
market in 2023. Perhaps not since the 1970s—when runaway inflation and sky-high
interest rates were the crisis du jour—has monetary policy affected investment
outcomes in such a pronounced way.
Yet look more closely, and it would seem that Wall Street has been more influenced by
perception than reality: Company and individual balance sheets remain mostly healthy,
businesses are battle tested and unemployment remains low. Similarly, the malaise
surrounding the economic environment belies what we are seeing. Cruise ships are sold
out, restaurants are packed, holiday shopping was off to a strong start and 82% of S&P
500 companies reported a positive earnings surprise in the third quarter.
Still, a nervous atmosphere has undercut stock performance. Scores of share prices
have been lackluster as company fundamentals have been eclipsed by macroeconomic
conjecture. We have lost the trees in the forest.
But as someone once declared, “It is a market of stocks, not a stock market.” This is a
wise reminder that no matter the conditions, there are investment opportunities to be
had. In fact, the more economic obfuscation, the more sectors are hammered, the more
stocks are orphaned, the better the odds of long-term investment success.
After a year of hand-wringing through monetary policy guesswork and market
fluctuations, many wonder how best to maneuver in the new year. Here’s our advice:
Avoiding some of the biggest market traps can be a winning strategy.
Don’t Fed-watch
“Don’t fight the Fed” is a well-known market mantra. The idea is to buy stocks when the
Fed is lowering interest rates and sell when the Fed is raising them.
This psychology has dominated the stock market all year, creating a futile guessing
game. Are they still raising rates? For how much longer? Will rates fall soon? Will it be a
hard landing or a soft landing? But this Fed obsession, reacting to every pronouncement, simply sucks up time. It has all been noise. Despite the fear and uncertainty, dire predictions didn’t come true.
What that means is that sectors that sold off because of heightened fears—including
banks, some industrial names and anything real estate related—could be wellpositioned
for investors willing to take a longer-term view.
After surviving a midyear crisis, for instance, the banking sector is already beginning to
show signs of recovery as market anxiety subsides. Similarly, oversold housing-related
stocks should rebound once people adjust to the new rate environment, and the U.S.
housing shortage, exacerbated by the pandemic, drives new construction.
It doesn’t mean every sector that got hit by investor angst is ripe for buying. Commercial
real estate is an obvious example. But it does mean that if you invested by watching the
Fed like a tennis match, and then reacting to every volley, you will get it wrong.
Don’t buy the hype
The selloff in many areas has inflicted pain that has been concealed by the capweighted
dominance of a few celebrity stocks in the S&P 500 index. A handful of tech
and tech-related stocks, weight-loss drugs and artificial-intelligence providers offer the
sum total of stock-market outperformance this year. Beyond these headliners, there is
less and less attention on individual names.
Those tech behemoths, dubbed the “Magnificent Seven,” account for more than 30% of
the index and 87% of its return through October. Let us say that again: Just seven
stocks represent one-third of the S&P 500 index. Some now consider Google parent
Alphabet, Amazon.com, Apple, Facebook parent Meta Platforms, Microsoft, Nvidia and
Tesla to be defensive businesses that can grow through any economic cycle.
We’ve seen this before, and the lesson is always the same: Winner-takes-all can
dominate over shorter time frames but is rarely a winning bet in the long run. At some
point, this narrow market supremacy will end, to the benefit of many overlooked issues.
In other words, these hyped celebrity stocks have more downside than upside from
here. There are more-compelling opportunities to be had.
For example, the small-fry stocks found in the Russell 2000 index are among the most
neglected shares waiting to get their due. The index has been languishing in a bear
market since 2021—partially driven by their perceived economic sensitivity and partially
driven by Wall Street indifference.
The result is that the total market cap of the Magnificent Seven is now three times the
size of every single stock in the Russell 2000 index combined—making just seven
stocks the equivalent of 6,000 small-cap names. On average, 47 analysts follow the
typical Magnificent Seven stock versus just five for a small-cap name. Nine percent of
smaller companies have no followers at all.
Here’s the silver lining: Less coverage means more market inefficiency means more
opportunities. Stock prices trade on fundamentals. And when those solid fundamentals
shine through, share prices rise. Additionally, when tepid U.S. growth inevitably picks
up, small-caps are poised to strongly outperform as they have done every other time in
the past.
The upshot is that you can go ahead and buy the hype if you want to, blinded by the
celebrity names. But that’s not where the upside opportunities are likely to be.
Don’t anchor to the here and now
This time is different. Except it hardly ever is.
That’s a lesson investors rarely learn. Case in point: the extremely low interest rates
that have persisted for much of the past two decades. Over the past 50 years, U.S.
interest rates have averaged 5.98%. Today’s 5.5% rate seems high compared with the
0.25% paid during the recession of 2008, but no comparison to 1980 when rates topped
out at 20%.
Similarly, at the start of the new millennium, a 30-year fixed-rate mortgage was 8.08%—
basically in line with 2023 levels, but significantly higher than the bargain 2.96% rate
that could be had just two years ago.
Higher interest rates now feel like a shock to our systems because we got anchored to
some extreme lows. When considered in the full context of a longer history, though,
they are in line.
Now people are anchored to the S&P 500 beating everything else. But just as we have
seen with interest rates in 2023, the trend will revert to the mean, even if it takes a
while.
Don’t fear volatility
Although it may feel uncomfortable, it is often easier to invest at the extremes—when
valuations are crushed, buy signals are blaring and the bad news is priced in. Such
conditions have the greatest profit potential, but the inherent volatility makes investors
nervous.
This angst is playing out in the price action surrounding earnings announcements.
FactSet reports that stocks are getting hit harder for negative earnings surprises. In
turn, this drives up their volatility. In the third quarter, an earnings miss cost the typical
company 5.2% in market value—more than twice the 2.3% average over the past five
years.
Instead of running for the exits, we view volatility as our friend and actively seek to take
advantage of the price movements. Everyone says they want to buy low, but when the
opportunity arises, many wait for the dust to settle and miss the moneymaking moment.
Don’t bet against America
The market has turned more optimistic as the year winds down and we see plenty of
value-beneath-the-surface stocks.
But even if investors have found some trees, they still have some concerns about the
forest. Two terrible wars, congressional dysfunction, a border emergency and mounting
unrest lurk over our economy as well as those around the globe.
In these unnerving moments, we are comforted by the faith in the resiliency of our
capitalist democracy from capitalism’s own Yoda, Warren Buffett. He wrote in the 2012
Berkshire Hathaway shareholder letter, “Of course, the immediate future is unknown;
America has faced the unknown since 1776…. Periodic setbacks will occur, yes, but
investors and managers are in a game that is heavily stacked in their favor.”
Indeed, our markets have overcome a Great Depression, multiple recessions, global
and regional conflicts, a modern-day pandemic and all other kinds of unforeseeable
blows. Through it all, America has endured, and we have every reason to believe she
will continue to do so.
*****
Sincerely,
Justin Kobe, CFA
Founder, Portfolio Manager & Adviser
Pacificus Capital Management
A referral is the best compliment.
Feel free to forward this email to friends and colleagues.
*****
Advisory services through Cambridge Investment Research Advisors, Inc., a Registered Investment Adviser. Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a broker-dealer, member FINRA/SIPC. Cambridge and Pacificus Capital Management are not affiliated. Material discussed is meant for general illustration and/or informational purposes only, and it is not to be construed as investment, tax, or legal advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon when coordinated with individual professional advice. These are the opinions of Justin Kobe and not necessarily those of Cambridge Investment Research, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Investing in the bond market is subject to risks, including market, interest rate, issuer credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies is impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counter-party capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Diversification and asset allocation strategies do not assure profit or protect against loss.