Takeaways from 2020 and thoughts for the coming year.
The ups and downs of the market during 2020 have been fast, unpredictable, and sometimes hard to fathom, yet they serve as reminders of key aspects of investing in stocks.
(1) The Market is Unpredictable
Going into 2020, the median estimate provided by strategists for the expected return of the S&P 500 Index was +2.7%. Come April, a revised survey of forecasts due to the pandemic produced an expected return of -11% for the year. As of 12/24, the year-to-date total return sits at nearly 17%. While market outlooks are not useless, as they provide thought provoking analysis of what could impact the market, the actual estimates of longtime market pro's can almost never be relied upon. Even if the strategists were able to see a pandemic coming, they likely would've forecast a negative return rather than an above average positive return. The fact that the market may have done better this year than if there had not been a pandemic goes to show how little we are able to predict when it comes to short-term market movements.
(2) The Market is Not the Economy
The current economic environment is a historically poor indicator of the stock market as the correlation between stock market returns and annual economic growth is nonexistent. As famed investor Bill Miller says "The market predicts the economy; the economy does not predict the market" (Bill Miller 2Q Quarterly Letter). Additionally, the top 5 companies in the S&P 500 Index (Apple, Microsoft, Google, Facebook, Amazon) currently make up 22% of the index, have each returned between 33% and 86% this year, and have contributed an outsized portion of the index's total return. The dispersion of returns by sector has been incredibly wide (the technology sector has returned 43% so far while the energy sector has returned -32%) but you wouldn't know that by looking at the overall index return. While the economy suffered, these large technology businesses thrived, helping to bring the S&P 500 year-to-date total return back into positive territory by mid-July, while the economy was still deep in a recession. More economically sensitive sectors have also recovered from their March lows, contributing to strong stock market returns in the second half of the year. The market is forward looking and, as such, quickly adjusts its views.
(3) Downturns Present Opportunity
Had you invested in mid-March after the S&P 500 had fallen 20% from its previous peak, that money would have returned close to 40% so far. Referring back to a previous post from March, Action Plans in Downturns, "subsequent 1 year periods following draw-downs of 20% or more have positive returns 86% of the time when looking at the S&P 500 Index back to 1950. Additionally, the average subsequent 3 year annual return following such declines is 10% per year". Hindsight is always 20/20 and it can be incredibly hard to invest in the midst of a rapid collapse, but focusing on the probabilities shown to us by history can be an effective way to mitigate natural behavioral biases.
Even if you do not have extra money to invest in such times, these are good stats to reference if you are feeling the urge to sell out of the market or postpone scheduled 401(k) contributions. Additionally, if you have a taxable account, downturns present an opportunity to tax loss harvest by selling investments at a loss, reinvesting the proceeds in an investment with a similar market exposure, and using the capital losses to offset realized capital gains or a portion of taxable earned income.
(4) Markets Are Cyclical
Different stock markets rotate in and out of favor over intermediate periods of time. Historically, what has worked for the last 7-10 years is less likely to exhibit the same kind of performance over the next 7-10 years. For instance, US stocks have dominated international stocks for the 10 years ended 12/24/20: US Stocks (S&P 500) have returned 13.7% per year, developed market international stocks (MSCI EAFE) have returned 5.4% per year, and emerging market international stocks (MSCI EM) have returned just 3.5% per year. This compares, however, to the previous 10 year period in which international stocks outperformed US stocks. From 12/31/2000-12/31/2010, emerging market stocks returned 15.9% annually, international developed returned 3.5% and large US returned 1.4%. Any guess what happened from 1990-2000? I'll save you the google search: US stocks won that decade. What will happen in the 2020's is anyone's guess, but having exposure to multiple regions, investment styles, and markets can improve diversification and steady your investing journey.
(5) The Financial Media is Often Just Noise to Be Ignored
Paying attention to headlines and articles that attempt to anticipate the impact that a pandemic, an election, or recently released economic data may have on the market will likely only do one thing for you: stimulate the behavioral and emotional aspects of investing. After the recovery from the downturn in March, the election was the next thing that was supposed to derail or stir up the market. It has, however, been more or less smooth sailing through election day and into the holiday season with the S&P 500 up over 10% since 9/30/20. Always remember, market timing requires two decisions: when to get out, and when to get back in. Even if you get the first one right, the chances of you getting the second one right as well are very low.
(6) Often Times, it Pays to Do Nothing
You may be tempted to act when markets go crazy, but buy and hold investing with a long-term focus is the most tried and true strategy there is. Take a deep breath, stick to the plan, and ride it out. Unemotional actions can be very beneficial, such as tax loss harvesting in a downturn or rebalancing to your desired levels of stocks and bonds when they stray far from targets. The key is to avoid the actions that will cost you in the long run, and these tend to be the drastic ones.
Have a happy and safe holiday season and best wishes to you and your families!