A Review of Markets 2020: Electronic Herd, Dividend Volatility, Retirement Income in Focus
As the world celebrates a New Year, it’s a great time to take stock on the core principles of investments. Looking back, 2020 was a year that had all the key ingredients that individuals need to understand to be a successful long-term investor. Enclosed are a few critical points and observations:
In January 2020, we were going into the 11th year of the US economic expansion. The unemployment rate was at an extreme low at 3.5% and University of Michigan consumer sentiment was at a high of 97%. On January 9, 2020, I gave a lunch briefing on monetary policy, presidential election cycle and the stock market to a group of about 50 people. Most folks were upbeat and very positive about their jobs, financial position in life and their stock portfolios.
By the week of February 24, 2020, the stock market had seen two down 1,000 point-days. I keep a daily journal and have for about ten-years now of thoughts, investment ideas and daily research activities.
By early March, the market was limit down 2,000 points, which is a 7% decline on March 9, 2020. On March 11th the market was down over 1,000 points and again on March 12th with a 15-minute trading halt. On March 15, which was a Sunday, the Fed cut interest rates to ZERO. That Monday morning, March 16, 2020 the market was down 3,000 points. At this time, my first formal client communication letter was sent on March 15, 2020 where I wrote about my framework and thinking on current events. A quote from that letter, “In fact, now is a good time to buy stocks. Ted William wrote a book called, The Science of Hitting, where he said, “the most important thing in being a good hitter is to wait for the fat pitch in the sweet spot. I believe the fat pitch is now.”
Warren Buffett talks about the market (Mr. Market) as being a manic depressive. Here is a quote from a 1987 shareholder letter, “you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.” Buffett goes on to state, “Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market’s quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times, he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions, he will name a very low price, since he is terrified that you will unload your interest on him.” 2020 was a year in which we saw both sides of Mr. Market euphoric and depressed states. However, the point is to always remember the market is there to serve you, not to instruct you. I think of the market as a restaurant waiter. He takes your order and provides you the check at the end of the meal. That’s it! It’s up to the individual investor to choose what they want to eat and how long they want to stay.
In 2020, we also saw the rise of Robinhood, which is an on-line trading platform. The company’s pitch is pay $0 commission on online stock, ETF, and options and “tools you need to put your money in motion” claims their official website. As a long-term investor with a time horizon of 5-7 years, the concept of buying a stock for a day, week or less than one-year to pay short-term capital gains tax (ordinary income tax rates) is not investing. It has the vogue, new seductive appeal of quick profits. However, if investing were that easy, everyone would be a millionaire. Warren Buffett talks about the electronic herd and how it can be destructive to price. One of my Critical Findings in my dissertation work: https://search.proquest.com/openview/1e55c8a3fbcec0cd23a1d9a436f5a9a5/1?cbl=18750&diss=y&pq-origsite=gscholar was Buffett’s comments on the electronic herd. He states, “There is an electronic herd of people around the world managing huge amounts of money who think that a decision on everything in their portfolio should be made, basically, daily, or hourly or by the minute.” Buffett goes further to say, “It just means that the participants are playing a different game, and that different game can have different consequences than in a buy-and-hold environment.”
In 2020, we managed through the COVID-19 crisis by not reacting but by being steady, slow and smooth. We did this by focusing on company fundamentals (accounting numbers, quarterly earnings reports, management comments) and one-on-one conversations with our portfolio holdings. One of the themes that I think market participants learned in 2020 was the fact that long-term business performance can be disconnected from the stock price for extended periods. Howard Marks in his book, The Most Important Thing, discusses the relationship between price and value. By March 2020, investor psychology turned negative and prices deviated wildly from value.
Retirement Income:
Many people’s time horizons shorten as they enter retirement. However, I think that is a mistake in this low interest rate environment. I believe the main goal should be to keep your cash flow and income picture stable. For retirees, cash flow is a major risk factor. Over the last few years, dividend payments from stocks have been more stable during economic downturns than equity prices. Stuart Lucas in his book, The Taxable Investors Manifesto, states, “since WWII ended, the US stock market has experienced 29 corrections. In contrast, rolling annual dividend payments declined more than 5% only four times and only once during the financial crisis of 2007-2009, did they fall double digits.” This means that dividend volatility has been a much better factor to monitor than equity prices. In fact, a review of our core holdings in Q4202 reveal that the average dividend yield in our portfolio is in a range of 4%-5%, with payout ratios holding steady in the face of short-term earnings declines. That level of dividend yield produces solid annual income from retirees, which is 2-3 times the income of bonds at present levels.
Conclusion:
Currently, I see a reward/risk ratio of 3 to 1 in our current investment portfolios. Our investment strategy has tilted toward small capitalization, industrial, cyclical infrastructure and banking sector. That’s where we see value in 2021. We live in the spectacular now, where it’s a wonderful time to seek and find mispriced equites to buy and hold over a long-term horizon. The key is patience, research, both of which point to the main underlying goal of investing: A better understanding of the underlying true intrinsic value of the company. Then purchasing the stock when Mr. Market has one of his manic depression periods.
Respectfully,
Dr. Christian Koch, CFP®, CPWA®, CDFA®, RICP®
