Betting on the Status Quo

“Buy stocks for the long run. Diversify. Stay patient and watch your dollars grow.” We believe this investing mantra remains true, but it sure doesn’t feel easy this year. A lot of us are worried – about our jobs, our investments, our health, and our families. And it feels like this uncertainty arrived without warning. 

The challenge is that humans are wired to plan and predict. We generally believe tomorrow will look like today. Over long stretches, this works well because life moves in patterns. We should plant crops based on seasonal cycles. We should develop tools and equipment so that the next time we do a job, life is a little easier. And we should invest our financial capital in businesses that continue to improve our world. But this last one gets difficult when it’s hard to know what the future will look like over the next few months, or maybe even the next few years. And for me this highlights a big idea worth discussing: betting on the status quo. 

“Progress happens too slowly for people to notice; setbacks happen too fast for people to ignore. There are lots of overnight tragedies. There are rarely overnight miracles.”  Morgan Housel - Five Lessons from History 

Investing is hard because we mentally bet on continuation. Over time, markets go up. We believe that is the status quo, so bear markets feel surprising even when history shows us that major declines - mixed into the longer upward trajectory - are routine. A portfolio may have an average annual return of 7% with a standard deviation of 10%. If you invest long enough the returns average about 7% per year, but over shorter time horizons you could easily range between 27% and negative 13% - and as we saw just this year, the downside can be even higher at times! When we experience those negative returns, the status quo changes. Behavioral ticks beyond our control produce a strong negative reaction to the loss. Fear sets in and we want, more than anything, to protect against additional losses. It is easy to predict that our five percent loss will continue snowballing to ten, and then twenty, until eventually we go broke. 

The challenge with investing is recognizing a meaningful change in the status quo versus a surprising yet arguably routine change in prices. The status quo is that investments provide positive returns over time but experience significant price swings. Stock portfolios go through bouts of severe loss, but the losses have always proven temporary. So far in 2020, this looks much the same, even if it feels different. We might recover in a few months; it might take a few years and more gut-wrenching losses. The big decision is setting goals and adopting a portfolio that provides adequate returns, and risk levels you can live with.  

Buying stocks means buying ownership stakes in companies. Over time, it has proven profitable and we don’t see this changing any time soon. But even if this crisis genuinely presents ’nothing new’ in terms of long-term investment strategy, it has potential to shake up how our world works, and how we interact with one another, in very real ways. Here are some areas we are thinking about when it comes to the ‘status quo’ going forward. 

Value v. Growth 

Value stocks tend to be mature or established businesses – think AT&T, JP Morgan Chase, Exxon Mobil, and Johnson & Johnson. Growth stocks present strong future opportunities and often trade at a premium – companies like Visa, Netflix, Amazon, and Facebook. Growth stocks have been leading the market for many years now and have proven resilient during the March 2020 decline. Is this temporary or part of a bigger change that is just starting to play itself out? 

Technology is changing how humans work and could be breaking down the classic ideas we have around value vs. growth. The changes will be amplified if Covid-19 and other global pandemics fundamentally shift the way we interact as a society. Being an industry leader may soon require digital and cloud-based solutions, remote access, and service without borders. “Asset lite” business models, companies that don’t require significant capital investment in people or production, may also be better positioned to weather financial storms like the one we are currently experiencing. 

We design portfolios, and partner with fund managers, with these ideas in mind. And we are open to talking with you about funds and companies that may do well in the future, regardless of how things shake out with the current pandemic. 

U.S. Stocks > International Stocks 

Over the past few years, we’ve noticed more market commentators discounting the importance of including international equity within investment portfolios. U.S. stocks have significantly outperformed international stocks over the past ten years, thanks in no small part to global leadership in the growth/technology space. Our team will continue to invest in these leading technology companies but feel it would be unwise to abandon our global investment strategy. International stocks trade at lower valuations and have been tempered by a strong U.S. dollar. While U.S. stocks have been bid up to prices that some would argue defy current economic realities, there is arguably more ‘value’ in the prices attached to many international companies. Further, we note that going back to the 1970s you can see clear swings in ‘leadership’ between U.S. and international stocks.  

Many leading fund companies we respect, including BlackRock and Vanguard, believe that international stocks will outperform U.S. stocks over the next 5-10 years.  

The “Everybody Wins” Game of Poker 

In market downturns we often expect conservative bond funds to maintain value, or in some cases provide a positive return, when stocks decline. In early 2020 most bond funds fell in lockstep with stocks although they declined less. Many suggest this was less about the quality of the bonds and more about a need for cash. Sellers rushed to raise cash and this drove down the price of bonds. 

As this was happening, government stimulus efforts moved quickly. Among other things, the Federal Reserve ramped up asset purchases (“quantitative easing”). The Fed started buying bonds in the open market to provide liquidity, lower interest rates, and encourage borrowing. This began during the Great Recession and in the past focused more on safe treasury bonds and government-backed mortgage bonds. But on April 9th this program expanded to include corporate bond fund ETFs and possibly even high yield or “junk” debt. In other words, the Fed could start buying up the debt of American businesses, even those that are struggling, to help prop up the markets. 

The good news is that bonds started to recover. But it seems like a game of poker where everybody wins. Maybe it proves temporary, but what does it mean to have this backstop in place during challenging times? In a world with financial derivatives and other liquidity traps, do guard rails on the potential losses faced by private business help reduce economic damage? Or do they create the wrong incentives for companies if it appears no one can lose, with the ‘house’ invested in the players at the table, even the players making riskier bets? This is a meaningful deviation from past practices and may introduce some unanticipated risks that will take time to better understand.  

The Shortest Path to Living Wealthy 

Most of our recent thoughts and discussions have centered on the direction of the markets, the best investment opportunities, and how we can preserve capital and limit losses. We shared some ideas here on investments, but the hard truth is that thousands if not millions of smart people are looking at these same opportunities, vetting the risks, and moving stock prices to better match those expectations. There are few if any “home run” ideas out there, and a lot of smart people fighting over the same pitches. In a changing environment, even our best laid plans may fall short. This reminds me of a valuable idea that we hear so often, one that is easy in theory but much harder in practice: giving energy and attention to what is within our control. 

This year shows us how fast things can change, and in ways we previously never imagined. It feels like things are happening beyond our control, and in many ways that is true. But our balanced approach to financial planning and investment portfolios prepares us for these tough times. It is within our control to stick to the game plan. It is within our control to adjust and make changes. And it is within our control to define for ourselves what living wealthy means. 

We have control over how we approach these days. If our emotions and personal well-being are set by stock market performance, the daily news cycle, or radical Facebook posts, we effectively relinquish control of our own happiness. We take back control by directing our attention to loved ones, our good health, time spent outdoors, and the food on our plates. Outside of our borders, many don’t have those luxuries right now. Would things for us look different if the stock market goes up or down? Sure, but maybe not by as much as we think. The shortest path to living wealthy remains being content with what we have. With the right mindset, living ‘wealthy’ is always within our reach.