Below are excerpts from our year-end letter to clients. We hope investors find the charts and messages helpful. As always, if anyone has any questions please let us know.
Now in the books, 2022 was certainly not a good year for the market.
As we have written about many times before, however, the key to good long-term investing is staying disciplined.
For us, staying disciplined meant that we kept allocations relatively close to our targets this past quarter and were able to capture a rally that took global stock markets and municipal bond indices up approximately 10% and 3%, respectively, over the past three months.
Unfortunately, though, this positive run wasn’t enough to overcome drops earlier in the year and markets produced negative full-year returns for 2022.
Calendar-year negative returns are rare and, as we have highlighted in previous notes, rarely repeat, but they are now playing into a common year-end tradition. Tis the season on Wall Street for invitations to gather to hear yearly forecasts and New Year’s calls to action – both of which we are currently receiving most every day.
Many of the presentations offer good thoughts and we are joining these calls to keep an eye open for potential opportunities. In addition, we are remaining mindful that history consistently shows that the accuracy of the forecasts will be poor.
It’s not that many top minds aren’t working hard to find an edge – they are. A problem is chaos.
Markets and the factors that move them are part of what is called a Level Two Chaotic System. Every time we act on a market forecast, our interaction with the system or model makes it less stable. As an example, if investors think a stock, bond, or market segment is cheap or expensive, they may buy or sell. These actions, especially if done by larger groups reacting to the same forecast, can immediately change the price or valuation variables that went into the projection about what the future return of the trade might be.
As we wrote in a piece about market statistics, investment models are not driven by physics constants that are reliable. The factors and inputs we use are constantly changing, which can make the forecasts, and the recommendations that are driven by them, inherently unreliable.
Over the long-term, fundamentals and trends can influence prices, but over short-term periods, markets are likely to be driven by unexpected events and investors’ emotional reactions to them.
With so much evidence against the accuracy of forecasting economic growth or market movements, you may wonder why investors spend so much time on them. Well, the reality is that many leading investors don’t.
Warren Buffett, Howard Marks, Peter Lynch, and Benjamin Graham all stated that they don’t put much faith in forecasts. As they and many other investors have said, the keys are to appreciate that we will be wrong often and to be prepared for the unpredictable.
An old saying goes that investor emotions create 50-year market floods about every 5 years. Because of this, it is important to build diversified portfolios and temper big bets and market calls that can lead to big mistakes.
Tempered approaches like this can seem boring, but the track records of many successful professionals can be attributed to keeping it simple and avoiding unforced errors. David Swensen, the long-time Chief Investment Officer of Yale’s top performing endowment talked about this in his book, Unconventional Success.
The chart below highlights the dangers of trying to time the market in response to feelings or forecasts. Due to the positive skewness of stocks, and the fact that the U.S. stock market is positive on a calendar year basis approximately 80% of the time, the key to achieving attractive returns often comes down to just a few days.
Dangers of Market Timing
Source: Standard & Poors and Crandall, Pierce, and Company, period ending 12/31/22
As the Dangers of Market Timing illustration highlights, being out of the stock market for only one key day each year for 50 years cuts the annualized return more than in half – from 7% down to 3%. Translating this to compounded dollars, an investor who invested $100,000 during this period, and missed just the single best day in the market each year, lost out on over $2.8 million of potential gains.
This cautionary tale reminds us of a red and green chart that we first posted at the end of 2018 – another calendar year that was negative and included sizable swings. The following is an update as of the end of 2022.
S&P 500 – Cumulative Total Returns – Period Ending 12/31/2022
Source: Standard & Poors and Black Diamond
The one-year red section of the chart makes news, can influence forecasts, and drives short-term behavior. The green in every other box is what we stay anchored on and highlights the long-term returns we strive to achieve.
Our investment policy approach drives us to buy or sell if allocations get too far outside targets and helps us avoid large errors. We are never pleased with negative years, but by staying true to our strategy we have been able to steadily compound long-term returns and feel that we are prudently positioned for the future.
As always, if you have any questions or would like to have a review call, please let us know.
Recessions – What Should Investors Do
The Same Thing – Over and Over
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Past performance is no guarantee of future results, which may vary, and investing involves risk, including possible loss of principal. The value of the investments and the income derived from them may fluctuate over time.
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The reference to the U.S. stock market being positive approximately 80% of the time represents the total returns of the S&P500 from 1950 through the full year ending 2022 per calculations run by Crandell, Pierce and Company.
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