The Decade Challenge
It was hard to lose money in 2019. Nearly all major asset classes posted strong performance. Global stocks gained 27.3%, while a broad index of bonds gained 8.7%. Even commodities were up 7.7% last year. The only way you didn’t participate is if you sold everything a year ago.
2019 also capped off a strong decade of performance. The world has come a long way in the last ten years. At the start of 2010, the world was struggling with the aftermath of the largest economic contraction since the Great Depression. The unemployment rate in the US was 9.9%. The Federal Reserve and other global central banks launched an unprecedented monetary intervention to combat deflation. Many feared the unintended consequences of such policies would result in a stunted economy, high inflation, or both.
Those fears didn’t pan out. Since 2009, US inflation has averaged 1.7% per year, and the economy grew at a modest but respectable rate of 2.3% per year. The markets have been up and down along the way – eight pullbacks of at least 10% (plus several smaller ones), but stocks have also made new highs since 2014. On the whole, it was a good decade for stocks. Global stocks averaged 9.4% per year in the 2010s, not as good as 20% in the 1980s or 11.7% of the ‘90s, but much improved over the 0.9% earned in the 2000s.
Technology stocks were at the heart of those strong returns. While 2% economic growth is better than nothing, it left investors clamoring for companies with higher profits through innovation and disruption delivered by technology companies.
That theme was widespread. Tech is why US stocks have outperformed stocks in Europe, Japan, and elsewhere. It is also why growth stocks have outperformed value over the last decade to the frustration of many faithful Ben Graham value investors, Warren Buffett included. Over the last decade, US growth stocks returned an annual average return of 15.0%, while value stocks only returned 11.7%. That’s the difference between $100 growing to $306 versus $202 over ten years.
Tech has affected more than our financial accounts. Two-day shipping, Uber, Siri, Alexa, and Twitter have changed our daily lives, but it hasn’t impacted everyone equally. While new opportunities were created, some jobs were lost forever. Free markets excel at rewarding innovation. It is silent on how all this innovation and technology should be used.
Tech has affected more than our financial accounts. Two-day shipping, Uber, Siri, Alexa, and Twitter have changed our daily lives, but it hasn’t impacted everyone equally. While new opportunities were created, some jobs were lost forever. Free markets excel at rewarding innovation. It is silent on how all this innovation and technology should be used.
A year like 2019 makes us wonder if we will get to keep all these gains next year. As for 2020, nearly anything could happen. Since 1970, stocks have returned greater than 20% 15 times prior to this year. The average return following those gangbuster years was 9%. That’s not much different than the average of all the years of 10.8%. The dispersion has been wide around that 9% too. Will next year be like 1972 or 1999 where the market retreated 14.5% and 13.9%, respectively? Or will it be more like 1985, when after a stellar 41% gain, the market added another 42% in 1986?
TECH TODAY AND THE “NIFTY FIFTY”
If you think the S&P 500 is a broadly diversified portfolio, you could be painfully wrong. It is only a slice of a much larger market. The S&P has benefitted from being heavily weighted towards tech firms, so much so it’s effectively become a tech fund. Just two stocks, Microsoft and Apple, accounted for 15% of the S&P 500’s gains for 2019.
It’s not unusual for a select cohort of stocks to drive the return of an index. Railroad stocks dominated the markets of the 19th century, while energy and raw materials companies were drivers for most of the 20th century. The influence of these companies on the market is much smaller today.
The popular “nifty fifty” basket of large US stocks was credited for leading the bull market in the ‘60s and early ‘70s. Valuations for these same stocks became so elevated these blue-chip companies couldn’t meet investors’ lofty expectations. While many of these companies are still in business, these stocks underperformed the market over the next three decades[1].
Few complain when the returns are good, but it won’t be quite as fun when they are not. It’s more important than ever to diversify beyond large US stocks and prudently manage this concentration risk.
WHAT IT ALL MEANS
It has been a great year for the balanced portfolio – both stocks and bonds have returned numbers that are above what we believe can be expected going forward. Low interest rates do not necessarily mean the 60/40 will be a less superior portfolio. However, it may ultimately mean that returns may be lower over the next twenty years than they have been over the last twenty. But returns for all portfolios will likely be lower as well – even ones with commodities, private funds and the other more expensive, and less reliable, options.
When planning ahead, especially when it comes to the financial markets, we are forced to make assumptions about the future. Will it be like the past? How will it be different? Don’t bank on history repeating. Today’s market conditions have implications for the future. Investors should carefully incorporate these conditions and lessons from history into a process for a well-crafted long-term plan.
[1] “The Nifty Fifty Revisited.” Jeff Fesenmaier and Gary Smith. http://economics-files.pomona.edu/GarySmith/Nifty50/Nifty50.html
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