While 2020 was the most challenging year we’ve endured, on a number of levels, our investment performance finished the year on a high note. For the quarter ending December 31, 2020, performance was exceptionally strong, both on an absolute basis and relative to the S&P 500 Index. In fact, performance for the nine-months ending December 31, 2020 was our highest nine-month return in a decade.
As we stated in our Q1-2020 letter, we used the market downdraft as an opportunity to upgrade the quality of client equity portfolios by buying higher-quality, larger-capitalization stocks of better businesses we previously viewed as too expensive.
While we remain steadfast and loyal to our “Value” strategy, we thought it made good sense to broaden our definition of “Value,” a term that had become to mean strictly “low-multiple,” whether that refers to price-to-earnings, enterprise value –to-EBITDA, cash flow or other metrics. Whereas these valuation metrics can be useful in screening the universe of stocks for possible investment candidates, you have to assess a company’s products, competitive position, growth prospects, quality of management and many other factors before you can judge whether a cheap stock is a discarded “cigar butt” lying in the street or undervalued opportunity.
Though we’ve been willing to pay more for size and quality, we’re still 100% committed to finding undervalued stocks (not buying overvalued stocks just because they’re going up). We firmly believed the fortunes of “Value” would turn for the better at some point and our portfolio would benefit, if and when that happened. Until then, we thought it made good sense to not have our fortunes so closes tied to that happening.
As always, past performance is no guarantee of future results, but this is precisely how our strategy has played out. Although “Value” underperformed “Growth” by the biggest margin on record for the full year 2020, “Value” staged an impressive comeback in the final quarter of 2020, as the “growth scarcity” premium that powered the mega-capitalization technology darlings abated as progress on COVID vaccine front brought visibility to the reopening/recovery of the economy.
While valuations aren’t as attractive as they were back in March, we still like what we own. The market’s overall forward P/E of about 22.5X is high on an absolute basis, but in the context of the 10-Year U.S. Treasury Bond yielding just over 1% doesn’t seem overly worrisome. While there are certainly a number of potential negatives for stocks (overheated IPO market, stratospheric technology sector valuations, speculative pockets like Bitcoin and record margin debt), we think fundamentals are good and improving. The vaccine rollout should boost economic activity and we’re encouraged companies are generally guiding earnings expectations higher.
We are aware a good three-month or even nine-month period doesn’t necessarily mark the beginning of a reversal of the painful trend of the massive outperformance of “Growth.” We can’t say for sure our (and your) frustrating multi-year walk through the performance desert is finally over. There have been what proved to be false starts before and there’s no guarantee Lucy won’t pull the football away again. In fact, we’d be surprised if there aren’t setbacks along the way. Still, it feels great having the wind at our backs for a change!
Lessons Learned/Reinforced in 2020
Even though 2020 was a terrible, gut-wrenching year, the likes of which we hope to never have to experience again, it highlighted some timeless investing concepts.
Trees don’t grow to the sky and the “Value tortoise” is on the move
Thanks to our clients, we’ve been in business more than 45 years. Over that time, we’ve witnessed numerous bull and bear markets, economic expansions and recessions and seen many investment fads come and go.
Back in the 1960s and early 1970s, there was a group of “blue chip” growth stocks investors “had to own,” known as the “Nifty Fifty.” The widely-held mantra was these were “one-decision” stocks that you could simply buy, hold forever and prosper. The roster included stalwarts that have stood the test of time, like Coca-Cola, Disney, McDonald’s and American Express. However, it also included companies that would eventually perish, like Joseph Schlitz Brewing Company, Polaroid, S.S. Kresge and Sears, Roebuck and Company.
Due to their popularity, investors were willing to pay more than twice as much for a dollar of earnings for this small group of stock than for the S&P 500 as a whole. Alas, as it always eventually turns out, trees don’t grow to the sky. In hindsight, the stocks got too far ahead of their fundamentals and even the stalwarts crashed 60-80% during the bear market of 1973-1974 (see graph below).
Fast forward to the present and there is a new group of market darlings, the high-growth FAAMG stocks (Facebook, Apple, Amazon, Microsoft and Google). Recall the S&P 500 is a capitalization-weighted index, which means the performance of the largest-capitalization stocks impact the performance of the index more than the smaller-capitalization stocks. Together, the five FAAMG stocks account for about 23% of the capitalization weight of the index, even though they comprise only 1% of the stocks (5/500). The five largest stocks in the S&P 500 typically have a combined weight of about 10%, so the S&P 500 today is unusually “top heavy.”
Clearly, if you didn’t own Facebook (2.2% weight/+33.1 % in 2020), Apple (6.4%/+82.3%), Amazon (4.5%/+76.3%), Microsoft (5.4%/+42.5%) and Google (3.5%/+30.9%) in 2020 (and several years prior), we can attest it’s been a mighty struggle to keep pace with the S&P 500. Indeed, as shown in the graph below from Barron’s, the 35.7% performance gap between the Russell 1000 Growth Index (+38.5%) and the Russell 1000 Value Index (+2.8%) in 2020 was the largest difference since 1994.
The graph below from Crandall, Pierce depicts the “Growth” vs. “Value” performance history slightly differently. While “Growth” and “Value” have almost identical performance over a forty-year period, under-/overperformance has run in distinct cycles of varying durations and magnitude. The most recent period of “Value” outperformance started when the technology/internet bubble popped in 2000 and lasted about six and a half years. Over that period, “Value” compounded at 8.49% annually while “Growth” compounded at -6.99% annually. The ensuing period of “Growth” outperformance lasted fourteen years. Over that period, “Growth” compounded at 13.16% and “Value” at 6.21% (less than half). As you can see at the far right of the graph, from August 2020 through the end of the year, “Value” had more than double the return of “Growth.”
As we stated at the beginning of the letter, only time will tell if August 2020 marked the beginning of a period of “Value” outperformance. Similar, we doubt any of the FAAMGs will perish and we’re not predicting they’ll fall 60-80%. However, history has shown trees don’t grow to the sky, so are hopeful the “Value” tortoise continues to move ahead.
Stocks are inherently volatile, so stay calm, stay in and stay the course
From February 19 to March 23 (23 trading days), the S&P 500 suffered its most rapid meltdown in history, dropping a nauseating 33.9%. Of the 21 trading days between February 27 and March 27, 18 days saw moves in the S&P 500 of more than 2%; eleven down and seven up. They included the second-biggest percentage loss since 1940 (-12.0% on March 16, trailing only the -20.5% loss on “Black Monday,” October 19, 1987), but also the biggest daily percentage gain since 1933 (9.4% on March 24). In fact, the 17.6% surge in the S&P 500 from March 24-26 was the biggest three-day advance in more than 80 years.
In other words, we had both the most rapid meltdown in history and biggest three-day advance in more than 80 years occur in the first quarter of 2020!
- Stay calm. As shown in the graph from J.P. Morgan, stock market volatility is perfectly normal. Between 1980 and 2020, the S&P 500 experienced an average intra-year drop of 14.3% (peak-to-trough), yet had a positive return in 31 of 41 calendar years.
- Stay in. It would have been easy to have been scared out of the market on March 23, but then you would have missed the ensuing 17.6% recovery that happened in the next three days. According to Fidelity, $10,000 invested in the S&P 500 on January 1, 1980 would have grown to $952,512 by August 31, 2020. However, an investor who missed just 10 of the best-performing days in those past 40 years (more than 10 thousand trading days) would have lost out on more than half of the gains (growing instead to only $425,369).” Stocks are inherently volatile and missed upside can dramatically cut into long-term returns. We acknowledge staying invested is very difficult during a violent downdraft. As pugilist Mike Tyson famously said, “Everyone has a plan until they get punched in the mouth.”
- Stay the course. For long-term investors, time is on your side and time in the market is more important than timing the market. Historically, the longer you stay in the market, the greater the probability for a positive outcome. According to Crandall Pierce, for rolling periods between January 1950 and December 2020, one-year returns for the S&P 500 were positive 79% of the time (range of -43.3% to 61.2%), five-year returns were positive 92% of the time (-6.6% to 29.6%) and 10-year returns were positive 97% of the time (-3.4% to 19.5%).
There are ALWAYS reasons not to invest
As you can see in the graph from Crandall, Pierce, investors have faced a number of crises over the past century plus. Many times it seemed like the world was coming to an end. However, it never did. Each crisis eventually ended and stocks moved higher. The COVID pandemic was #125 on the list. We have no idea what it is or when it will happen, but there will be a #126. Again, past performance is no guarantee of future results, but history suggests that Crisis #126 will also pass and stocks will eventually move higher.
Our non-forecast for 2021
One of the other lessons reinforced in 2020 is forecasts are worthless, so we don’t attempt to forecast the economy or markets (which is like trying to predict a casino game). No matter how much we wish, no one can predict the market. No one will know when to go to cash and when to go all in. Like a broken clock, sometimes forecasts can be correct, but they lack persistence. Anyone who tells you differently is not being truthful.
Our non- forecast for 2021 is the same as last year. It is persistent and reliable because it is based on how we feel, and temptations we face as investors. Not only are these more predictable than market outcomes, they are also more important to investor well-being.
While we cannot control the volatility and outcomes of the stock market, we can control how we behave and respond to market outcomes. Financial markets are only one side of the investing equation; the other side is the choices you make. We think it’s best to focus on the part we have control over. Additionally, understanding what we may face can help us improve our decision-making process.
- The economy/market will do something that surprises us.
- Investors who watch the market often will experience more stress than those that don’t.
- While we can’t predict the future, all will seem obvious in hindsight.
- You will be tempted to abandon your plan at some point based on expert forecasts and/or short-term market performance.
- Investors that focus on those things they can control will have a better investment experience than those that focus on what they can’t control nor predict.
- Do you remember where you were when the clock struck midnight on January 1, 2000, when the “Y2K” apocalypse would be unleashed?
- Dangers, known and unknown, lurk everywhere and can appear at any time.
- Investing with your gut, or feelings, will result in lower returns and higher stress than if you remain disciplined to your financial plan.
- Not looking, aka “strategic ignorance”, will result in less stress and greater personal enjoyment than watching the market.
Successful investing is simple, but not easy. It is difficult to stick with a strategy when it is out of favor, like “Value” has been for more than a decade. Patience and discipline are virtues because they aren’t easy, yet they are essential for your success. As your adviser, one of our most important roles is helping you decipher the noise from what really matters for your financial success, as we hopefully did in 2020.
We wish you a prosperous, fulfilling and happy 2021. Thank you for allowing us to be your trusted partner along the journey.
Associate Director of Client Service Zach Greiner awarded CERTIFIED FINANCIAL PLANNER™ certification by CFP Board
We’re pleased to announce Zach Greiner, CFP®, Associate Director of Client Service, was recently awarded CERTIFIED FINANCIAL PLANNER™ certification by the CFP Board. This is an important professional accomplishment and milestone as Kirr, Marbach strives to be the “go-to” financial resource for our clients for advice ranging from investments to retirement to personal finance.
We congratulate Zach on completing this rigorous program and passing a very difficult exam!
Kirr, Marbach & Company, LLC
Past performance is not a guarantee of future results.
The S&P 500 Index is an unmanaged, capitalization-weighted index generally representative of the U.S. market for large capitalization stocks. This index cannot be invested in directly.
The Russell 1000 Index is an unmanaged, capitalization-weighted index generally representative of the U.S. market for large-capitalization stocks. This index cannot be invested in directly.
The Russell 1000 Growth Index is an unmanaged, capitalization-weighted index that measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 Index companies with higher price-to-book ratios and higher forecasted growth values. This index cannot be invested in directly.
The Russell 1000 Value Index is an unmanaged, capitalization-weighted index that measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 Index companies with lower price-to-book ratios and lower expected growth values. This index cannot be invested in directly.
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