January 2020
By Darren Nyce, CFA
Senior Research Analyst, Castle Investment Advisors®, LLC


Calvin strip

This Calvin & Hobbes strip was written by Bill Watterson and published in December 1989; I’ll save you the math, that was 30 years ago. Reading news headlines and the themes of many social media posts indicate that many people in 2020 share Calvin’s perspective. It is easy to be pessimistic. Problems abound, unjust acts cry out to be righted, and life just isn’t as easy as we thought it would be. But when you step away from the minute by minute descriptions of all that is wrong with the world and take in some of the improvements that have evolved over the past few decades, the progress is outstanding.

Morgan Housel wrote a blog recently comparing current conditions to 1981, the year that the median-aged person in America would have been born. Here are some of the findings:

  1981 Current
Auto Fatality Rate per 100,000 21.49 11.18
Homicide Rate per 100,000 10 5
Infant Mortality per 1,000 12.1 5.6
Average Miles per gallon 14.9 22.3
Median Personal Income (inflation adjusted) $22,682 $33,706
Commercial Aviation Deaths (previous 10 years) 25,995 9,197
Cigarettes smoked in U.S. 640 billion 249 billion
Heart-disease deaths per 100,000 400 168

Source: collaborativefund.com January 2, 2020 by Morgan House

In a December article in “The Spectator” Matt Ridley argues that we’ve just had the best decade in human history sighting the following:

  • Falling poverty rates
  • Famine is virtually extinct
  • Decline of malaria, polio, and heart disease
  • Rising productivity of agriculture
  • Expansion of forests
  • Energy saving innovations.

So, long-term progress is certainly being made on many fronts. And, if you need a reason to feel good about more short-term data, you only need to look at your December brokerage statement. The chart below demonstrates each of the major asset classes showing positive performance for 2019:

asset class performance 820

The move in the stock market was especially impressive as there was a year-over-year decline in the overall earnings for the S&P 500 during the year. Stock buyers instead chose to focus on a decrease in trade tensions and lower interest rates.

The economy remains in pretty good shape as the longest economic expansion since the Civil War continues. Through the first three quarters of 2019, GDP grew at 2.1%. This is not the robust 3% that many would like, but solid growth, nonetheless. With fewer babies being born and lower immigration numbers, there doesn’t appear to be enough new workers to bump GDP up to 3% anytime soon.

Most indicators do not indicate that a recession is coming soon. 

  • Consumer spending remains strong - with unemployment at 3.5%, most people who want a job, have a job. 
  • Cyclical areas such as housing, cars, and inventories are not at frothy levels that would prompt a recession.
  • It is likely that the Federal Reserve will be less inclined to move interest rates in an election year where the economy is solid, and inflation is consistently around 2%.

The stock market’s strong performance has indeed pushed valuations higher as the forward P/E is over 18. This should probably be a sign to lower expectations as to what kinds of returns are possible in the next few years, but we would not consider this a time to exit the market.

If you flipped a coin and got tails 10 times in a row, does this change the likelihood of getting heads on the 11th flip? No, the probability is still 50/50. People tend to apply this logic to the stock market as well. Does the market being up significantly in one year change the probability that it will be positive in the next? The data would say no. Below is a chart that shows how the Dow Jones Industrial Average performed in the year following certain scenarios:

Can you tell the difference

The Dow has risen in 66% of the calendar years of its existence (it has been around since 1897).

  • When the Dow is up one year, 65% of the time it is up the next. 
  • When the Dow is up over 19.3%, 65% of the time it is up the following year.

Annual performance is independent of what happened the previous year. 

As we head into 2020, our plan is to position portfolios in a way that appropriately meshes the evidence displayed by current market and economic conditions with the long-term goals of each client. We expect to trim back equity positions that have grown above their target allocations in order to reduce the risks of a more expensive market, while prudently evaluating new opportunities.

The end of a decade lends itself to periods of reflection and analysis. In that spirit, it seems like this would be a good time to share a list of investment principles that I use to sharpen my perspective and help keep me anchored. The list, which grows and morphs over time, is a compilation of ideas I have learned, observed, and stolen. It is not a complete investing philosophy, but some thoughts that have served me well over the years. Because they are bullet-point in nature, each item of course oversimplifies the underlying message, but no one reading a newsletter wants a page and a half of written prose fleshing out the details. Here’s the list:

  • Goals should drive the composition of an investment portfolio.
  • Resist the illusion of control that comes from taking action when doing nothing is better.
  • Minimize fees where possible, but total return tells the whole story.
  • The longer your holding period, the higher your chances of achieving your goals.
  • Buy stocks that are cheap – valuation matters.
  • Don’t neglect inflation’s deterioration of purchasing power.
  • Specific forecasts are meaningless and frequently foolish.
  • Use the power of mean reversion to your benefit.
  • Process wins over time - luck and skill are often indistinguishable in the short run.
  • Change your mind when facts change.
  • Time is more valuable than money.
  • It is okay to not know.
  • Tops and bottoms are impossible to recognize in real-time.
  • Someone will have better returns than you.
  • Diversification is “the only rational deployment of our ignorance” (Peter Bernstein) that results in always having something in your portfolio that is out of favor.
  • Fight the urge to make emotional investment decisions – stick to a long-term plan during the inevitable downturns.
  • Be realistic about expected returns.
  • Be brutally honest about evaluating past decisions.
  • Don’t use your most recent experience as a baseline for what will happen in the future.

Looking forward to great things in the '20s and thankful to live in a world that is becoming a better place. Have a great year.

DarrenSignature

Disclosures: 
Tax, legal, and estate planning advice contained in this article is general in nature. Always consult an attorney or tax professional regarding your specific legal or tax situation. This article was prepared for informational purposes only and does not constitute an offer to buy or sell, or a solicitation of any offer to buy or sell the securities mentioned herein. Information presented does not involve the rendering of personalized investment advice, but is limited to the dissemination of general information regarding products and services. It should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. Any strategy discussed herein may not be suitable for all investors. Before implementing any strategy, investors should confer with their financial advisor. No current or prospective client should assume that the future performance of any specific investment, investment strategy or product made reference to directly or indirectly, will be profitable or equal to past performance levels.