No One Expects a 40% Return for the S&P 500 This Year
I defy you to find a pundit optimistic about the stock market. Is anyone predicting double digit returns? Low to mid-single digits seems to be the popular view among those shouting the loudest. Short term returns have been stellar as the S&P 500 gained almost 12% in 2016. Intermediate returns have been stellar with the S&P 500 averaging 14.65% for the last 5 years.
So we’re due for a hefty pullback, right? Let’s look at the time frame that’s important to investors.
Long term returns have actually been sub-par. The S&P 500 returned short of 7% per year over the last 10 years. The historic average is 10%. If the market is due for a correction because the short and intermediate numbers are above average, does it also have room to run to the upside over the long term?
As usual, Warren Buffett’s letter to shareholders of Berkshire Hathaway is a must-read. It is well known that he advocates low-fee indexing for most investors. As his famous bet with a hedge fund of funds manager winds down, Buffett unleashed both barrels on high-fee money managers:
“The underlying hedge-fund managers in our bet received payments from their limited partners that likely averaged a bit under the prevailing hedge-fund standard of “2 and 20,” meaning a 2% annual fixed fee, payable even when losses are huge, and 20% of profits with no clawback (if good years were followed by bad ones). Under this lopsided arrangement, a hedge fund operator’s ability to simply pile up assets under management has made many of these managers extraordinarily rich, even as their investments have performed poorly.
Still, we’re not through with fees. Remember, there were the fund-of-funds managers to be fed as well. These managers received an additional fixed amount that was usually set at 1% of assets. Then, despite the terrible overall record of the five funds-of-funds, some experienced a few good years and collected “performance” fees. Consequently, I estimate that over the nine-year period roughly 60% – gulp! – of all gains achieved by the five funds-of-funds were diverted to the two levels of managers. That was their misbegotten reward for accomplishing something far short of what their many hundreds of limited partners could have effortlessly – and with virtually no cost – achieved on their own.”
Punxsutawney Phil practices accurate ambiguity. The vast majority of the time, he sees his shadow. This portends 6 more weeks of winter, generally lining up with the Spring Equinox. What a great strategy. Winter usually lasts 6 more weeks so predict 6 more weeks of winter and most of the time you’ll be right. He does not predict exact temperatures or exactly when it will turn warm.
Contrast this with the investment world. The market generally goes up, but we seek out experts to comfort us with false precision. How much screen time is wasted discussing resistance levels, Dow 20,000, or predicting the S&P 500’s earnings? If you’re a long-term investor, none of this matters. What matters is that the market goes up over time. Like the changing of the seasons, the market has its ups and downs, but the harder you try to pinpoint these changes, the more likely you are to wind up wearing cargo shorts in the snow. Continue Reading →
We’ve witnessed the peaceful exchange of power in the most powerful country on the planet. Now, how do we create a “Trump Portfolio” of only the best, really the greatest, everybody says so securities? Does it make sense to overweight small cap manufacturing stocks that might benefit from a strong dollar or perhaps bank stocks to take advantage of rising rates?
Here’s a better question: What’s more important, the person in the White House or the person who owns the portfolio? It doesn’t make sense to put Grandma in volatile small cap stocks if what she really needs is income. Likewise, it wouldn’t be prudent for a 20-something to move everything to cash because they don’t agree with the President’s politics. I hope you already knew this, but there is no optimal “Trump Portfolio”. Rather than rebuilding their portfolio every time the winds change in Washington, D.C., investors should build around their personal needs and goals.\
The stock market started the year on the wrong foot with a 10% drawdown. It was the worst start to a calendar year ever and prompted knee-jerk reactions such as the RBS note for their clients to “sell everything”. At the end of June, the UK held a referendum on whether to withdraw from the European Union. “Bremain” was the clear leader heading into the election as “Brexit” was viewed as dangerous and sure to drop the markets into a tailspin. Brexit won. There was an election here in the United States which also had a surprise outcome. All three of these events were supposed to be harbingers of disaster. Instead, stocks went on a tear as the S&P 500 gained 12%. The city of Cleveland also got in on the action. The Cleveland Indians lost a heartbreaking World Series, but UFC, minor league hockey, and NBA championships were all brought home to the greatest location in the nation, defying experts every step of the way.
The S&P 500 has been up for 8 consecutive calendar years (kind of – 2015 was negative if you don’t count dividends), but like my dad says, “It ain’t the years, it’s the mileage.” Since the market bottom in March of 2009, the S&P 500 has experienced a cumulative 287% return. For some perspective, it gained 450% from 1991-1999 so our current bull market has not climbed “too far, too fast” as some may argue. There is an old Wall Street saying that the market takes the elevator down and the stairs back up. Maybe it should be revised as we’ve been strolling up a ramp for the last 8 years. Looking back, it can seem like the recovery has been a gentle walk, but this slow stroll hasn’t been without its hiccups. During the recovery we’ve had 4 corrections (10% or greater drawdown). Each of these was supposed to be the end of the bull market so congratulations if you didn’t get scared out of your allocations.
The S&P 500 is up over 3% since the election. I hesitate to call this a “Trump Rally”, especially as the election looms so large in recent memory. For now, it seems prudent to recognize that the election has brought with it a reduction in uncertainty and a sigh of relief that the contentious campaign season has come to an end. While the media is distracted by every shiny object the President-elect waves in front of them, they are missing a bigger story. The Federal Reserve is expected to raise rates in December which would send ripples through multiple markets. What would a rate spike look like? We don’t have to go very far to find out. We just had one.
No matter your political leaning, you likely didn’t expect Donald Trump to win the election last week. Most of the “experts” (the pollsters, the pundits, the media) sure didn’t see it coming, Hillary Clinton seemed a lock. Nor did you likely expect the stock market would rally in the days after his win. Again, the “experts” (the Wall Street analysts, the talking heads on CNBC, even yours truly) warned that a Trump victory would likely lead to an immediate sell-off, due to the surprise and uncertainty such a win would cause. Yet the Dow rallied over 4% in the three days after the election. In a recent Bloomberg survey, not one of 65 Wall Street analysts predicted 10-year Treasuries would rise about 2% by year-end. Yet the 10-Year rate now sits at nearly 2.25%.
As a whisky (whiskey here in the States) matures, it loses about 2% of its volume to evaporation each year. Distilleries call this The Angels’ Share. They fill oak casks with a precious liquid knowing that each year part of their hard work will simply disappear. I can’t help but think of the angels’ share when I look at expense ratios. An investor sets aside a certain amount of money, let’s say $100,000. They pay a money manager to invest that money – I’ll use the S&P 500 as an example When the investor looks at their statement, they should see that their investment returned the same amount as the index, less whatever the expense was, right? Looking at the annualized returns, yes, that’s approximately right. Looking at actual dollars, we see something different. A portion of the returns evaporates, escaping the pockets of both investor and money manager.
The 2016 Harvard Management Company Annual Endowment Report is out. What was once a great write-up about the cutting edge of investment management now serves as a warning that every investor can learn from. The endowment’s fixation on keeping up with the Joneses (Yale and Stanford, especially) has led to management turnover, investment collection, and poor returns.
The endowment lost 2% over the twelve months ending on June 30, 2016. The S&P 500 was up 4% over that time while a 60% S&P 500 / 40% Barclays Aggregate Bond Index portfolio would have been up 5%. The report blames the poor performance on everything from low interest rates to market volatility, but it looks more and more like the problem stems from trying to keep up with the Joneses. Peer returns are even listed as one of Harvard Management Company’s three investment objectives alongside real returns and relative returns.
What do you remember most about the markets over the last 12 months or so? Was it the big drawdown in the first quarter? Brexit? Maybe the flash crash from a year ago? How did you feel during each of these supposedly world-ending crises and how do you feel now that they are in the rear-view mirror?