SFM 4th Quarter Update
Market Synopsis: Fourth Quarter 2020
Staying the course during the global pandemic of 2020 may have been one of the most difficult market decisions we as investors have had to make in our lifetimes. There was no question that initial unemployment would increase dramatically and the economy would fall precipitously, while entire industries like airlines, hotels, restaurants and retail stores would operate at a small fraction of capacity, leading to the inevitable pile-up of bankruptcies.
The reward for sticking to our conviction that stocks still offered the best long-term opportunities was the very strong recovery in stock prices and the overall strong investment returns during 2020. As investors most of us are better off, but not without many anxious moments. US Equities as measured by the S&P 500 increased +18.3% during 2020 and internationally stocks were up +8.2% as measured by the MSCI Developed Market EAFE Index. Bonds also had a solid year with the Bloomberg Barclays Aggregate Bond Index posting a +7.5% total return.
People who participate in sports are familiar with the term “muscle memory”, where a repetition and replication of a movement is necessary for a more successful experience in the future. In the investment world we do something similar. When negative global events unfold there are many investors that have a knee-jerk reaction to calamity, selling first and waiting for calmer conditions before venturing back in. At SFM, our “muscle memory” led us to do the opposite, holding steady while looking for opportunities to invest in over-sold assets. During 2020 the exercise was more like “bungee-jumping”; experiencing an extremely frightening fall, and then an exhilarating rise as the markets bounced back quickly (long before any signs of an economic recovery). At the end of the day, the equity markets are forward-looking and more focused on expectations for where things will be six months to a year from now than it is on what is happening at the current moment in time.
Thanks to the speedy and massive amount of government stimulus around the world, and the more recent medical breakthroughs on the vaccine front, it appears that we can once again think about economic growth in 2021 as the economy climbs out of this global recession. The global stock market is well-positioned to benefit from this. With respect to bonds, interest rates have been driven so low on government bonds that it is difficult to envision returns that can come close to those realized over the last 40 years. In 1979 the 30 year US Treasury bond closed the year paying income of over 10%/year, today it is around 1.85%/year. We still find investment opportunities in the bond market, however most of the attractive investments are in corporate bonds and other bonds backed by collateral and not the low-yielding bonds issued by governments.
As a review, the price of a bond rises as interest rates go down and the price falls when interest rates climb, and the interest rate on a bond is a good estimation of the future return you will earn. Due to the current low interest rate environment, expectations for future returns on bonds should be reduced. Interest rates are not likely to rise in the short-term, however future returns will be lower than in the past unless interest rates on bonds decline significantly into negative territory like we have seen in Europe. We do still expect bonds to offer a stabilizing effect on portfolios during volatile markets, but we think interest rates are too low to offer the same degree of protection as in the past. Due to this, we have diversified your investments in 2020 and over the last few years into alternative investments and other areas that we believe offer above average investment returns that are less correlated with the stock market. Earlier in 2020 we invested roughly 3% of your account in gold, through exchange traded funds or ETFs. We have also invested in diversified private real estate funds in your account, which provide a solid income stream and lower downside risk than stocks. Both of these investment classes (along with equities) have historically fared well during times of higher levels of inflation (and rising interest rates). Right now inflation is the last thing on everyone’s mind as the anemic economy and higher unemployment have kept things in check. However, the unprecedented stimulus in 2020 and continuing in 2021 is likely to cause continuing pressure on the US dollar as well as an eventual increase in the borrowing costs of the US government. Through these diversified investments outside of stocks and bonds, we are effectively attempting to, in the words of Wayne Gretzky’s father Walter, “skate to where the puck is going to be, not where it has been.”
During the fourth quarter of 2020, there was a major shift in market preference towards small and medium-sized companies, reflecting significant valuation differences as larger companies excelled during the first nine months of the year. Some investments owned by SFM clients that benefited from this include the iShares S&P Small-Cap ETF +31.2% in the 4th quarter, the iShares Mid-Cap ETF +24.4%, and the Vanguard Small Cap ETF +27.2%. Value stocks also had a burst of outperformance after years of lackluster results compared to growth, as anticipation of a broad economic re-opening aided these more cyclical companies. Three investments that we purchased in your account on the same day during the summer of 2020 benefited from this theme during the fourth quarter: MGM Resorts +44.9%, Blackstone Group +25.3%, and Southwest Airlines +24.3%.
In addition, the fourth quarter brought a recovery in other SFM owned stocks including the large US bank JP Morgan Chase +33.2%, the software firm Autodesk +32.2%, the global restaurant company Starbucks +25.1%, and the parent company of Google known as Alphabet +19.6%. All of these four stocks benefited from expectations of life eventually getting more back to normal in 2021. The recovery also helped some stock funds that are focused on growing companies such as the PRIMECAP Odyssey Aggressive Growth Fund +21.3%, the Allianz Technology Fund +19.0%, and the Artisan Int’l Small-Mid Cap Fund +18.0%. It was also a great quarter for our two diversified emerging market stock funds the Artisan Developing World Fund +20.1% and the Invesco Developing Markets Fund +19.0%. The strong rebound in global markets during the quarter did leave some stocks behind after their strong returns in the first 9 months of the year, such as Salesforce.com -11.5% (which lagged due to its major acquisition of Slack), Home Depot -3.8% (which trailed after a strong start to the year due to better than expected sales during the pandemic as home renovation soared), and the Swiss food & beverage company Nestle -1.2% (which pulled back after benefiting from pantry-loading earlier in 2020). Meanwhile, actions by the Chinese government to reign in their technology sector caused underperformance during the quarter in two dominant Chinese companies: Alibaba -20.8% and Tencent Holdings +6.3%.
The coming year will most likely be impacted by the change in administration in the US, but our belief is that the investment climate remains favorable (see the “SFM Quarterly Chart” below). There are still many hurdles before we have fully cleared this crisis, and there will be long debates on the proper fiscal and monetary actions post Covid-19. The government has been the main supporter of getting aid to individuals, as well as struggling companies. The stimulus decisions made back in March 2020 most certainly prevented a modern day depression in the US, and hopefully gave enough of a cushion to allow for a healthy recovery.
As you can see from this chart, the US stock market has performed pretty well over the last nearly 100 years, regardless of who is in office or what their political party is. In the final calendar year of the Trump Presidency the S&P 500 increased 18.3% during 2020 (not shown on chart).
Our thoughts are with those that have been irreparably damaged by the events of 2020, and we are optimistic that the creative and entrepreneurial nature of the US capital markets will continue to prove to be the ideal arena for investing. As always, if there is anything we can do to help please do not hesitate to contact us. We appreciate your continued support and hope you have an incredible 2021.
Sincerely, Glenn, Chris, Sam, Debbie and Steve