2020 Was Hard

As we entered 2020, I was astonished that the bull market was still limping along.  I was concerned that the Federal Reserve was failing at normalizing interest rates and reducing their balance sheet.  So much so that I wrote How to Handle the Next Recession in May of 2019 to prepare my clients that a recession was coming and remind them of our buy-hold-and rebalance strategy.  In December 2019, the largest U.S. banks quit lending to each other and there were rumors that one of them was in trouble or that large hedge fund had blown up.  Instead of letting markets work themselves out, the Federal Reserve began Quantitative Easing 4 (QE4) and sent stocks artificially soaring to their February peak.

In the first two months of the year, we were watching the Princess cruise ship, China, and Italy.  It was expected that Covid would travel the world, but following Communist China’s junk-science and locking down the world would not have been expected unless you paid thousands of dollars to be tipped off by Senator, Richard Burr. They told us it would just be 2 weeks to “flatten the curve” and that lockdowns wouldn’t save lives, they would just free up hospital beds and push deaths out into the future.  Then on March 11, it got real when we all saw Mark Cuban’s reaction to the NBA shutting down the 2019-20 season.

Stocks were in free fall and there were margin loans being called daily.  The extreme distress was leaking into even safer assets as funds and individuals were being forced to liquidate at any price.  On March 18, I was looking over the ticker symbols I track and had to do a second take.  A pretty safe municipal bond ETF was down 14% that day and had lost 32% peak to trough; almost as much as the S&P 500 had!  That wasn’t supposed to be possible.  In some ways the ferocity of the selling was worse than the Fall of 2008.

After receiving dozens of concerned phone calls, I sent out How Will this Movie End? two trading days before the low of 2020 to try and help clients process what was going on.  I spent hours trying to come up with the right words of wisdom, knowing that making a mistake after a 30% crash could cost investors hundreds of thousands of dollars.  I posited that the S&P 500 was down 33% at the time and that was bad enough where we could see stocks go right back up like they did after the 1987 crash.  I then stated a “very large bounce should be expected soon” but it would be impossible to know if that was going to put the low in or not.  After reminding everyone how hard market timing is, I explained how we should expect the worst and a new low after a bounce to get mentally prepared for what could have been a grueling and extended bear market.

Then hedgefund manager, Bill Ackman,  was trotted on TV to warn us “Hell is coming”   and stocks, bonds, gold, Bitcoin, lumber, and almost everything put their lows in and started a light-your-hair-on-fire-rally.  Those were scary times for your health and wealth.  Imagine if fear overtook you and you had sold last March in the hopes that you could later buy back in lower.  It would have been almost impossible to buy back in.  There was an 8% drop in April that only lasted 5 trading days.  June had a 5 day drop of about 10% and then it was almost straight up.  During the rally, investment legends like Jeff Gundlach and Stanley Drukenmiller were public telling us they thought new lows were coming.  It was so easy to expect stocks to drop as cities were burning from protests.

The depression had taken down Gold’s Gym, Chesapeake, Hertz, Neimans, Pier 1, J.C. Penney, Frontier Communications, J. Crew, and Brooks Brothers, millions were out of work, and stocks were FLYING with no real dip to buy back in.  Every week or so I was hearing statistics like we just had the best week in stocks since 1937.  The market just had its best month since 1974.  In the depths of despair it was very hard to see that Jay Powell’s money printer go BRRR and the Cares Act were going to create such a powerful rally.  While I was open to the idea that stocks had fallen close to enough to put the bottom in, I would have said it was next to impossible to see all-time highs in stocks by year-end.  And who could have predicted the day trading phenomenon that was spurred in part by Dave Portnoy of Barstool Sports last year?

Good investors need to guard against hindsight bias.  It is toxic to misremember that you had any idea what was going to happen in 2020 or any other year.  Bitcoin was almost $10,500 in February and crashed 60% to almost $4,000 in March.  The internet was littered with insults about how Bitcoin was a joke and obviously not a good store of value during a stock market crash.  Congratulations to the HODLERs who were able to keep their faith.  It was not obvious that Bitcoin was about to rise over 900% in ten months to over $40,000.  It also was not easy to own Tesla as it crashed 60% from it’s high in February to $70 in March.  Many investors panic sold Tesla, expecting a global depression to reduce demand for new cars.  It was not obvious to them that Tesla was going to rise from $70 to $900 in ten months.  And by the way, they still can’t turn a profit without selling regulatory credits!

Being honest with yourself is a great virtue.  “The first principal is that you must not fool yourself and you are the easiest person to fool.” – Richard Feynman  “It is tough to make predictions, especially about the future.” Yogi Berra.  2020 was a great reminder that we can’t predict the future.  Imagine someone from 2021 coming back in time to 2019 to tell you what was about to happen in 2020.  It would sound like far-fetched lunacy and would be impossible to believe…but it happened.  Larry Swedroe, my favorite financial author, has written a great series called Investment Lessons the Market Taught in 2020 that can be found here, here, here, and here.

2021 Isn’t Going to be any Easier

Now that we are mostly through the pandemic and have the elections behind us, you would think that investing might be easier this year.  Let me tell you…it is never easy.  I feel like the range of outcomes over the next 12 months are enormous.  I would not be surprised if stocks went up or down 30% this year.  A few years ago, it was unimaginable that some of the top billionaire-investors would openly be predicting a civil war.  Well here we are.  Bond King, Jeff Gundlach, expects substantial changes that even include breaking up the U.S.  In the last minute of this clip he opines that we are in a “fourth turning” and starts to compare current day U.S. to France in 1789 before the host is told to cut for a commercial.  Ray Dalio, founder of the Bridgewater Hedgefunds, recently said “I believe we are on the brink of a terrible civil war.”  Maybe they are wrong, but my point is that it was impossible to imagine two of the most respected investors alive talking like this, even a few years ago.

At today’s levels and with a new level or irrational exuberance, it is hard for me to get excited about the U.S. stock market.  In the chart below, you can the see the “Buffet Indicator” is showing stocks to be more expensive than they were during the technology-media-telecom bubble.  Watching traders like, 80 year-old, Nancy Pelosi and the Robinhooders buying YOLO options feels like 99 to me.  Just when it feels too easy, you learn that it never is.  It is not hard for me imagine the economy rolling over as  10 million people are behind on their rent and businesses realize the difference between liquidity and solvency.  It hard to not hear Warren Buffet in my head reminding me to be fearful when others are greedy.

The “Buffet Indicator” of stock market cap divided by GDP is above the 2000 Bubble! Source: St. Louis Fed

At the same time, I also have to hold my nose to buy bonds with their paltry yields here.  The two quality bond funds I invest in for safety are paying only 1.25 and 1.36% respectively.  It is hard to imagine them keeping with up inflation over the next ten years.  The Fed and Central Banks have ruined markets.  TINA-There IS NO Alternative (to stocks)!  “More money has been lost reaching for yield than at the point of a gun.” Ray DeVoe.  Nothing seems obvious here.  Investing is hard.

I can also make the bull case that expensive things can get more expensive when you have Jay Powell running the presses and promising to keep rates at 0% 4eva!  Congress just passed a $1 trillion pork-bill in December and I hear a $1.9 trillion bill is about to get passed in February followed by a likely green energy/infrastructure bill.  Maybe Scott Minerd at Guggenheim is right and we are about to get a boom with the pent up demand when people feel safe again.  Perhaps we are in the initial stages of what Ludwig Von Mises called the “crack-up boom.”  The one thing I am certain of is that the Central Banks and world’s governments are in a bad place.  For further learning, listen to Luke Gromen’s interview on the Macrovoices Podcast.

I have to constantly remind myself that markets can do anything.  It was impossible to believe in 2009 that the U.S. stock market would make this epic bull run.  I was convinced at the beginning of the cycle that the money printing and deficit spending would send gold to $5,000 and 70’s style inflation was around the corner.  Who could have imagined that start ups like Airbnb, Stripe, Shopify, Tesla, Uber, Lyft, and Twitter were going to change the world like the did from what we knew in 2009?  Financial markets are too complicated to out guess.  Fortunately we can build time-tested diversified portfolio and follow the  wisdom of buying-holding-and-rebalancing.

Introducing Momentum

In the fall of 2020, I started implementing the strategy of dual momentum, based on the excellent work of Gary Antonacci.  Momentum is one of the five factors that help explain excess returns across investments.  The other four are beta, size, value, and quality.  Nobel Prize winner, Eugene Fama, called momentum “the premier anomaly.”  Many have tried and failed to use momentum to capitalize on individual stocks.  Antonacci discovered it could be applied by comparing the relative strength of U.S. stocks versus Foreign stocks.

Over long periods of time U.S. stocks and Foreign stocks have performed about the same, but there are often stretches of years where one has momentum.  I believe this to be persistent and am now using an indicator to help tilt IRAs towards US or Foreign stocks.  The indicator is currently favoring U.S. stocks as they have had a very good run compared to Foreign stocks.  The SPY ETF that tracks the S&P 500 has averaged about 13.5% per year for the last 10 years while EEM that tracks the MSCI Emerging Markets Index has only averaged about 4% per year.  Emerging markets are relatively cheap and I am glad to have a rules-based indicator to help me shift towards them eventually.

SPY vs EEM over the last 10 years. Source: Morningstar.com

While the average person doesn’t track the Dollar Index $DXY, it is important to note that it got creamed last year.  The high to low last year was a drop of 13%.  That is an enormous move for the Global Reserve Currency.  Every major economy is deficit spending and trying to stimulate their economy out of a depression, but this chart shows me that nobody is doing it bigger relative to their economy than Uncle Sam and as I mentioned above, expect many more trillions in pork to be passed in the coming years.

If you were allowed to go to Europe right now, you would feel how weak the dollar is. Source: Thinkorswim

All things considered, a falling dollar boosts returns of stocks that are denominated in Euros, Dongs, and Yen.  While it is isn’t easy for me to be excited about U.S. stocks after their huge run, I am glad to know that at some point my indicator will tilt towards Foreign stocks that have been relatively poor performers for the last decade.  May the odds be ever in your favor!

Fun Fact: you can buy both the FTSE 100 (UK stocks) and the Nikkei 225 (Japan) today for less than their markets were trading for in 1998!  U.S. stocks have been the clear winner since 2009, but lest not forget that after the 2000 bubble the S&P 500 had a 0.0% return for 13 long years.  If you have further interest in dual momentum, please click the hyperlink at the beginning of this section to ready Antonocci’s excellent article.

It is Not Too Late to Refinance

Rates for mortgages are still really low.  With good credit, you can get a 30 year mortgage for about 2.5% and a 15 year mortgage for about 1.75%!  Kim and I bought our new house last January and already refinanced our mortgage in the fall.  This interest rate sale will not last forever.  Please let me know if I can help you determine the break-even and if it makes sense for you to swap a 3 for something with a 1 handle.

Non-Itemizers Can Deduct up to $300 in 2020

The TCJA tax act passed in late 2017 gave everybody huge standard deductions and less than 20% of people can itemize their deductions now.  As you prepare your 2020 1040 tax returns, don’t forget that cash gifts to charities of up to $300 per household can be deducted for people who can’t itemize.  This is per household and does not count gifts made to donor advised funds, gifts made from your IRA (QCD), household items, or securities donated.  In 2021 you will be able to deduct up to $600 if you file married filing jointly.