If 2020 taught us anything, it is the folly and futility of trying to predict future events. And, perhaps of equal importance, predicting how the world will react to those events. Because even if a crystal ball had given us a glimpse of the COVID-19 pandemic, and the toll it would take in human lives, jobs, and economic devastation, there’s no way we would’ve predicted that both stocks and bonds, in the U.S. and abroad, would actually end the year higher. And yet they did. The fastest bear market in history turned out to be the shortest as well, as a full market cycle was compressed into less than a year.
And as if to remind us that this folly and futility was not solely a 2020 phenomenon, the first week of 2021 has been marked by a perfect storm of political events that most any pundit would’ve warned would send stocks lower. Yet, as of this writing, U.S. stocks, along with most other asset classes and geographies, sit at or near all-time highs.
The smart money said if Biden won, stocks would drop. But they didn’t. Ostensibly because Republicans appeared to keep control of the Senate, and markets like gridlock. As attention turned to the January 5 Georgia run-offs, the expectation was that if the Democrats took both seats, that would be bad for stocks. Wrong again. Even as we watched the horrifying events unfold at our nation’s Capitol on January 6, the stock market largely shrugged it off.
So, how do we make intelligent investment decisions in a world where, by our own admission, future events are impossible to predict?
One of Warren Buffett’s frequent observations may hold the key to that answer – specifically, that investing is not an endeavor where the highest IQ wins, but rather, one that requires the right temperament. And that temperament requires the rare ability to balance humility and self-confidence. It requires, among other things, maintaining a focus on the longer-term rather than on short-term views or predictions. It’s a temperament we seek in the investment managers we engage on your behalf. We have no idea what stocks will do tomorrow, or next week, or next year. But we know that odds are, over time, they will work their way higher.
We are frequently asked our views on the market, and while it may sound like a canned answer, we tend to be short-term cautious and long-term optimistic. Along these same lines, Bill Gates had the self-confidence to bet everything he had on Microsoft, but he also had the humility to keep a year’s worth of payroll in cash. He believed in his long-term vision but knew anything could happen. While saving like a pessimist, he invested like an optimist.
So, what do we know? And what do we think? We know interest rates are very near historic lows. We know that inflation remains low. And we know that the Fed has adopted a policy stance that is very supportive of equities. As a result of what we know, we think that stock valuations are elevated compared to historical norms, yet reasonable, if not compelling, compared to the returns available on cash or bonds. We think the path of least resistance for stocks is higher. And we think the biggest risks to financial assets are inflation and a weaker dollar, both the result of all the stimulus necessitated by the pandemic, and the subsequent increase in interest rates that might occur. And while stock valuations would compress under such a scenario, neither bonds nor cash would provide much protection. But non-dollar-denominated assets would. So we continue to believe a healthy allocation to non-U.S. equities will serve us well, especially in an inflationary or weak dollar environment. Within the U.S. equity markets, we think there are both pockets of value and pockets of excess. And we believe indexed assets are skewed to the latter. So we expect active, value-oriented stock-picking to finally enjoy some time in the sun after a long spell in the shadows. All of which bodes well for how we position client assets.