Our parents all told us that money doesn’t grow on trees. The message is that things of material value simply don’t appear for free. But what if trees could tell us more about investing than we thought?
The life cycle of a tree probably doesn’t elicit too much excitement considering that you can’t visually see it take place on a day-to-day basis. Some trees can take as long as 30 years to reach full size. But not all growth is created equal. Young trees that spend their early decades under their mother’s shade will grow at a slower rate due to lack of sunlight. This slower growth causes the wood to be dense and strong, increasing the chances that the tree can grow to its full potential. Conversely, a tree planted in an open field may grow quickly, taking in all the sunlight it can absorb. This accelerated growth will lead to the wood being softer and ripe for fungus and disease. These issues can challenge the tree’s potential and make it less likely to grow old.
The lifecycle of trees and markets are very much alike. Companies that attempt to reach levels of unsustainable growth may quickly flame out under the weight of unrealistic investor expectations. For every Amazon, there are hundreds of companies deemed “the next Amazon” that don’t survive or simply never reach their previous peaks (i.e Cisco). Many forgot that Amazon once lost almost 90% of its value over a 2-year span (see the chart below). Everyone claims they “knew” Amazon was going to be a huge success back in 2000 but stocks don’t sell off if no one sells. Spoiler: People love to spin stories about things like this.
Why Do We Care?
Right now, one of the biggest challenges in the market is trying to calibrate expectations. We have seen a bear market that lasted less than a month. We have seen companies go up 100+% while never showing any profitability. We have seen growth stocks outperform value by the highest level ever, only to see value come roaring back to outperform growth by the highest level on record. We have seen interest rates go up 580% and counting. We have seen digital images (not a real physical piece of art) that can only be seen on the internet, sold for tens of millions of dollars because it is a “Non-Fungible Token.” And we have seen all this in the past 12 months, or approximately 1% of the past 100 years.
One of the most dangerous things we can do in investing is to latch on to an outlier event and extrapolate it into normalcy. It will almost always cause our behavior to change in a way that will lead to harmful actions. And while it may be easy to recognize this in theory, it is difficult to appreciate these events in real time. The returns we have seen in the market over the past months, weeks, and even days can not only lead us to believe that these abnormalities are sustainable but that they should be the norm going forward. What was once a typical annual return projection suddenly feels underwhelming if not achieved in half that time. This leads to gorging on all the sunlight we find as we try to grow our trees as fast as possible, giving no real thought to whether or not the root structure is deep and strong.
HCM has spent significant time over the past 6 months designing an investment thesis built on the belief that economic growth would continue to strengthen behind a combination of stimulus, both fiscal and monetary, and increasing vaccine rates across the country. In our opinion, this higher growth will cause interest rates to move higher, taking inflation with them. This increase in both economic growth and/or inflation will favor Value over Growth. Even as this thesis has played out according to plan, many investors are still focused on the “next Amazon,” hoping to condense the time horizon of returns into the realm of the outlier.
One of the most powerful forces in the market for generating return is time. Since 1871, investors have a 95% probability of earning a positive return on US stocks over any rolling 10 year period. That number drops to 60% over any 2 month period. It shows that the tree will grow if we let it, but it just may not grow at the pace we hope, no matter how much we try to convince ourselves that it should.
As we move into the second quarter and further into 2021, we are optimistic that stocks will be higher at year end, although corrections along the way are to be expected. If they occur, we will likely view them as opportunities to increase our stock exposure. We believe in a market that trades on improving fundamentals and a range of historical valuations. We believe value assets can still provide some cushion against market volatility. A majority of these companies are established and profitable, similar to the trees that have grown slowly over time and remain strong and healthy during droughts and storms.
Weekly Focus – Think About It
“The desire to perform all the time is usually a barrier to performing over time”
Performance last week for the four major asset classes were:
- U.S. Stocks – Russell 3000 (IWV) – Gain of 1.09%
- Developed Foreign Markets (EFA) – Gain of 0.22%
- Emerging Markets (EEM) – Loss of -1.50%
- Fixed Income (AGG) – Gain of 0.35%
(Note: performance is based on the change in price plus dividends)
Last Week’s Headlines
- Stocks edged out a slight gain last week as markets marked the 1-year anniversary of March 2020 bottom.
- Weekly jobless claims showed a sizable decline, falling by nearly 100k to 684k. This is the first reading under 700k since the pandemic began, though still well above normal levels.
- The Suez Canal was blocked for several days as a sideways container ship ran aground. The ship was finally freed and traffic is moving normally once again.
Eye on the Week Ahead
- Investors will remain focused on the bond market as yields continue to creep higher and test the markets resolve.
- Core PPI will headline a light week for economic reports.
If you have questions about the recent price volatility please contact a member of HCM’s Wealth Advisory Team:
Any tax or other advice contained in this document, including any attachments, is not intended and cannot be used for the purpose of avoiding penalties under Internal Revenue Code. No action should be taken on any information contained in this message without first consulting with your tax/legal advisors regarding the tax/legal consequences for your particular circumstances.
- The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.
- Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
- Past performance does not guarantee future results.
- You cannot invest directly in an index.
- Consult your financial professional before making any investment decisions.
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