Warren Buffett in July, 1999: “If I had to pick the most probable return over the next 20 year, it would be 6%.”
Gallup poll in 1999: “Investors expect stocks to return 13-22% annually.”
S&P avg. return from 1999-2019: 6.117%. (Source: Vetle Forsland)
As hard as it is to believe, another decade is coming to an end! It is as good of time as any to look at the market environment around us, and discuss reasonable strategies for moving forward. Equities have had a stellar decade and year, rebounding from the Financial Crisis lows in 2009, and more recently the bear market of late 2018. Valuations are very high by most metrics, with the big exception being in comparison to bonds, due to record-low interest rates. Remember that much of fixed income returns have been due to the declining interest rate environment, which is likely to reverse over the next 10-years. That can be a major problem for many investors with sizable allocations to bonds.
When Buffett made the comment listed at the top in 1999, there was a similarly euphoric decade-long bull market going on, but interest rates were quite a bit higher, providing a more viable alternative to stocks. When the Tech Bubble crashed, beginning in early 2000, the Nasdaq ultimately dropped by 75%. From 2000-2010, stocks went virtually nowhere, while investors endured two 50% selloffs. The problem is that recency bias is such a powerful characteristic in most humans, so current actions are usually dictated by experiences in the recent past. The problems of 2000-2010 are less on our minds than what we just experienced from 2010-2020.
Concurrently, we are in an environment where the rule of thumb being marketed by many advisors, is simply to own index funds, meaning you’d be 100% long the market regardless of valuations. Retirees that would normally be strongly overweight bonds, in many cases, have been pushed further out into the risk spectrum with nearly all-equity portfolios. What I am saying in short, is that there are a lot of factors that would lead me to believe that the next decade will bring vastly inferior equity returns than the last decade. That doesn’t mean one shouldn’t be invested, or that they should try to time the market. Instead what it means is that investment decisions should be carefully examined based on the fundamental merits, as opposed to a feeling of an expectation based on what has recently transpired.
Returns must be weighed against the risks taken to achieve them. In the late 1990’s, it wasn’t uncommon for tech funds to be returning 90-100% at times. Almost all, if not all of those funds, eventually went bust, devastating investors’ retirement savings. If someone bets correctly on black in roulette 5 times in a row, that makes them lucky, and not a good investor. The gambling process is not a sound one, just as investing without regard to valuations is not very sensible.
Fortunately, at T&T Capital Management, we manage our own money in the same strategies and securities as we do for clients. This means that we are laser-focused on both protecting capital, and growing it to the best of our abilities. Over the last month or so, we have been taking some risk off the table. Many of our investments are conservatively structured, with sold puts way out of the money on very undervalued stocks. We have allowed ourselves to be called away on some of our covered calls, freeing up capital and setting the stage for new investments. I would describe our strategy as playing defense to create offense.
Think of a great basketball team like the Celtics or Lakers in the 1980’s. Kareem Abdul-Jabaar, or Robert Parish would often block the shot of an opponent, recover the ball and then pass it to Magic Johnson or Larry Bird for a fast break basket. That is what we are trying to do with our current approach. We want to be able to make money in most environments, even if the market is flat or slightly negative. If the market is up 30% again next year, which would be quite surprising, we’d fully expect to under-perform a bit, but still should do very well. If the market tanks, we should do a lot better than that, and we’d be positioned to aggressively take advantage of the recovery. Those that were aggressively positioned going into 2000 or 2008, didn’t have the capacity to take advantage of the attractive dislocations that occurred, which allowed many to get very rich. We must not make that mistake whenever we face the next existential market crisis.
The first step to winning a race is to be able to finish it. I’ve seen too many people blow themselves up with leverage or gambling based on intuition, or recent trends. At the same time, there are people like John Hussman that have been worried about a bear market for the last 9 years, and have ended up demolishing their clients’ capital with those bearish stances, likely even in a worse way than they would have experienced going through a major bear market.
Remember that value stocks have been more out of favor, relative to growth stocks, than any time other than the Tech Bubble and 1929. The trend has gotten a bit better since September, but mean-reversion would be a massive tailwind for our strategy, while being a headwind for others. If we are right that overall returns are lower in the next decade, the value of strategies like selling-cash secured puts to generate income and reduce our purchase prices for securities, magnifies greatly.
Over the next ten years, it will be essential to identify undervalued opportunities and have the courage to fully exploit them via putting enough capital into them. It will be vital to not panic when times get tough, just as we did not panic during the European Crisis of 2011, the major corrections in 2015 and 2018, or during Brexit. We must not focus on any one quarter or year, but instead focus on obtaining the outcomes needed to meet our financial requirements and objectives. I’m confident that we are well-poised to do this and I’m excited by the investments that we are making. There are fantastic opportunities and we just want to be smart in how we exploit them.