2020 was a dark year in our lives and of the world. It began with great cheery optimism and by the first days of Spring the market plummeted losing a third of its opening values. There was a flight to safety in cash and Treasury bonds causing interest rates to drop to amounts we have never seen in this country, not even in the depths of the 2008/2009 disaster, which was not pretty.
We lived through the 2008/2009 period and also the September 11, 2001 bombings, even though those events, when they occurred, were beyond our realm of conception. The markets’ reactions to the pandemic which is continuing with a vague end in sight that hopefully will be later this year, has completely confounded me. It makes no sense to me. I’ll take it. I’m not complaining. But, it makes no sense, is beyond reason, seems to be a myopic reaction (and possibly wishful thinking) to daily news headlines and fails to consider a long-term view of the economy.
Do not get me wrong. I believe that the long term financial strength of this country is good and believe that this strength will be reflected in the prices of a broad based portfolio of stocks over a reasonable period of about seven to ten years. However, the facts on the ground do not warrant the increases we’ve seen this year. What this means is that today’s prices include some of tomorrow’s growth resulting in a slower growth, but, in my opinion, a growth nevertheless.
I just want to mention two things that will be a drag on the economy. There are more, but these should provide an indication of how I am thinking, and provide some fodder for your thoughts. Historically 70% of the U.S. economy was driven by consumers and half of the nation’s jobs were in small businesses. Far too many people have lost jobs and far too many small businesses failed and will not be recreated. Not only has cash flow ended for them, but many had their savings wiped out. This will have the effect of stunting consumer spending for years. The second thing is that the federal debt has greatly increased. I am not commenting on or criticizing this growth, but it is debt that will need to be supported by interest payments. Even if the debt does not have to be repaid and is able to be continuously rolled over, the interest will need to be paid annually. Right now we have record low-interest rates, but at some point the rates will increase and that will put pressure on the federal budget resulting in increased taxes which are always a drag on the economy.
Now, let’s look at what happened.
The stock market went up. The four major indexes that I follow all increased. The only index not heavily laden with technology stocks is the Russell 2000 comprised of small-cap stocks and that was up 18%. The DJIA increase was specifically due to increases in Microsoft and Apple (because of its split Apple is no longer in the DJIA top 10, but it was most of the year). The S&P 500 was up due to its top 5 components: Microsoft, Apple, Amazon.com, Facebook and Alphabet. Tesla became its fifth-largest stock but only joined that index the end of December not affecting the index that much in 2020. The NASDAQ is overloaded with tech stocks and they went through the roof.
Let me digress here for the definitions of capitalization or cap categories. Large-cap are companies with a market value over $10 billion. Mid-cap companies have values from $2 billion up to $10 billion. Small-cap go from $200 million to $2 billion. Microcap $50 to $200 million. These are general ranges and different funds and investment managers have their own amounts, but these are pretty good ranges to go by.
People that are risk-averse show it in many ways. Some only buy short-term bank CDs while others will only invest in the major stock index funds. While index funds are a great idea for diversification, if you look at the segment breakdown of equal investments in the three major indexes, you will end up with over 30% in tech companies. Even just sticking with the S&P 500 index you will have almost this same percentage in the tech sector. There are some index funds that strip out the tech companies and these did not have significant gains last year. Sector funds can be a way to avoid the very large-cap tech companies, but you would lose diversification. Perhaps 30% is the right percentage in tech stocks. No matter, I am just calling it to your attention.
We are discussing gains in the indexes, but all these indexes pay dividends, and that added to the gains, and nothing beats cash flow. Also, the dividend rates are significantly greater than short and intermediate-term interest rates pushing bonds out of contention for investments from many people. Long term bond rates are also at all-time lows. This has the effect of making stocks attractive to some fixed-income investors that previously avoided stocks. This also will draw money out of the fixed income arena into stocks which also has the tendency to push prices up.
Short-term bonds have maturities up to 2 years, Intermediate or medium-term bonds are from 2 to 10 years while long-term bonds have maturities over 10 years. Bank certificates of deposit (CDs) usually have maturities up to 5 years, but can occasionally exceed this. Right now these yields are way below expected inflation rates meaning that over time, CD investors will lose ground as measured by buying power. Currently investing in fixed income is very complicated and an added risk is that as interest rates increase, bond market values will decline. However, bond owners with previous purchases of longer-term bonds, or even five year CDs, would have locked in their yields when they purchased the bonds or CDs and those intending to, and are able to, hold them until maturity will receive anticipated amounts along with the return of their principal (assuming no defaults). When those proceeds are reinvested, they will then be subject to the current rates. When you look at my chart it shows big year-to-year percentage drops in the interest rates. That is so, but only for new purchases; not for those that locked in the rates with prior purchases. To be very frank, right now I have trouble discussing fixed-income investments with clients. There are very few “good” choices for cash flow with reasonable safety.
In terms of the stock market, I believe it is also a tough market to invest in. My suggestion, for now, is to stay on course with your investment plans, but revisit your goals and future spending needs and consider making adjustments to meet any new goals or circumstance you find yourself in.
I am rethinking all of this and will have a lot more to say, but will push it forward a few weeks, so stay tuned to my blogs.
If you want to hear me discuss some of this in real-time, I will be presenting a FREE one-hour Zoom program for the East Brunswick Public Library on Thursday, January 28 from Noon to 1:00.
The title is “How to be your own investment manager.”
Register Here
If you have any tax, business or financial issues you want to discuss please do not hesitate to contact me at [email protected].
Read More of the Partners’ Network Blog
