Hockey legend Wayne Gretzky memorably said, “I skate to where the puck is going, not to where it has been.” A year ago, stock markets were in freefall in the early days of the pandemic. Bartlett expected a forceful combination of monetary and fiscal policies would prevent a prolonged economic tailspin. Visualizing a year ahead (where the puck was headed), in a March 2020 commentary we wrote:
“In March 2021, we expect to reflect on mitigation and containment measures that worked, a vaccine that was developed, economies that recovered and grew again, and stock prices well above the panic-induced levels of today. We are “all in” on American resilience, perseverance, and ingenuity.”
It worked out even better than we expected. Three vaccines are being administered now. Economic growth in 2021 is expected to be the strongest since 1984. Unemployment, which spiked to 15% a year ago, is down to 6% and headed lower. Stock markets are at record high levels, a rewarding comeback for steadfast investors.
Back to Gretzky. Where is the puck going?
Economic conditions are much stronger now. Previously closed businesses are gradually reopening. A bold infrastructure program has been proposed. The Federal Reserve has pledged to keep its policy interest rates low until the labor market is closer to full employment and inflation above 2%. This seems like a very bullish combination, and market conditions reflect a growing optimism. However, Bartlett’s assessment is more realistic. We believe stock market progress during the next few years will be moderate. What we wrote in our January update bears repeating today.
“The most rewarding periods for equity investors are in the early stages of improvement after economic setbacks, when stock prices are buoyed by expectations of an upturn. As recovery unfolds and economic growth settles at a more sustainable pace, progress becomes more measured.”
As we think of where the puck is going, we see some developing headwinds. Long-term interest rates (which are less controllable by the Fed) have been rising and inflation is trending up. Higher business tax rates have been proposed and higher taxes on capital gains and dividends are also probable. These factors make it likely that very strong economic growth in 2021 will be followed by slower progress in 2022.
The upshot is that with the stock market at record high levels, a wise investor should temper expectations and maintain appropriate safeguards. This requires careful stock selection and rebalancing so that appropriate bond and cash positions are maintained. As to stocks, lower quality and more cyclical companies have recently enjoyed a strong resurgence, buoyed by growing optimism about the 2021 economy. We think this popularity will be ephemeral. More sustainable performance will come from financially stronger companies with steadier business fundamentals and good potential for increasing dividends. We think a diversified portfolio of quality stocks will also be less vulnerable if there is another market setback. Meanwhile, quality bonds and cash are an especially important part of balanced portfolios for clients relying on periodic distributions. We are, as always, laser-focused on Bartlett’s goal of providing “all weather” performance, participating well when market conditions are strong and holding up comparatively well through difficult periods.
Lessons from a Calamity
As we write in early April, the spectacular demise of Archegos Capital Management has been a headline news story. It is believed this family office of onetime hedge fund superstar Bill Hwang lost almost $10 billion in a matter of weeks. Bankruptcy is likely and various Wall Street banks will absorb losses on loans to the company. Thus far, the collapse of the company and the forced sale of its investments has not created any lasting aftershocks in the stock market. There has been nothing reminiscent of the volatility aroused by the memorable implosion of the Long-Term Capital Management hedge fund in 1998, which required a bailout orchestrated by the Federal Reserve.
Though the downfall of Archegos has no direct implication for Bartlett clients, this episode confirms critical investing principles. Why did it collapse? We think it comes down to hubris and leverage, always a toxic combination. The company was seeking extraordinarily high returns by following a more complex strategy that entailed concentrating its investments in just a few stocks and amplifying performance by borrowing. All it took was one precipitating event – a significant decline for one of its stocks – to provoke a margin call, which set in motion a cascade of falling dominoes. The company had a fragile foundation; the Wall Street banks that enabled it should have known better.
A durable strategy is based on diversified investments grounded in careful research assessments, seeking realistic performance goals without borrowing. It is not flashy but it works. Bartlett looks forward to many more decades of serving clients with this proven approach.
We are very grateful for your business. Working for you is always a cherished privilege but especially now as we reflect on the extraordinary market conditions we navigated together over the last year. Bartlett has been adding new business at a steady pace and most of our new relationships have been referred to us by longtime clients. We hope you will recommend us to family, friends, and colleagues who could benefit from our financial planning and investment management services.