Do you know of anyone who predicted the pandemic? Anyone who guessed we would enter 2020 and within months see a pandemic that would result in over 1.6 million deaths? Who could have predicted that the United States would be the country with the highest number of cases and the highest number of deaths? Who could have predicted the market would drop 34%, only to recover to an almost normal ~14% gain by the end of the year?
Frankly, no one.
Looking back on 2020, here are five important lessons that I and all investors should learn:
1. Black Swans happen. Every so often in a bevy of white swans, there will be a black swan born. It is random and unpredictable. That term, “black swan” is used to describe events in the stock market that are unpredictable. Whether it is called “tail-risk” or a black swan, these events can be unsettling. But they happen, and they will continue to happen. Only broad guesses about a pandemic could ever be made, let alone an airborne flu-type striking worldwide. But now it is important to be prepared for the next one. It might not happen, then again, isn’t the safest plan to be prepared? Isn’t the prudent thing to have enough money that, in the event of another black swan or two or three, you will still have plenty of cushion to get through it?
2. Financial plans faltered. Financial plans are based on historical data, but there has not been a pandemic since the Spanish flu in 1919. Financial plans look backward, not forward, and assume that the future will look like the past. In the case of the COVID-19 pandemic, the markets in total have done well. However, there can be no assurance that will be the case in the next black swan.
3. So called “Quant Funds” also faltered. These computer-driven funds have the ability to examine terabytes of historical data, more than a human could ever comprehend. Like financial plans, however, the past did not reveal how to respond to COVID-19. Based on the very best and most comprehensive historical data, quant funds struggled during 2020.
4. Value stocks are becoming, what I call, “black and blue” stocks. Often, they were the blue chips of the past. They were called value stocks because the value of each share of stock was significantly above their stock price. Years like 2020 have, in the past, been good for value stocks increasing more than growth stocks. A number of the determinants which define a value stock did not continue to do well in 2020. Some stocks rated as value stocks are actually dying stocks – the companies are on their last legs and in many cases not far from dissolution.
5. Superior stock selection beats indexing. Index funds contain both the good, the bad and the ugly stocks. I have to say past performance is no guarantee of future results, but there are investment managers who, over the longer-term of 10, 15, and even 40 years, have done on the average better than the indices. 2020 showed some investment managers outshined, even as some widely followed index funds like the S&P 500 total return struggled.
What surprises me every year is how few investors really evaluate their source of information and blindly accept their advisor input. Investors listen to the story and seem to forget what the story was last year and the year before. Philip Tetlock is probably the world’s greatest effort on evaluating forecasters. He divides the forecasters into two groups: hedgehogs and foxes. The Hedgehogs are the forecasters with the big ideas and very often the highest media coverage. The foxes are the ones with a plethora of small ideas and multitude of approaches. Tetlock found the greater the media coverage the worse the predictions were.
Which raises two questions:
To whom do you listen? How did your investments do this year? If you cannot say you had a great year, doesn’t that raise a final question: Are you really getting good advice?
I spent 18 ½ years working for the big brokerage firms. They told their advisors to convince clients to like them. “Sell the personality, not the performance.”
Can you say with 2020 hindsight you are working with the right person?