Post-Game Lessons with Bill Belichick Prepare, Don’t Predict

By Bruce Thompson on January 26, 2024

Happy New Year! The turn of the calendar brought news that Bill Belichick will be leaving the New England Patriots after 24 years as head coach. He led the team to an incredible 17 AFC East Championships and 8 Super Bowl titles. His tenure was characterized by excellence, a commitment to professionalism and, shall we say, a “tell it like it is” style with the press.

For this quarter’s Client Letter, we honor Bill by engaging him in an imagined post-2023 market review conference. Maybe he has some parting lessons we can bank on in 2024 and beyond.

First, here is a summary of asset class returns for the period ending December 31, 2023. It includes performance since the prior stock market peak near the end of 2021, and since the market bottom near September 30, 2022.

Asset Class Summary as of December 31, 2023

To view a larger version of this chart, click HERE.

Bill, how did stocks do last year?

It’s all there in black and white, pretty self-explanatory. Good year, but lots of volatility. Finished strong in the 4^th quarter with a jump of 11%. Stocks were up 22.2% for the year, and 26.6% since September 30, 2022, when the market hit bottom, recapturing all the ground lost in 2022.

Were you surprised by the markets’ performance last year?

Stocks go up, they go down, they go up again. Always been that way. Doesn’t seem that unusual.

What do you think drove the rebound?

More people were buying than selling. Look, there is a record $8.8 trillion of cash on the sidelines in money market accounts and it just needed a spark to be invested. Next question.

But what do you think sparked it?

Your newspaper published a survey in early 2023 — 85% of economists expected a recession by year-end. They were wrong, as they often are. The Fed had been raising interest rates to battle inflation and that’s come back down a lot. Despite the higher rates, the economy grew at about 3% for the year and unemployment remains near generational lows. The Fed indicated it doesn’t currently plan to raise rates further and may begin to cut them as 2024 goes on.

Maybe we’re out of the woods. Maybe not. We’ll have to see.

Some equity classes did better than others, especially large growth companies, what’s your take?

As we look at the film there is reason for celebration but also for some caution. Let me explain.

US large company stocks, as reflected by the S&P 500 Index, are roughly evenly divided between growth and value stocks. Much of last year’s return came from the growth components of the index, which rose 46.9% versus 9.2% for value stocks. In fact, just seven companies, the so-called “Magnificent Seven” — Microsoft, Apple, Amazon, Nvidia, Alphabet (Google), Tesla, Meta — accounted for 62% of the S&P 500’s returns!

From a shorter-term view, growth stocks were bouncing back from an equally large drubbing in 2022.

From a longer-term view, growth stocks have been the clear market leaders since the previous bull market started in early 2009. The large-cap growth portion of the index has had total returns of 269% over the last ten years and 831% over the last fifteen. That’s pretty astounding and it not only reflects on the power of technological innovation in our economy but also on the quality of management at these companies.

It’s also remarkable in the sense that, historically, bear markets like we had in 2022 typically have been followed by changes in market leadership. If you look at returns since the market top in late 2021, value stocks actually have had slightly better returns, leading market watchers to think such a rotation was afoot. But it appears growth stocks have caught fresh tailwinds amid excitement around the growth potential of Artificial Intelligence.

There are positives and negatives here. As a group just these seven companies, which have very rich valuations, now account for about 30% of the capitalization of the S&P 500 Index, meaning it is less diversified. With those high valuations come high expectations for growth and, if they should disappoint, which could happen for any number of reasons, it could have an outsized negative impact on the market.

Much is made of the stock market’s relatively high valuation right now, implying that upside is limited. However, the good news is that, if you subtract those seven companies, the rest of the market is trading at much more reasonable valuations, indicating room for further upside as and if the rally broadens.

We continue to believe that the best offense is a good defense and that it is critical to maintain broad equity diversification, including value, small-cap, and international stocks.

Bill, Real Estate Investment Trusts (REITS) have stunk up the works the last couple of years. Aren’t you worried about the office space vacancies?

REITS are interest rate sensitive, obviously since they borrow to buy properties and rates are up. So, they’ve lagged. But we’re taking a long-term view and check it out, the REIT index was MVP in Q4, rising 16%. By the way, our core REIT funds hold almost no commercial office space.

How did bonds do last year?

Well, the Fed held pat on interest rates in Q4, but market-based interest rates dropped. For example, the 10-Year US Treasury Bond yield declined from a tad over 5% to a bit under 4%. So, Core Bond holdings returned 6.8% in Q4 and 5.5% for the year, though the bond index is still about 4% below where it was at the end of 2021.

The short-term bond index was up 4.6% last year and those total returns are now slightly positive compared to the end of 2021.

The big winner in bonds was in the High Yield sector, which had a 13.4% index return. The returns there tend to be more tied to how the economy is doing, so this reflects confidence that we may avoid a recession.

Explain how bond yields dropped even though the Fed held the line on rates?

The Fed sets only short-term rates, and this is directly reflected in money market yields. But the rates on intermediate and longer-term bonds really are determined by market forces. If more investors buy than sell, the prices go up and the yields go down. In this case, investors appear to be betting that rates will trend back down a bit. Again, we can’t predict what will happen in the future.

One thing is that mortgage rates are chiefly based on the 10-Year US Treasury Bond yield, so we saw mortgage rates come down late in the year, which is helpful.

How should investors think about what’s happened in the bond market in the last couple of years?

Short-term pain, long-term gain. The downturn in bonds is an opportunity to lock in higher yields and this is really positive for balanced investors. Since 2021, bond interest has risen from around 1% to around 5% on a diversified collection of bonds. If you do the math, we’re in a better place.

What about “Inflation?”

We had nothing to do with deflating those footballs.

I meant inflation, not “Inflategate!”

Do you need an interpreter? Like I said, we can’t predict the future. No one can.

Having said that, I think it’s reasonable to assume that even though inflation has come way back down to about 3.5% or so from upwards of 9% last year, getting across the goal line –getting CPI back to where it was around 2% or so – is going to be a challenge. That may depend a lot on rental costs, which have begun to decline a bit, but are apt to be sticky because there is such a shortage of residential real estate.

Anyway, for the short run we’ll have to see what happens. There’s a war going on in the Middle East and if it spreads that could cause supply chain disruptions and a jump in energy prices.

Mostly, we should keep in mind that the low inflation of the last decade or so reflects residual economic weakness coming out of the mortgage crisis. Before that, inflation of 3-4% was the norm and stocks and bonds still provided good returns over the years. In fact, over the long run stocks and the dividends they pay have provided the best defense against inflation, despite the periodic volatility.

Do you think we’ll have a recession this year?

Next question (scowl).

C’mon Bill…

Look, even if you could know economic results in advance, it is difficult to know how the markets might react. That’s partly because you can’t be sure what’s already priced in.

Imagine that on September 30, 2022, when inflation was running near 9%, you were provided with a crystal ball that would enable you to see the major geopolitical and economic events of the coming year. Given what happened, it’s hard to imagine that any investor would have predicted that the S&P 500 would rise 28%, the MSCI EAFE (International Stock) Index would rise 30%, and the Bloomberg Aggregate Bond Index would rise 6%.

If investors have learned anything from the events of 2023, it is the difficulty of making accurate predictions about the market’s next turn.

What do you think will happen in the markets in 2024? Will the rally continue?

It’ll either go up, down, or sideways.

Come on, Bill, can you give us more than that?

Like I said before, forecasters can’t forecast, but you still want a forecast? You folks in the media tend to focus lots of attention on forecasts because they get clicks. But when we look at the record of forecasters, they make sports bookies look good.

Last year’s forecasts for the S&P 500 from leading investment firms ranged from a loss of -5% to a gain of 24%. The average forecast was a gain of 6%. The S&P closed up 26.3%. Investors are best served by following my friend Warren Buffett’s advice on guru forecasts:

“We have long felt that the only value of stock forecasters is to make fortunetellers look good. Short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.”

(The following chart from Avantis shows that the median stock market forecast is typically wrong by a wide margin.)

To view a larger version of this chart, click HERE.

THAT’S WHY OUR MOTTO IS “PREPARE, DON’T PREDICT.” No one knows for sure where the economy or the markets are headed in the short run. So, what we focus on the things we can know, control, and manage.

What are those things, Bill?

Well, we have an acronym – “ADEPPTS”.

• “A” stands for asset allocation – holding the right balance between risky and lower-risk investments based on your financial planning needs and risk tolerances is really important.

• “D” stands for diversification – holding a broad mix of investments in each asset class, which both minimizes the risks of individual securities, but also holding a broad mix of sectors, which increases the opportunity set.

• “E” stands for expenses –it is important to keep investment-related costs as low as possible, so you keep more return. Occasionally, it makes sense to pay a little more for a fund, but the hurdle is high in that it should have a demonstrated return advantage.

• “P” stands for our psychology or behavior as investors, which is something we can control, and may be the single most important success factor. “Don’t “out-dumb yourself” by making behavioral errors, like jumping in and out of markets as they fluctuate.

• “P”—the second “P” stands for price or value, and it points to the wisdom of rebalancing. Individual asset categories may go through extended periods of high or low relative performance. But as we’ve seen over cycles, high-priced investment returns tend to revert back down and low-priced investment returns tend to revert back up toward longer-term mean returns. Through the process of rebalancing, we can reduce risks and capture added returns over the years.

• “T” stands for taxes. That means managing the portfolio in such a way as to keep as much of your return as possible after taxes. That includes “asset location” and “tax loss harvesting.”

• “S” stands for managing how much you spend and save — something clients have some control over and it’s really key to the success of a financial plan over time.

What do you think investors should do?

Well, like Buffett suggests, savvy investors should approach their stocks like they do with their real estate and think long-term. Just because stocks are highly marketable and can be sold at any time doesn’t mean you should follow such a strategy. That’s a rookie mistake.

Our scouts tell us that, historically, most of the market’s returns were bunched in short spurts. For the last 97 years, the S&P earned 10.3% per year. But if you missed the 97 highest return months, which tended to happen after big pull backs, the average return would have been zero.

Other teams can do what they want, but if your goal is to capture market returns over the horizon of your financial plan, “Don’t out- dumb yourself” by trying to jump in and out of the markets. That’s especially true when you add taxes to the equation.

But I was online recently and…

“I don’t Twitter, I don’t do SnapFace, I don’t do InstaChat.” We’re going to stick to our plan.

There’s a Presidential election coming up, how should that affect my strategy?

Ignore the noise. It would be a losing game to swap your investments every four years or so around elections. Express your views with your votes, not with your investments. This chart from Jim Bianco shows sentiment broken out by Democrats and Republicans over time:

To view a larger version of this chart, click HERE.

When Obama was President, Republicans were less confident about things, but the S&P returned 210% in his eight years. When Trump was President, Democrats were less confident, but the market rose 63% in his four years.

Comparing historical market returns over different Presidents is of limited use anyway. The split of power between the Senate, House, and Presidency is at least as important. Also, the impact of economic policies enacted during one presidency often doesn’t don’t play out until the next President’s term.

As investors, it is important to be aware of how our choices and actions might be influenced by our biases. Over time, the markets have done just fine under both parties.

One more question…

Time’s up.

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Disclosure
Lexington Wealth Management is a group comprised of investment professionals registered with Hightower Advisors, LLC, an SEC registered investment adviser. Some investment professionals may also be registered with Hightower Securities, LLC, member FINRA and SIPC. Advisory services are offered through Hightower Advisors, LLC. Securities are offered through Hightower Securities, LLC. This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is neither indicative nor a guarantee of future results. The investment opportunities referenced herein may not be suitable for all investors. All data or other information referenced herein is from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other data or information contained in this presentation is provided as general market commentary and does not constitute investment advice. Lexington Wealth Management and Hightower Advisors, LLC or any of its affiliates make no representations or warranties express or implied as to the accuracy or completeness of the information or for statements or errors or omissions, or results obtained from the use of this information. Lexington Wealth Management and Hightower Advisors, LLC assume no liability for any action made or taken in reliance on or relating in any way to this information. The information is provided as of the date referenced in the document. Such data and other information are subject to change without notice. This document was created for informational purposes only; the opinions expressed herein are solely those of the author(s) and do not represent those of Hightower Advisors, LLC, or any of its affiliates.