Dear Clients & Friends,
Happy 2024! It is my privilege to bring you another edition of my monthly commentary. As always, my goal is to deliver straightforward and timely economic and market updates along with compelling investment advice to help you protect and grow your money over the long-term.
It is often said that simplicity is the ultimate form of sophistication, so allow me to summarize the performance of the equity markets, not only in the calendar year that just ended, but over the last two years in the following two sentences: In 2022, the Dow, the S&P 500 and the Nasdaq 100 experienced peak-to-trough declines of 21%, 25% and 35%, respectively. Just before Christmas 2023, all three were in new high ground on a total return basis (including dividends).
Why stocks did this is irrelevant to the wonderful lessons that can be drawn from this experience. There are almost as many theories and explanations of why as there are market pundits in the media. (However, I would point out that the number of said market pundits who successfully predicted both the market actions of 2022 and that of 2023 is, to my knowledge, exactly zero.)
What should really matter most to us long-term, goal-focused, plan-driven equity investors is not why this happened but that it happened. Specifically, that there could be a very significant bear market one year, and that those declines could be entirely erased in the following year. Although not nearly as quickly or as perfectly symmetrical as the 2022/2023 experience, but in the broadest sense that’s how it works. Businesses adapt and the markets always come back!
As always, I will break my January commentary into two parts: first the timeless and enduring principles that shape our overall investment approach – with an extended and more robust version of our guiding philosophy – and then an observation of the current market conditions.
The only rational long-term definition of “money” is “purchasing power.” The number of units of currency one holds, and the nominal returns of that currency, are at any given moment irrelevant. Therefore, goal of long-term investing should be the growth of your purchasing power.
In the long run, the owners of successful businesses (the stockholders) must make far greater returns than do the lenders to those businesses (the bondholders). This is simple logic: if rational owners could not earn a significant return above their borrowing costs, they would not borrow.
This logic is fully supported by the historical record. Over the last near century, the S&P 500—Stock Index (and its predecessor until 1957, the S&P 90) compounded, net of inflation, at 7% per year. The most comparable bond index compounded at an inflation-adjusted rate of 3% per year.
The true test of an investment’s long-term safety is its long-term total return in excess of inflation. That excess return to the stockholders has historically been more than twice the directly comparable return to the bondholders. Therefore, by the standard that matters most stocks have been significantly safer than bonds in that they produce superior inflation-adjusted returns.
However – it must be stated – the return of stocks has been significantly more random around its positive sloping trendline over the long-term than that of bonds. This simply means higher highs as well as lower lows— much more “volatility” for stocks in both directions.
The average annual peak-to-trough drawdown over the last century has been around 15%. Average declines of nearly twice that have taken place about every five years on average. Since the end of WWII, there have been three declines averaging 50%, but the longest time to breakeven with dividends reinvested was (according to the Wharton School’s Dr. Jeremy Siegel) five years and eight months. Stated another way, the prices of mainstream equities have gone down often, and sometimes meaningfully. But not for long. After which returns have always caught up to their long-term trend. Once again, businesses adjust, and the markets recover.
The cash dividend of the S&P 500 has grown since 1926 at a 5% compound rate versus the average inflation rate of 3%. Since 1980, the rate of dividend growth has accelerated to very nearly 6%, while CPI inflation has continued at about 3%. Dividends that grow significantly faster than inflation will be a critical element for retirees that need their capital to last for possibly three-decades or more.
The economy cannot be consistently forecast, nor the equity market consistently timed. Thus, the only way to fully capture the equity market premium over the long-term is to remain invested.
All successful long-term investing is goal-focused and planning-driven. Investing must at all times be driven by the plan, and never by current events. Investment strategy that is based on short-term views of the economy and/or the markets will likely fail in the long run. Ultimately, if you try to outguess the market you will end up earning less than what the market has to offer.
Second only to love, the most powerful force on earth is human ingenuity— and equities are the only financial asset that fully captures human ingenuity. It is my core belief that the path to investing success requires unwavering faith, patience, and discipline. Those of us who are able to summon those all-important traits when the fears and fads of the moment are strongest will reap the rewards over time, whereas those who succumb to the temptations of trying to “outperform” or “perfectly time” the market will be doomed to financial mediocrity or worse.
I’m convinced that the long-term effects and disruptions resulting from the COVID-19 pandemic are still working themselves out in the economy, the capital markets, and throughout society itself, in ways that can’t be predicted, much less used to create a coherent investment strategy.
The key financial event in response to COVID was a 40% explosion in the M2 money supply by the Federal Reserve -- they predictably ignited a firestorm of inflation (the highest we’ve seen in 40 years). To stamp out that inflation, the Fed then implemented the sharpest, fastest interest rate spike in its 110-year history. Both the debt and equity markets cratered in response in 2022.
Despite this, economic activity just about everywhere, except in the housing sector, has remained relatively strong; at least so far, employment activity has been largely unaffected. If you remember, this time last year, most economists were predicting a mild recession by late 2023, however the economy has remained stubbornly resilient, and no such recession has materialized.
Inflation has come down significantly, though not yet close to the Fed’s 2% target. But prices for most goods and nearly all services remain elevated, straining middle-class budgets. On a side note: there is a common misconception that when we hear that inflation is coming down, we expect to see prices of goods and services coming down too, but that is not the way it works. Once prices go up, they tend to stay up. What’s been going down is the year over year percentage change at which prices are going up— this drop is known as disinflation (and that’s a really good thing). When the inflation rate falls below zero and the prices of goods and services go down across the economy, that is known as deflation, and that is not what’s happening now.
With inflation moderating and corporations adjusting their business models to the new higher interest rate environment, the capital markets have recovered significantly. The main speculation now centers on when and how much the Fed may lower interest rates in 2024, and whether a recession may yet begin. These outcomes are unknowable—probably even to the Fed itself—and don’t lend themselves to forming a rational long-term investment policy.
It's worth noting, of course, there are still major uncertainties facing the markets. Trends in the U.S. federal deficit and the national debt continue to appear unsustainable. Social Security and Medicare appear to be on paths to eventual insolvency unless reformed. The serial debt ceiling crisis continues, and a bitterly partisan presidential election approaches. The markets will face significant challenges in the year ahead just as they always do every year.
The overall recommendations of the advisory team at Mercer Partners are essentially what they were two years ago at this time, and what they have always been. Let’s revisit your most important long-term financial goals soon. If we find that those goals haven’t changed, we’ll recommend staying with our current plan. And if our plan isn’t changing, there’s likely no compelling reason to materially change your investment strategy. We continue to preach the virtues of building a low-cost, broadly diversified portfolio of high-quality stocks across different sectors, industries, and geographies— this remains and will continue to remain – the core tenants of our approach to building your wealth and guiding you toward your most cherished life goals.
As always, we welcome your questions and comments, and look forward to talking with you soon. Thank you again for the opportunity to serve you and your family. It’s our privilege to do so.
Nick Enzweiler, CFP® is a registered representative with, and securities offered through LPL Financial. Member FINRA/SIPC. Investment advice offered through Mariner Independent Advisor Network, a registered investment advisor. Mercer Partners Wealth Management and Mariner Independent Advisor Network are separate entities from LPL Financial.
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.
References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.
All data is provided as of January 3, 2024.
Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities.
All index data from FactSet.
The Standard & Poor’s 500 Index (S&P500) is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
This Research material was prepared by LPL Financial, LLC. All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Past performance does not guarantee future results.
Asset allocation does not ensure a profit or protect against a loss.
For a list of descriptions of the indexes and economic terms referenced, please visit our website at lplresearch.com/definitions.