This Time is Different

My first letter of the year and I am feeling a sense of optimism that 2022 will truly be better than last year. In January of last year, I expressed the same sentiment and boy was that a case of wishful thinking. The pandemic doubled down, in terms of death toll and hospitalizations, surpassing the 1918 Spanish Flu and the Civil War to become the largest mass casualty event in US history. Of course, the US population is much larger now than in 1918 and 1864, but the numbers beg reflection.

Speaking of Civil War, I do not believe at all that is where we are headed. However, the civil discourse in 2021 was certainly very bellicose, as we were at each other’s throats about masks, vaccination status, distance learning, and political persuasion. If there’s a silver lining, I feel that a lot of this negative sentiment lives online, in the social media echo chambers. My interactions with people in the real world are generally positive and I am sure that experience is not unique to me. In other words, we can figure this stuff out if we listen to our better angels, perhaps starting in 2022?

2022 Sign

Despite all the pessimism triggered by the pandemic and social divisions, the US stock market was very optimistic, up 19-27% depending on what index you look at. And it wasn’t just investors who were making hay. Wages increased 4.7% in 2021 according to the US Department of Labor. Some news outlets were quick to report that real wages probably declined for most workers after factoring in inflation, but that does not account for the fact that people tend to adjust their spending patterns based on inflation, US household were flush with pandemic aid, and the lowest paid workers saw the biggest percentage pay increases. The latter is welcome for many reasons, but especially considering that low-wage workers are most vulnerable to increases in the price of food, gasoline, and rents.

Stuck in a dead-end job no more. Workers are quitting their jobs in record numbers. In November 2021, a record 4.5 million Americans quit their jobs. That seems like an alarming headline, but it is only half the headline. The vast majority of them are quitting for better jobs: better pay, better benefits, more rewarding work, better boss, less pricy locale. Correspondingly, the unemployment rate dropped to a very low 3.9% in December, according to the Labor Department.

If the stock market was driven by optimism and even euphoria if you look at cryptocurrencies, NFTs, meme stocks, and other speculative assets, the bond market was decidedly less enamored with 2021, producing single digit negative returns in nominal terms, and much worse if you consider inflation might have staying power. The US stock market far outpaced international developed stock markets, not to mention emerging markets, which were in the red largely because of China. US exceptionalism prevailed once more. Though with persistent inflation (transitory is out), high asset values, and a less accommodating Fed, the road ahead may be less generous to US-centric investors.

So where do we go from here? We are preprogrammed to want to invest in ideas, whereas a better approach is probably to invest in process. The future will be different from the past, but the future will also be different from what the consensus is of what the future will be. A winning portfolio is one that can survive, or better yet thrive, whether the future ends up being what we imagined or different. 

To make that more actionable, one should not assume that certain outcomes are inevitable. For example, I hear quite a bit of chatter in my network about the inevitability of a large market correction in the very near future. 2019, 2020, and 2021 were stellar stock market years and it can’t possibly last any longer, with valuations stretched. I am susceptible to this line of thinking because I too believe stock values are stretched and speculation is rife. However, if we go back to the 90s – wouldn’t that be great? – 1995, 1996, and 1997 were amazing years in the stock market, followed by 1998 and 1999, during which the stock market increased by an additional 50+%. In 2000 the party was over and over the next 2.5 years the market dropped 50% and tech stocks, as measured by the Nasdaq-100 Index sank 80%. The lesson, I believe, is that both good and bad times can last longer and reach higher heights and lower depths than we can imagine. Putting all our money behind what we think are today’s best investment ideas or dialing our portfolio risk level all the way up or down based on our current outlook, is more likely to result in regret than early retirement.

Too Soon?

So given that we do not know if we are in today’s version of 1998 or 2000, in terms of a frothy stock market and given that interest rates are low, likely rising, and inflation is proving sticky, I favor stocks over bonds, other sectors over tech, and a healthy dose of non-US exposure. When I say I favor stocks over bonds, that is not to say that an investor should substitute all their bonds for stock. That would make the portfolio far riskier and prone to a deeper drawdown if there is stock market swoon. It is to say, however, that I would recommend less bond exposure and tilt the bond exposure to areas that have a fighting chance in this low-rate environment, like sovereign bonds, Treasury Inflation Protected Securities (TIPS), and other less-plain-vanilla parts of the bond market that would hold up better with inflationary shocks and rate hikes. All while bearing in mind that in a low-rate environment, bonds are just not going to look that pretty.

There is a saying in Dutch that roughly translates as follows: even if you put a golden ring on a monkey, it is still an ugly thing. Apologies to the monkey for the insult and personally I find them cute, but the lesson here is that spending money on more “fancy” alternatives to traditional bond exposure is no panacea. At the end of the day the fees are going to hurt, and the “low risk” portion of your portfolio is still likely to disappoint. I get frequent sales calls and emails trying to sell me on “alternatives” to deal with the low-rate environment, but the only guarantee on offer is that you will pay more for whatever product Wall Street has cooked up to address your bond fears.

Here is one low risk investment that offers a very solid return, I am tempted to even say “guaranteed,” though regulators who see that word in an investment newsletter get nervous and that makes me nervous:  7.12% on US Government I Bonds. These are savings bonds that adjust for inflation. Through April 2022, the rate is 7.12%. It then resets to whatever the prevailing inflation rate is and stays there for the next 6 months and so on. The compounding occurs every 6 months, whereby the interest is added to the principal. You must hold the bonds for at least 1 year and beyond that, if you redeem before 3 years, you have to forego the last 3 months’ worth of interest. It’s a terribly good deal, in my opinion. The catch is that you can only invest $10,000 per calendar year. But, if you have a spouse, or a business, or a spouse and a business, or a spouse with a business and a business (you get my drift?) you can open multiple accounts for your household and increase that $10,000 cap. It’s a worthy place to stash a portion of your bank savings, if you can part with it for at least 1 year. You would open an account with Treasury Direct and it is simple from there.

I-Bonds were hot, the stock market was hot, and unfortunately the planet was hot in 2021. Quite literally, it was on fire and temperatures in the Artic reached triple digits over the summer, for the first time in recorded history. The Canadian town of Lytton incinerated when the temperature there reached 121 degrees, and for a while the Pacific Northwest cooked in a once-in-a-millennium heat wave that will probably not take 1,000 years to repeat itself. Global warming isn’t the sole factor in these events, but it amplifies their frequency and intensity. Not to mention it creates a terrible feedback loop: global warming spawns wildfires, which increase carbon in the atmosphere, which triggers more warming and more fires. 5% of global emissions last year were from wildfires, in California that number was 25%.

temperature map globe
Source: Bloomberg. Colored areas reflect temperature records. 2021

In November, the world elite descended on Glasgow in their private jets for another UN Climate Summit on how to curb emissions. It is hard to miss the irony in that factual statement. Zoom was not an option apparently, but I understand there is value in face-to-face contact. These summits follow a familiar script: much anticipation, much diplomatic wrangling, angry young people rallied by Greta Thunberg, and ultimately disappointment and a giant waste of carbon. That’s the cynical view. On the other hand, world leaders can’t stop talking if we are to get a handle on climate change. Moreover, some positive achievements did come out of COP 26: 1) an agreement to limit methane emissions, which are more potent than CO2 and dissipate quicker from the atmosphere, so a bigger bang for your buck and 2) an agreement by 141 countries to halt and reverse forest loss and land degradation. The 141 include Brazil, Indonesia, and the Democratic Republic of Congo, where most of the future deforestation would otherwise take place. Some of the leaders of these countries do not inspire confidence, so we are not quite out of the woods yet, so to speak, but it’s a very positive development.

In my latest podcast, I had a conversation with my colleague Tom Konrad, CFA, about the common myths of green investing. You can listen to the full episode on Spotify here: One topic we discussed was how to find the next Tesla. By a long stretch, Tesla has been the best green stock to own over the last decade. It has trounced the stock market as well as the green mutual funds and ETFs.

The issue with finding the next Tesla, is that you cannot be remotely close to 100% sure you have identified it in advance of a home run. In fact, baseball terminology is pretty apt here: home run leaders will see 91-96% of their career at-bats not result in a home run. So, if you want to be sure you are going to hit it out of the park with the next Tesla, you probably need to invest in a dozen candidates that could be the next Tesla. In fact, to improve your odds you have “the one” you might need to buy an ETF or mutual fund or construct your own portfolio of a couple dozen or more stocks that could be the next Tesla. Invariably, these are growth companies, pre-profit, in the proving stage of their product. And therein lies the crux: most Tesla contenders will not be the one, so most of your portfolio will likely do poorly and if you did manage to scoop up the big winner, its results will not compensate for all the losers. 

To illustrate this point, I have included a 10-year chart of Tesla, vs. the WilderHill Clean Energy ETF, which has had Tesla among its top holdings for the whole decade, but also owns a lot of other growth companies that fizzle(d) out; a picture tells a thousand words.

10-year chart of Tesla, vs. the WilderHill Clean Energy ETF

I hope that 2022 is already off to a great start for you and look forward to connecting.


Jan Signature

Jan Schalkwijk, CFA


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