The True Cost of Investing + Financial Market Update + 1.26.21

The True Cost of Investing + Financial Market Update + 1.26.21

FINANCIAL MARKET UPDATE 1.26.2021

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

THE TRUE COST OF INVESTING

Long-time readers of the Weekly Market Update may know I am a fan of Morgan Housel, as his blog is frequently among the links in the Hot Reads section. Last year, Morgan published a book titled The Psychology of Money, which I found to be an excellent read as well. One thing that I think sets him apart is his ability to explain abstract financial concepts through stories and metaphors that may be more relatable to people outside of the industry. A chapter of the book covering market volatility really resonated with me. It provided a unique perspective on market swings that, if embraced, can improve your chances for investment success.

Since 1927, the US stock market has returned just over 10% per year on average. At that rate, an investor with a diversified portfolio of stocks would have seen their money double every seven years or so. All you had to do was set it and forget it. Of course, doing so is much easier said than done. Morgan writes:

Like everything else worthwhile, successful investing demands a price, but its currency is not dollars and cents. Its volatility, fear, doubt, uncertainty, and regret. All of which are easy to overlook until you are dealing with them in real-time. The inability to recognize that investing has a price can tempt us to try to get something for nothing, which, like shoplifting, rarely ends well.

The stock market’s 10% average return was much higher than what could have been earned on a risk-free investment. Any investor that hoped to achieve that return had to pay the corresponding price. The period was fraught with wars, natural disasters, market peaks, market crashes, a global pandemic, and many other events that generated substantial volatility and fear. As a result, the price for pursuing that return was quite high, and many were likely unwilling to pay it. Morgan further describes the cost of investing through an analogy of purchasing a car:

Say you want a new car, it costs $30,000. You have three options:

  1. Pay $30,000 for it
  2. Find a cheaper, used one
  3. Steal it

Like the car, you have a few options (when investing). You can pay this price, accepting volatility and upheaval, or you can find an asset with less uncertainty and a lower payout – the equivalent of a used car. Or you can attempt the equivalent of grand theft auto and try to get the return while avoiding the volatility that comes along with it. Many people in investing choose the third option, like a car thief, though well-meaning and law-abiding, they form tricks and strategies to get the return without paying the price. They trade in and out. They attempt to sell before the next recession and buy before the next boom. Most investors with even a little experience know that volatility is real and common. Many then take what seems like the next logical step, trying to avoid it. But the money gods do not look highly on those that seek a reward without paying the price. Some car thieves will get away with it. Many more will get caught. 

The penalty for “getting caught” can be illustrated by the famous analysis conducted by Dalbar Inc. Their study showed that fund investors in aggregate tend to underperform the funds they invest in, a result of performance chasing and failed attempts to time the market.

Risk and return are bound together. Assets with the prospect of a higher return only exist because their payoffs are uncertain. If a risky stock had the same expected return as a risk-free government bond, nobody would buy the stock. Why take risk if you can earn the same return risk-free? In order to attract investors, assets with uncertain payoffs must be priced so that investors may be rewarded for taking the risk. The larger the uncertainty in the potential payoff, the larger the reward that is required to attract investors. This is an especially critical concept for investors to understand in today’s market environment, where interest earned on risk-free investments is effectively zero and negative after inflation. For most people, financial goals require a return that is not only positive but exceeds inflation. To obtain such a return, they must take risk.

I’ll let Morgan close this out with his thoughts on how investors should think about that risk:

The question is, why do so many people, who are willing to pay the price of cars, houses, food, and vacations, try so hard to avoid paying the price of good investment returns. The answer is simple, the price of investing success is not immediately obvious. It’s not a price tag you can see. So, when the bill comes due, it does not feel like a fee for getting something good. It feels like a fine for doing something wrong. While people are generally fine with paying fees, fines are supposed to be avoided. You are supposed to make decisions that preempt and avoid fines. Traffic fines and IRS fines mean you did something wrong and deserved to be punished. The natural response for anyone who watches their wealth decline and views that drop as a fine is to avoid future fines. It sounds trivial, but thinking of market volatility as a fee, rather than a fine, is an important part of developing the kind of mindset that lets you stick around long enough for investing gains to work in your favor.

WEEK IN REVIEW

  • The Federal Reserve’s FOMC began its two-day policy meeting today and will conclude tomorrow afternoon. The end of the meeting will be followed by Chair Powell’s 1 PM CT press conference, which can be streamed on Yahoo Finance. There seems to be a consensus in the market that the Fed will leave its policy rate at the zero bound for an extended period. Early signs of an uptick in inflation, however, are causing some speculation on when quantitative easing (QE) will be wound down. QE refers to the bond buying program the Fed implemented during the height of market volatility last year. Reducing these purchases would likely be one of the first ways the Federal Reserve begins to tighten, and the market will pay close attention to any guidance from Powell on the subject.
  • In the Spring of 2013, the Fed Chair at the time, Ben Bernanke, suggested the Fed may begin to “taper” its financial crisis era QE program. Following those comments, interest rate volatility spiked and long-term yields rose dramatically through the remainder of the year. The event was dubbed the “Taper Tantrum,” a repeat of which Powell will certainly seek to avoid.
  • From an economic data standpoint, look for durable goods orders tomorrow. On Thursday, we will get an update on Jobless claims, the first estimate of Q4 GDP, and the index of leading economic indicators (LEI). Finally, we will get inflation data and a reading on consumer sentiment on Friday.

HOT READS

Markets

  • November Home Prices Rose 9.5%, One of the Highest Gains on Record, Case-Shiller Says (CNBC)
  • GameStop Day Traders Won’t Sack Wall Street (WSJ)
  • Saved Stimulus Checks Expected to Help Spur Economic Recovery (WSJ)

Investing

  • Every Warren Buffett Needs a Charlie Munger (Jason Zweig)
  • A responsible Version of Market-Timing (Morningstar)

Other

  • Why You’re More Creative in Coffee Shops (BBC)
  • The Good Kind of Brain Drain (The Atlantic)
  • Coffee Tied to Lower Risk of Prostate Cancer (NYT)

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

ECONOMIC CALENDAR

Source: MarketWatch

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ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + CHIEF INVESTMENT OFFICER

Josh Jenkins is the Chief Investment Officer at Lutz Financial. With 10+ years of relevant experience, he specializes in assisting clients with portfolio construction, asset allocation, and investment risk management. In addition, he is responsible for portfolio trading, investment research and thought leadership for the division. He lives in Omaha, NE, with his wife Kirsten.

AREAS OF FOCUS
  • Asset Allocation
  • Portfolio Management
  • Research & Data Analytics
  • Trading System Operation & Execution
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst®
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

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The True Cost of Investing + Financial Market Update + 1.26.21

Growth Trounced Value in 2020 + Financial Market Update + 1.12.21

FINANCIAL MARKET UPDATE 1.12.2021

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

GROWTH TROUNCED VALUE IN 2020

For the fourth consecutive year, growth stocks have outperformed their value counterparts. The degree of outperformance in 2020, however, was on a different level. Small and mid-cap value stocks trailed by the largest amount since the technology bubble of the late 1990s, while large-cap value stocks trailed by the largest amount ever. Factors including low interest rates and the strong relative performance of the so-called work-from-home (WFH) stocks likely contributed to growth’s dominance.  

Now that we have entered 2021, what is the outlook for growth versus value stocks moving forward? There are a number of reasons to believe the performance of value stocks may be poised to rebound. The biggest support for this happening is the relative valuation between growth and value, as the two charts below illustrate.

Investors typically pay a premium relative to the market for companies that demonstrate rapid growth. The size of the premium that investors pay ebbs and flows with market conditions but tends to return to its long-term average level. Today, investors are paying the highest premium for growth in nearly twenty years!

 

Source: Morningstar Direct. Valuations are based on an equally weighted composite of price/book value, price/earnings, price/sales, and price/cash flow of each value index relative to the broad market. Large cap growth is represented by the S&P 500 growth Index. The broad market was represented by the Russell 3000 index. Data from 1/2001 to 12/2020.

Value stocks, on the other hand, typically trade at a discount relative to the broad market. As these companies fell further out of favor with investors over much of 2020, the discount continued to widen. By the end of the year, investors had the ability to purchase smaller, value-oriented companies at the largest relative discount in decades. For investors concerned about owning stocks while the market appears to be so expensive, small-cap and value-oriented companies offer an attractive opportunity.

Source: Morningstar Direct. Valuations are based on an equally weighted composite of price/book value, price/earnings, price/sales, and price/cash flow of each value index relative to the broad market. Small cap value is represented by the S&P 600 Value Index. The broad market was represented by the Russell 3000 index. Data from 1/2001 to 12/2020.

The last time the dispersion in performance and valuation, between growth and value, was this wide (1999), value stocks went on to outperform dramatically for several years. Of course, that does not mean the same will happen this time. It is possible that growth stocks will continue their dominance. Recently, small and value tilted companies have staged a small comeback, though we have seen multiple false starts over the past several years. Still, valuations have a tendency to revert to their long-term averages. Growth stocks are trading well above average, while value stocks are trading well below. A reversion would suggest strong relative performance for value.

WEEK IN REVIEW

  • Data published by the Bureau of Labor Statistics (BLS) last week showed the US economy shed 140,000 jobs, compared to forecasts of a 50,000 job gain. Job losses were concentrated in the virus-sensitive hospitality industry, including bars and restaurants, as accelerating Covid cases caused governments to intensify restrictions. The unemployment rate held steady at 6.7%.
  • This week kicks off the earnings season for Q4 2020, with many of the big Wall Street banks reporting. According to Factset, YoY earnings are expected to be -8.8%, which represents an improvement from the original estimate of -12.7%, made at the beginning of the quarter. Typically the pattern is for companies to guide earnings expectations lower throughout the quarter, which lowers the bar making them easier to beat. This is the second consecutive quarter where estimates have increased during the quarter. With valuations stretched, strong results are needed to justify more gains. One positive is that YoY growth rates are going to get a tailwind as the weak Q1 2020 quarter becomes the comparison for Q1 2021.
  • On Wednesday, look for an update on inflation. Jobless claims will be published on Thursday. Finally, retail sales and industrial production will be published on Friday.

HOT READS

Markets

  • Economy Sees Job Loss in December For The First Time in Eight Months as Surging Virus Takes Toll (CNBC)
  • Two Worlds: So Much Prosperity, So Much Skepticism (Morgan Housel)
  • Cash in Circulation is Soaring, and that Usually Means Good Things for the Economy (CNBC)

Investing

  • Unrelated Stock Sees Massive Gains Days After Elon Musk Said People Should ‘use Signal’ (CNBC)
  • The Stock Market is Causing the Bubbles (Michael Batnick)

Other

  • Former US Air Force Fighter Pilot Breaks Down 12 Fighter Pilot Scenes From Film & TV (Wired)
  • ‘The Browns Is The Browns’ (Sports Illustrated)
  • We are What we Remember (Farnam Street)

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

ECONOMIC CALENDAR

Source: MarketWatch

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ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + CHIEF INVESTMENT OFFICER

Josh Jenkins is the Chief Investment Officer at Lutz Financial. With 10+ years of relevant experience, he specializes in assisting clients with portfolio construction, asset allocation, and investment risk management. In addition, he is responsible for portfolio trading, investment research and thought leadership for the division. He lives in Omaha, NE, with his wife Kirsten.

AREAS OF FOCUS
  • Asset Allocation
  • Portfolio Management
  • Research & Data Analytics
  • Trading System Operation & Execution
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst®
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

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The True Cost of Investing + Financial Market Update + 1.26.21

2020: Year In Review + Financial Market Update + 1.5.2021

FINANCIAL MARKET UPDATE 1.5.2021

GUEST AUTHOR: JUSTIN VOSSEN, CFP®, NAPFA

STORY OF THE WEEK

2020: YEAR IN REVIEW

There are decades when nothing happens, and there are weeks where decades happen. As I sit with clients and reflect on the year that was, I am struck by all that can happen in a short amount of time. The last year brought about a large array of things that were unfathomable just 12 short months ago. The most difficult part for a middle-aged person like me is to digest a lifetime’s worth of changes so rapidly.

So, I think it is worth some time to look back at all that happened. Sometimes we learn more about events and ourselves reflecting after the fact. Because of all that was happening around us, it was hard to absorb everything in the moment. I will try to limit the virus statistics and political events as much as possible and try to focus on the financial changes that have occurred over the last year. 2020 was more than a decade’s worth of changes, and they will impact us all for many years to come.

  • January 4th – WHO announces unknown pneumonia case in Wuhan, China
  • January 20th – First confirmed case of Covid-19 in the United States
  • February 19th – S&P 500 closes at a record high of 3,386
  • February 28th – S&P 500 falls into correction territory (-10%) due to Covid-19 fears
  • March 3rd – The Fed announced an emergency rate cut of 0.50%
  • March 6th – Ten states report their first case of coronavirus, including Nebraska
  • March 9th – The Dow Jones loses more than 2,000 points in a day
    • The 10-year Treasury Note falls to 0.40%
    • Oil prices fell 22%
  • March 12th – Total U.S. Cases passed 1,500
    • The S&P 500 fell 9.4% in a day, effectively shaving more than 27% off the index over 16 trading days
    • The NBA, NCAA, NHL, MLB, PGA suspend or cancel their seasons
  • March 15th – The Fed lowers the fed funds target rate effectively to 0%
  • March 16th – The S&P 500 falls 7% at open to again halt trading in U.S. equities
    • The Dow suffers its worst daily point drop in history, closing down nearly 3,000 points or 12.9%
  • March 17th – The Federal Reserve announces establishment of new initiatives:
    • Commercial Paper Funding Facility (CPFF) to help money markets
    • Primary Dealer Credit Facility (PDCF) to help banks and credit
    • Money Market Liquidity Facility (MMLF) to assist money market funds
  • March 18th – The IRS announces that tax filers can defer personal income taxes until July 15th
  • March 19th – California announces the U.S.’s first “stay at home order”
  • March 20th – Bond spreads widen to recent records over Treasuries
    • Investment-grade corporates nearly 4%
    • High yield bonds more than 10%
  • March 23rd – Federal Reserve begins to buy Treasury securities and agency mortgage-backed securities in “whatever amount is needed to support market functions.”  Also, the Fed expands money market purchases to municipal bonds
  • March 23rd – The S&P 500 index hits lowest point. Peak-to-trough losses(1):
    • S&P 500 fell 34%
    • Small caps (S&P 600) fell 41%
    • High yield corporate bonds fell 22%
    • REITs fell 41%
    • Municipal bonds fell 9%
  • March 25th – The Dow rises 2,113 points or 11.4%
  • March 27th – CARES Act is passed, and the government starts sending checks to taxpayers
  • March 30th – For the month of March, the S&P 500’s average daily swing was 5.3%
    • The prior record for any month was November 1929 of 3.9%
  • April 2nd – Covid-19 cases top a million worldwide
  • April 3rd – The SBA announces “Paycheck Protection Program” loans to businesses
    • The SBA processes 14 years’ worth of loans in 14 days to 1.66 million small businesses
  • April 8th – The S&P 500 index has a 12-day streak of 1% moves up or down
  • April 9th – Federal Reserve to provide up to $2.3 Trillion of loans to support the economy as well as purchase high yield bonds and other low rated debt
  • April 20th – Crude oil prices turn negative as producers paid buyers to take the commodity off their hands as fears that storage capacity could run out in May
  • April 22nd – AAII publishes investor sentiment survey that shows the lowest levels of the year
  • April 29th – Real GDP falls 4.8% in the first quarter of 2020
  • April 30th – The S&P 500 rises 12.7% for the month of April
    • This is the best April for stocks since 1938
  • May 8th – BLS reports payrolls fell by 20.5 million and the unemployment rate rose to 14.7%
  • May 11th – Federal Reserve announces the Secondary Market Corporate Credit Facility will begin the purchase of exchange-traded funds
  • May 18th – Moderna reports positive results from its vaccine candidate in human trials
  • May 20th – CDC provides guidance as states begin to reopen
  • May 21st – Covid-19 cases eclipse 5 million worldwide
  • May 26th – NYSE reopens the trading floor
  • June 5th – BLS reports 2.5 million of job gains in May and a decline in the unemployment rate to 13.3%
  • June 8th – The National Bureau of Economic Research declared a recession began in February of 2020, ending the 128th month of expansion, the longest in the history of U.S. business cycles
    • The S&P 500 turns positive on the year after losing nearly 34% during the 21 trading days between February 20th and March 23rd
  • June 30th – The S&P 500 moves higher by 18.7% in the second quarter ended 6/30/2020
    • This is the best quarterly return for the market since December of 1998
  • July 21st – European Union leaders pass $857 billion stimulus package
  • July 28th – Gold rises to a level not seen since 2011, up 27% for the year
  • August 8th – The unemployment rate falls to 10.2% in July from 14.7% in April
  • August 27th – Fed Chairman Jerome Powell announced policy shift toward “average inflation targeting” to maintain maximum employment and price stability
  • September 23rd – The S&P 500 closed lower, falling 9.6% for the month of September
  • September 30th – Global equity markets experience first down month since March
  • October – Global Covid-19 infections rise dramatically
  • October 29th – U.S. GDP Booms at 33.1% annualized increase for the quarter but still down in raw percentage 9% from the level in Q3 2019
  • October 31st – The S&P 500 has its second consecutive negative month, falling 2.7%
  • November 8th – The U.S. surpassed 10 million infections
  • November 9th – The S&P 500 gains 7.3% week after the election
  • November 10th – Unemployment for October falls to 6.9%
  • December 11th – The FDA approves the first vaccine for emergency use from Pfizer
  • December 24th – 30-year mortgage rates fall to a low of 2.66% according to Freddie Mac
  • December 31st – The S&P 500 rises 12.2% for the fourth quarter of 2020
    • S&P 500 rises 16.2% on the year
    • 10-Year Treasury Note ends the year at 0.91%

It’s a long list, and there are valid arguments for adding a dozen or more events. While an army of forecasters offered their predictions for what 2020 would bring, it’s unlikely anyone anticipated anything near the above timeline. So, it is oftentimes better to reflect than try to guess what will happen in the future. However, this certainly won’t stop them from trying again in 2021!

1. Source: Morningstar Direct. Peak-to-trough return calculated as the period between 2/20/20 and 3/23/2020. Asset classes were represented by the following ETFs: S&P 500 (VOO), S&P 600 (IJR), high-yield bonds (HYG), REITs (VNQ), municipals (MUB)

WEEK IN REVIEW

  • According to a report by the Wall Street Journal,  Saudi Arabia and Russia reached an agreement this morning that would maintain reduced oil production levels until March. Last year, OPEC and nearly a dozen other oil producers led by Russia, agreed to cut production to support prices as the pandemic response crushed oil demand. The initial reduction amounted to about 9.7 million barrels a day, roughly a quarter of which has already been restored. West Texas Intermediate (WTI), the US benchmark for oil prices, rallied nearly 5% on the news and briefly touched $50/barrel for the first time since last February. The group, referred to as OPEC-plus, decided to pause the production increase due to fears about more lockdowns and the slow rollout of Covid Vaccines.
  • The Institute for Supply Management (ISM) published its December Index of Manufacturing Activity, which showed an increase to a two-year high of 60.7 from last month’s 57.5 (anything over 50 signals expansion). Prior to Covid, the services sector was doing better than the manufacturing sector, but that has since reversed as a result of social distancing and government restrictions.
  • It’s a big week for economic data. Later this week, look for the minutes from the last FOMC meeting, an update on services sector activity, and jobless claims. Headlining the week of data releases will be the jobs report published on Friday.

ECONOMIC CALENDAR

Source: MarketWatch

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

HOT READS

Markets

  • Why the Fed’s Inflation Push Could Turn From Friend to Foe For the Market This Year (CNBC)
  • China’s Economic Data: A Guide for the Dazed and Confused (WSJ)
  • Home Prices are Rising Faster in the Middle of the U.S. as Covid Drives People Away from Coasts (CNBC)

Investing

Other

  • German Automakers Are Charged Up and Ready to Take on Tesla (NYT)
  • A monster Wind Turbine is Upending an Industry (NYT)
  • Bowl Season Dropouts’ Economic Worries Trump Pandemic Concerns (Sportico)

Do you want to receive financial market updates in your inbox? Sign up here! 

ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + CHIEF INVESTMENT OFFICER

Josh Jenkins is the Chief Investment Officer at Lutz Financial. With 10+ years of relevant experience, he specializes in assisting clients with portfolio construction, asset allocation, and investment risk management. In addition, he is responsible for portfolio trading, investment research and thought leadership for the division. He lives in Omaha, NE, with his wife Kirsten.

AREAS OF FOCUS
  • Asset Allocation
  • Portfolio Management
  • Research & Data Analytics
  • Trading System Operation & Execution
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst®
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

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bitcoin back in the spotlight + Financial market Update + 12.29.20

bitcoin back in the spotlight + Financial market Update + 12.29.20

FINANCIAL MARKET UPDATE 12.29.2020

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

BITCOIN BACK IN THE SPOTLIGHT

Over the last few months, Bitcoin has recaptured the imagination of investors. While risk assets, in general, have had a strong quarter, Bitcoin has been on another level entirely. Since the start of October, the price of the popular cryptocurrency has increased 154%. In the last two weeks alone, the price has increased by nearly $10,000, rocketing to a new all-time high. The previous peak, achieved in December of 2017, came courtesy of a similarly explosive rally. In the twelve months that followed, Bitcoin experienced a devastating selloff that reduced its value by 83%(1).

The recent rally has been propelled by several factors. There has been increased institutional backing for Bitcoin. Prominent Hedge Fund managers, including Stanley Druckenmiller and Paul Tudor Jones, have publicly indicated they have made purchases. A few corporations, including software company MicroStrategy and insurance giant MassMutual, have also made headlines after announcing they purchased Bitcoin into their corporate treasuries. Finally, fintech companies have made it considerably easier to purchase Bitcoin. Popular services, including those operated by PayPal, Square, and Robinhood, allow individuals to make a purchase with a few quick taps of their smartphone.

Another factor that has likely supported the rise in Bitcoin has been inflation. Global central banks have aggressively eased monetary policy in response to the pandemic induced economic slowdown. This has generated fears that a sharp rise in inflation will degrade the purchasing power of the US Dollar and other major currencies. The code that underpins Bitcoin, meanwhile, caps its total supply at 21 million. This feature is a cornerstone of the belief that Bitcoin offers a strong hedge against inflation, but more on that later.

Unsurprisingly, the soaring value of cryptocurrencies has once again piqued the interest of many individual investors. In order to assess whether Bitcoin is suitable as an investment, it would be informative to compare it to other traditional investments. In a paper published just days before the 2017 Bitcoin peak, Dimensional Fund Advisors (DFA) went through such an exercise(2). The excerpt below summarizes the comparison:

When a company issues stock, it offers investors a residual claim on its future profits. When a company issues a bond, it offers investors a promised stream of future cash flows, including the repayment of principal when the bond matures. The price of a stock or bond reflects the return investors demand to exchange their cash today for an uncertain but greater amount of expected cash in the future. One important role these securities play in a portfolio is to provide positive expected returns by allowing investors to share in the future profits earned by corporations globally. By investing in stocks and bonds today, you expect to grow your wealth and enable greater consumption tomorrow.    

Holding cash does not provide an expected stream of future cash flow. One US dollar in your wallet today does not entitle you to more dollars in the future. The same logic applies to holding other fiat currencies — and holding Bitcoins in a digital wallet.

The fact that stocks and bonds generally produce a positive cash flow is the critical differentiator. Similar to gold, Beanie Babies, and tulips, Bitcoin does not generate any cash flow. The entire investment thesis for Bitcoin revolves around the belief (hope) that someone will be willing to pay you more than your initial purchase price on some date in the future. Unfortunately, an investment strategy based on hope is merely speculation. This simple but powerful reason for avoiding cryptocurrencies will likely not be heeded by everyone. The allure of a potential rapid increase in wealth can elicit emotions that are difficult to suppress.

If you are determined to purchase Bitcoin, there are a few additional things you should consider:

  • Determine an appropriate position size. A widely accepted practice for doing this is to hold assets in proportion to their total market value. This idea is the basis for popular market cap indices, including the S&P 500. The total market value of Bitcoin is about $493 billion(3), compared to the global stock market value of $95 trillion(4) and the global bond market value of $106 trillion(4). This would suggest an appropriate position size for Bitcoin of no more than 0.25% of an investor’s portfolio.
  • The idea that bitcoin has a finite supply is a common thesis for its use as a hedge against inflation. This logic fails to consider that Bitcoin is just one among thousands of different cryptocurrencies, the supply of which is essentially limitless. Additionally, the US has not experienced high inflation since the creation of Bitcoin, so the jury is still out. Also, there are some studies that question whether Bitcoin will prove an effective hedge(5).
  • There is risk associated with Bitcoin storage. Some estimates suggest that as much as 4 million Bitcoin have been permanently lost due to broken computers, lost private keys, or otherwise inaccessible wallets(6).
  • There is risk of regulation. While no one entity controls Bitcoin or the underlying blockchain, the government has power over many of the gatekeepers that are helping to make it mainstream. This includes the exchanges and other apps like PayPal, Robinhood, and Cash App.
  • Transacting in Bitcoin can be accompanied by high fees, wide spreads, and potential tax consequences. In 2014, the IRS issued IRS Notice 2014-21, which established “virtual currencies” as property for Federal income tax purposes. Among other things, this means that sellers of Bitcoin must recognize a capital gain or loss on the sale.  

After spending a few years in relative obscurity (an 83% loss of value will do that to you), Bitcoin’s blistering rally has it once again dominating the headlines. Our view is that there is no basis for an expected return because Bitcoin does not produce any cashflows. The ability to make money rests solely on the hope that another buyer will come along and be willing to pay a higher price in the future. While this is certainly possible, this represents a gamble rather than an investment.

1.. Source: Koyfin. Bitcoin price and return data represented by BTCUSD.

2. “To Bit or Not to Bit: What Should Investors Make of Bitcoin Mania?” Dimensional Fund Advisors, 14 Dec. 2017, https://www.mydimensional.com/to-bit-or-not-to-bit

3. Source: Coinmarketcap.com

4. Source: SIFMA Capital Markets Factbook 2020

5. Erb, Claude B., Bitcoin is Exactly Like Gold Except When it Isn’t (December 14, 2020). Available at SSRN:  https://ssrn.com/abstract=

6. Source: Chainalysis

WEEK IN REVIEW

  • It has been an excellent quarter for the equity markets, with major US stock indices at or near record highs as of the close on Monday. There are only three more trading days left in 2020 including today, although the market is down slightly as of this writing.
  • President Trump signed the Pandemic Relief Bill on Sunday, which will provide $900 billion of aid and fund the government through September. The House subsequently passed a bill that would increase the stimulus checks for individuals from $600 to $2,000 on Monday. On Tuesday an attempt in the Senate to call a vote on an increase to the stimulus amount was blocked.  
  • The final week of the year is light in terms of economic data releases. This morning the S&P Case-Shiller Home Price Index showed the fastest rate of home price appreciation in six years. Tomorrow we will get an update on pending home sales. On Thursday, look for an update on jobless claims. The market will be closed on Friday for New Year’s Day, and there will be no economic data published that day.

HOT READS

Markets

  • U.S. Home Prices Rise at Fastest Pace in More than 6 Years (CNBC)
  • How the 2020 QE Boom Might Trip Up Central Bankers (WSJ)
  • Pandemic Reshapes U.S. Employment, Speeding Changes Across Industries (WSJ)

Investing

Other

  • The Best Books I read in 2020 (Ben Carlson)
  • You Got a New iPhone 12 For The Holidays – Here Are The First Things You Should Do (CNBC)

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

ECONOMIC CALENDAR

Source: MarketWatch

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ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + CHIEF INVESTMENT OFFICER

Josh Jenkins is the Chief Investment Officer at Lutz Financial. With 10+ years of relevant experience, he specializes in assisting clients with portfolio construction, asset allocation, and investment risk management. In addition, he is responsible for portfolio trading, investment research and thought leadership for the division. He lives in Omaha, NE, with his wife Kirsten.

AREAS OF FOCUS
  • Asset Allocation
  • Portfolio Management
  • Research & Data Analytics
  • Trading System Operation & Execution
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst®
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

FORM CRS RELATIONSHIP SUMMARY

bitcoin back in the spotlight + Financial market Update + 12.29.20

IPOs Approach Record Volume in 2020 + Financial Market Update + 12.15.20

FINANCIAL MARKET UPDATE 12.15.2020

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

IPOS APPROACH RECORD VOLUME IN 2020

The volume of Initial Public Offerings (IPOs) is within striking distance of a record in 2020. Recently, investors have been willing to open their wallets for any stock offering growth as the global pandemic continues to weigh on the economy. The generous prices being paid on stocks in general and new issues, in particular, have enticed many private companies to go public. Although some of these newly public companies have seen their share prices spike on their first day of trading, IPOs have historically been a poor investment for individual investors.

With the exception of 2014, when Alibaba became the largest-ever U.S. listed IPO, 2020 has already seen the largest dollar volume of IPOs since the peak of the Tech Bubble (1999/2000). The high volume of deals isn’t the only reason to draw comparisons with that period. Frothy investor sentiment, sky-high valuations, and a concentration within the technology sector offer additional similarities. While market exuberance doesn’t appear to have fully reached tech bubble levels, as the chart below illustrates, these characteristics typically do not signal strong returns ahead. 

 

Note: Price-to-sales ratio based on trailing 12 months revenue before IPO, measured after first day of trading. Source: WSJ & Jay Ritter, University of Florida

Speaking of tech companies going public, last week saw the much-anticipated IPOs of Airbnb and DoorDash. Each company saw its share price roughly double during the first day of trading. Nothing sparks demand for new share issuance like watching other people double their money in a single day. Unfortunately, investors looking to get in on the action and capitalize on the next big IPO may be disappointed.

Studies, like the one from Dimensional Fund Advisors (DFA) below, have shown that the performance of IPOs has historically lagged the broader stock market. As the table illustrates, both the Russell 3000 (a proxy for the domestic stock market) and the Russell 2000 (small-cap stocks) have handily outperformed IPO stocks(1) during the full period from 1992 to 2018, and they did so with a fraction of the volatility.

Source: Dimensional using Bloomberg data. The sample includes US market IPOs, including US-domiciled companies and foreign-domiciled IPOs in the US, with an offering date between January 1, 1991, and December 31, 2018. IPOs with an offer price below $5, unit offers, REITs, closed-end funds, ADRs, partnerships, and acquisition companies are excluded. The hypothetical IPO portfolio is formed December 31, 1991, and rebalanced monthly to include all firms with an initial public offering during the prior 12-month period. Weights are based on month-end market capitalization. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indices.

One of the primary factors that make IPOs look like an exciting and lucrative opportunity is the pop in share prices that often occurs on the initial day of trading. It is also a major contributor to the subsequent underperformance for individual investors. Institutions typically soak up the bulk of the allocation of newly issued shares, forcing individuals to purchase the shares in the open market once trading begins. By the time individuals are able to get access, it’s too late. The initial bounce has already occurred, and individuals effectively provide the exit for the institutions that received an initial allocation.

To illustrate this point, consider Airbnb’s IPO last Thursday. The company sold roughly 50 million shares at an initial-public-offering price of $68 a share. Despite the market opening at 8:30 AM CT, the first trade of Airbnb shares did not occur until 12:38 PM CT. During the first four hours of the trading session, the exchange aggregated orders to ensure the first trade(s) occurred at a fair price. The first trade consisted of a block of nearly seven million shares and executed at a price of $146, representing a roughly 114% gain. This means even if you were the very first in line to purchase shares of Airbnb, you missed the entire first-day gain.

Of course, there are times when individuals are able to participate in the initial share allocation, but there is an adverse selection problem here. The allocations that individuals can access are limited to ones the institutions don’t want, presumably because there is a high likelihood of poor performance.

Another factor that can lead to poor subsequent returns for IPOs relates to company insiders selling shares. As much as half of the shares held by insiders are subject to lock-up periods that may last 6-12 months. At the expiration of the lock-up period, selling by insiders can put downward pressure on share prices.

High market demand has allowed private companies to go public with very generous terms. This trend may continue to entice private companies to go public now, out of fear the market may soon turn less favorable. As investors see stories about large IPO gains, they would be well served to temper their expectations. Not all IPOs trade higher on the first day of trading, and the ones that do are generally not available for individual investors anyway. History has shown that investors are better off with a low-cost, diversified portfolio than they are trying to buy into IPOs. This is particularly true with valuations and sentiment as stretched as they are today.  

1. n DFA’s study, IPO stocks were represented by a hypothetical market cap-weighted portfolio consisting of IPOs issued over the preceding 12-month period, rebalanced monthly. By design, the hypothetical portfolio excluded the first day of trading for IPOs, as individual investors typically do not participate in the initial allocation.

WEEK IN REVIEW

  • The Federal Reserve begins the year’s last two-day meeting of the Federal Open Market Committee (FOMC) today. At the conclusion of the meeting tomorrow (1 PM CT), the committee will publish its official meeting statement and updated economic/rate projections. Shortly thereafter, Fed Chair Jerome Powell will hold his post-meeting press conference, which can typically be streamed on Yahoo Finance. Wall Street does not expect any changes to the level of its benchmark interest rate, but there are other items worth watching for. This includes guidance on the length of its bond-buying program, the maturity profile of the bonds it is purchasing, and updates to the Dot Plot.
  • While monetary policy has remained extremely loose, the market has been monitoring developments on the fiscal front. A narrow $750 billion stimulus package has been promoted by a bipartisan group of lawmakers that would extend unemployment insurance, provide relief for small businesses, and funding for vaccine distribution and schools.
  • There is a decent slate of economic data being published this week. Today we will get an update on industrial production, tomorrow we will get retail sales, service sector activity (PMIs), and the conclusion of the FOMC meeting, updated jobless claims data is scheduled for Thursday, and the Index of Leading Economic Indicators comes out on Friday.

HOT READS

Markets

  • America’s Small Stocks Are Leading the Market’s Charge (WSJ)
  • ‘It’s an Economic War’ – Warren Buffett Urges Congress to Extend Relief for Small Businesses (CNBC)
  • Ponzi Schemes, Other Investment Fraud on Rise During Pandemic, SEC Says (CNBC)

Investing

  • Could We See Record Stock Market Valuations This Cycle (Ben Carlson)
  • A Few Things I’m Pretty Sure About (Morgan Housel)
  • When the stock Market Is Too Much Fun (Jason Zweig)

Other

  • To Lose Weight With Exercise, Aim for 300 Minutes a Week (NYT)
  • Quantum Computing’s Growing Advantage (Axios)

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

ECONOMIC CALENDAR

Source: MarketWatch

Do you want to receive financial market updates in your inbox? Sign up here! 

ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + CHIEF INVESTMENT OFFICER

Josh Jenkins is the Chief Investment Officer at Lutz Financial. With 10+ years of relevant experience, he specializes in assisting clients with portfolio construction, asset allocation, and investment risk management. In addition, he is responsible for portfolio trading, investment research and thought leadership for the division. He lives in Omaha, NE, with his wife Kirsten.

AREAS OF FOCUS
  • Asset Allocation
  • Portfolio Management
  • Research & Data Analytics
  • Trading System Operation & Execution
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst®
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

FORM CRS RELATIONSHIP SUMMARY

bitcoin back in the spotlight + Financial market Update + 12.29.20

This Indicator Suggests Investors Are Too Optimistic + Financial Market Update + 12.8.20

FINANCIAL MARKET UPDATE 12.8.2020

AUTHOR: JOSH JENKINS, CFA

STORY OF THE WEEK

THIS INDICATOR SUGGESTS INVESTORS ARE TOO OPTIMISTIC

Investor sentiment surveys are powerful tools that provide the ability to gauge the expectations of other investors. Survey results can be noisy, but when sentiment is pushed to an extreme, it can be useful as a contrarian indicator. Recently, at least one widely followed survey has begun to indicate excessive optimism.

Back in April, we wrote about the AAII Investor Sentiment Survey. In short, this survey polls individual investors and asks them if they are bullish (positive outlook) or bearish (negative outlook) on the stock market over the next six months. For more detail on the survey, see our original post (here).

At the time of our original post, sentiment was flashing an excessively pessimistic level. The pain of the market selloff that lasted until late March was still fresh, and there was considerable fear the market could dive once again. Flash forward to today, and we have swung to the opposite end of the spectrum, with sentiment now in overly optimistic territory. The shift toward positive sentiment was accelerated by a few developments in early November, including the alleviation of much of the election uncertainty and the publication of better than expected efficacy rates for several potential Covid-19 vaccines. These developments sparked a substantial rally in stock prices, particularly within the industries that have been under the most pressure during the pandemic.

 

Source: American Association of Individual Investors 1/3/2013 – 12/3/2020. The bull versus bear spread represents the percentage of respondents that are bullish less the percentage that are bearish. 7.2% has been the historical average back to 1987. Extreme optimism (pessimism) is represented as 1 standard deviation above (below) the average. 

Two major takeaways from our post in April were:

  1. Investor sentiment typically reflects what has just happened. High pessimism followed periods where the market had negative performance, while high optimism followed periods where the market had above-average performance.
  2. When sentiment hits an extreme level, the market tends to reverse. Excessive pessimism has often been followed by above-average returns, while excessive optimism is typically followed by below-average returns.

While it won’t always be the case, these two takeaways match up perfectly with the survey we wrote about in April. The return on the S&P 500 three months leading up to that survey was -14.1%, while the return in the subsequent three months was +15.8%. Additionally, the return in the three months leading up to the most recent (and excessively optimistic) reading has been +8.4%, which is well above average.

Investor Sentiment versus Market Returns

Source: Sentiment from American Association of Individual Investors, from 12/31/1987 – 12/03/2020. Returns from Morningstar Direct and are not annualized. 3 month periods are estimated based on survey release dates (weekly).

So why is sentiment a contrarian indicator? When sentiment is high, so are investor expectations. If sentiment gets too high, unrealistic expectations can lead to a scenario where even a good outcome is not enough, resulting in falling stock prices. The same is true with pessimistic sentiment. When expectations are too low, even a relatively poor outcome can exceed expectations and generate positive stock movement.

As we approach the end of the year, investor sentiment has pushed to the highest level since late 2017. Additionally, valuations have continued to climb higher, particularly for large-growth stocks. Historically, this has not been a good recipe for strong returns.

It’s important to note that even when sentiment is overly optimistic, the stock market has still delivered a positive return on average; it just tends to be lower than normal. Additionally, investors who tilt their holdings towards small and value-oriented stocks don’t have as much of an issue with high valuations.

Although the survey results shouldn’t send investors running for the exits, it is probably a good time to temper expectations for returns in the near-term.

WEEK IN REVIEW

  • Last Friday, the Bureau of Labor Statistics published its monthly jobs report, which is one of the most widely followed pieces of economic data. According to the report, the economy added 245,000 jobs in November, missing the Wall St estimate of 460,000 by a wide margin. Under normal circumstances, a 245,000 gain in employment would be a great print. Unfortunately, we are not in normal circumstances, and the figure represents the slowest rate of job gains since the labor market recovery began in May. A couple of factors likely led to the disappointing figure. First, government employment declined by nearly 100,000 as work on the census winds down. Second, the government response to the current wave of Covid-19 infections has slowed hiring at bars and restaurants, which had been rapidly rehiring. Finally, the expectation of more online shopping for the holiday season led to less hiring in retail. The unemployment rate fell to 6.7% from 6.9% in October, but that was largely a result of workers dropping out of the labor force.
  • This morning news broke that the FDA has concluded the Pfizer/BioNTech vaccine, the first to be considered for U.S. distribution, “met the prescribed success criteria” in clinical trials. According to the WSJ, the FDA could greenlight distribution of the vaccine as early as this weekend. Across the Atlantic, the U.K. began administering the vaccine to its citizens today, making it the first Western country to do so. After trading slightly lower yesterday and again this morning, the U.S. stock market has moved back into the green following the announcement.
  • This will be a relatively light week for economic data. Look for jobless claims and inflation data on Thursday and consumer sentiment on Friday.

HOT READS

Markets

  • Tesla Is Watching Its Stock Prices Too (WSJ)
  • Employment Growth Slows Sharply in November Amid Coronavirus Surge (CNBC)

Investing

  • I Started Trading Hot Stocks on Robinhood. Then I Couldn’t Stop (Jason Zweig)
  • The reasonable Optimist (Morgan Housel)

Other

  • FDA Says Pfizer-BioNTech Vaccine Meets Success Criteria (WSJ)
  • 5 Big Picture Trends Being Accelerated by the Pandemic (Visual Capitalist)

ECONOMIC CALENDAR

Source: MarketWatch

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Do you want to receive financial market updates in your inbox? Sign up here! 

ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

LINKEDIN

JOSH JENKINS, CFA + CHIEF INVESTMENT OFFICER

Josh Jenkins is the Chief Investment Officer at Lutz Financial. With 10+ years of relevant experience, he specializes in assisting clients with portfolio construction, asset allocation, and investment risk management. In addition, he is responsible for portfolio trading, investment research and thought leadership for the division. He lives in Omaha, NE, with his wife Kirsten.

AREAS OF FOCUS
  • Asset Allocation
  • Portfolio Management
  • Research & Data Analytics
  • Trading System Operation & Execution
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst®
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

P: 402.827.2300 | F: 402.827.2319 | E: contact@lutzfinancial.com | 13616 California Street | Suite 200 | Omaha, NE 68154

All content © 2017 Lutz Financial  | Important Disclosure Information |  Privacy Policy

FORM CRS RELATIONSHIP SUMMARY