1) INTRODUCTION:
François Doyon La Rochelle:
You’re listening to Capital Topics, episode #59!
This is a monthly podcast about passive asset management and financial and tax planning ideas for the long-term investor.
Your hosts for this podcast are James Parkyn and me François Doyon La Rochelle, both portfolio managers with PWL Capital.
In this episode, we will discuss the following points:
For our first topic, we discuss the investing lessons of 2023.
And next, for our main topic, we will review the book titled “The Price of Time” by Edward Chancellor.
Enjoy!
2) 2023 INVESTING LESSONS:
François Doyon La Rochelle: I will start. In our last podcast, #59, we reviewed the capital markets results for 2023 and by doing so we underlined the main economic and geopolitical events that we believe have shaped the capital markets results last year. This being said every year brings valuable lessons to investors to help us stay disciplined and focused on the long-term and avoid being deterred by the short-term noise. So, James, as we do every year at this time, let’s review the Investing Lessons of 2023.
James Parkyn: Indeed François, in this first segment we will review Larry Swedroe’s lessons for 2023. He is, as our regular listeners know, the Head of Financial and Economic Research at Buckingham Strategic Wealth in the U.S.; he is a thought leader in finance and investing. We quote him often for his work in educating investors on the benefits of evidence-based investing. Over the years, he has authored or co-authored 16 books explaining in simple terms the science of investing. My colleague Cameron Passmore and I adapted his book “Playing the Winner’s Game” for Canadian investors a decade ago.
François Doyon La Rochelle: I can add James that I even had the privilege to go white river rafting with him and other PWL colleagues when he came to visit several years ago. He loves rafting; I remember him telling me that every time he’s on a trip somewhere new he enquires about the rafting possibilities in the area. In any event, let’s now look at his 12 Lessons the Market Taught Investors in 2023. As he mentions, many of the lessons repeat themselves from the prior year but it seems that investors tend to forget and fail to learn them. We will put a link to his article with the podcast.
So, lesson #1 is: No One Is Very Good at Consistently Getting Market Forecasts Right.
James Parkyn: Well, this is something we have mentioned before, it’s very hard to make accurate forecasts and 2023 was no different. Larry Swedroe looked at the forecasts of 23 analysts of leading investment firms for 2023 and their forecasts for the S&P500 ranged from -5% to +24% with an average forecast of +6%. As we now know the S&P500 ended the year with a return of 26.4% in 2023. That is a difference of close to 20 percentage points higher than the average estimate.
François Doyon La Rochelle: 2023 is not the exception for poor forecasting. The article provides a chart showing the median strategist estimates for the S&P500 vs actual returns going back to 2018 and you can see that there is a very wide difference between the median estimates and the actual returns. I have calculated the average difference over these six years to 2023 and it’s a staggering 17.8 percentage points difference.
James Parkyn: Well François, if you are trying to manage your portfolio by listening to the advice of market strategists making forecasts, good luck!
In our last podcast, We highlighted the Magnificent Seven stocks in our 2023 market review. Larry Swedroe interestingly has a different view on them.
This leads us to his lesson #2: Perhaps the Magnificent Seven Should Be Called the Magnificent Three
He agrees that the Magnificent Seven stocks had huge returns in 2023 but he highlights that three of them (Tesla, Google, and Amazon) ended the year below their 2021 closing prices. Only three of them (Apple, Microsoft, and NVIDIA) he points out managed to outperform the riskless one-month T-Bills, which returned 3.2% over the same period.
François Doyon La Rochelle: It’s a good point he brings, we can look at the market performances through different lenses. We can certainly affirm that the S&P500 Index had a superb return in 2023, but we can also say that it provided no returns at all between December 31st, 2021, and 2023, except for dividends, since it closed at almost the same level both years.
This leads us to his lesson #3: The Valuations Cannot be Used to Time Markets
James Parkyn: This is a classic lesson. U.S. equity valuations were at very high levels historically at the start of 2023 and this was particularly true for growth stocks. If you had stayed on the sidelines because of that overvaluation, you would have missed out on extraordinary gain. This is not new, going back almost 20 years now, to December 1996, Alan Greenspan, the former Fed chairman, used the terms Irrational Exuberance to warn investors about high stock valuations. And despite equity valuations being high when he made his speech stock prices kept increasing for 4 more years. During that period the S&P500 Index more than doubled in price.
François Doyon La Rochelle: We should not trade on stock valuations, however it’s still valuable information. At PWL, our research team uses stock valuations to estimate future expected returns over the long term.
James Parkyn: Now let’s look at his Lesson #4: It Takes Discipline to Stay the Course Through Periods of Poor Performance, as All Risk Assets Go Through Them.
François Doyon La Rochelle: I think our regular listeners know by now that this is part of our mantra. To gain the benefits of being invested in equities you must have discipline and stay the course in periods of good and especially bad times.
So the next lesson Larry shares with us, Lesson #5: Assets With Poor Performance Have Self-Healing Mechanisms
James Parkyn: This is a really important lesson. He explains that when stock prices fall, investors have the reflex to sell or avoid buying. However, he reminds us that when stock prices fall, future expected returns for them are now higher. He goes on to quote Warren Buffett and I quote “be fearful when others are greedy and be greedy only when others are fearful”. This is easy to say but hard to do.
François Doyon La Rochelle: Moving on to Lesson #6: Even With a Clear Crystal Ball, Markets Are Unpredictable
The point he raises here is interesting. If you had a crystal ball at the beginning of 2023 to see the major geopolitical and economic events that would happen during the year, I think most investors would have sold equities given all the negative news.
James Parkyn: I totally agree with Larry on this, François. I mentioned in our last podcast, Markets surprised everyone last year despite all the negative financial news.
Now let’s look at Lesson #7: Don’t Let Politics Influence Investment Decisions
François Doyon La Rochelle: It seems to me that this sort of reflects the fact that we are faced with many elections in major global countries, including the U.S. With this lesson, he warns investors to be wary of our beliefs and biases because they influence our decision making and it a causes mistakes in portfolio management. He reminds us to ignore our political views when making investment decisions. I feel that this especially true for American investors who fac a very difficult federal elections this year.
James Parkyn: The next lesson is # 8: Most Returns Were Earned Over Short Periods
Well, we mentioned in our last podcast that the bulk of the returns last year were generated in the last two months of the year. This was true in 2023 for most equity markets and significantly for the bond market. Historical evidence demonstrates that market returns generally come over short periods so 2023 was not unusual.
François Doyon La Rochelle: Yes, and Larry highlights in his article that from 1927 to 2023, 97 years, the S&P500 returned an annual 10.3%. However, if you remove the 97 highest returning months during that period, the remaining 1,067 months delivered an annualized return of only 0.01%. This means that only 8% of the months, which represent the highest returning months, returned 100% of the performance for the 97 years.
James Parkyn: That’s exactly why we say that you need to stay invested to capture capital market returns. It is time in the market not timing the market.
This leads us to his Lesson #9: Last Year’s Winners Are Just as Likely to Be This Year’s Dogs
This is a take on recency bias, he reminds us that individual investors are performance chasers, they buy yesterday’s winners and sell yesterday’s losers. I speak about this in my most recent blog, published on our Capital Topics website, where I address both recency bias and hindsight bias.
François Doyon La Rochelle: This is a very hot topic, after the phenomenal performance of the U.S. stock market over the last decade a lot of investors are asking why we still invest in other equity markets. A simple answer here is to remind them of the lost decade in the U.S. equity markets from the beginning of the year 2000 to the end of 2009 when the S&P500 Index generated an annualized return of negative 0.95%.
Now for Lesson #10: Active Management Is a Loser’s Game in Bull or Bear Markets
James Parkyn: Well, in a couple of weeks, once the SPIVA report comes out for 2023 we will be able to confirm if active management has been able to outperform passive indexes in 2023. Don’t hold your breath, I’m not expecting any surprises here. I think active managers will again have underperformed the indexes.
François Doyon La Rochelle: I agree James, if an active manager fails to include the Magnificent Seven in their portfolio there is a good likelihood that they will have underperformed.
James Parkyn: Now for Lesson 11: Diversification Is Always Working; Sometimes You Like the Results, and Sometimes You Don’t
This goes back to what you mentioned earlier François about the outperformance of the U.S. equity markets. Their overperformance relative to Canadian, international developed, and emerging markets over the last decade and especially last year makes us question the benefits of diversification. However, there will always be a sector, a country, or something else that outperforms your portfolio in any given year. Like Larry Swedroe says and I quote “The noise of the media will then test your ability to adhere to your strategy”.
François Doyon La Rochelle: Yes, and when that happens, when your discipline and patience are being tested, remember the reasons why you have properly diversified your portfolio in the first place. It’s all about reducing risk without reducing long-term expected returns. Even in a year like 2023, a U.S. equity investor could be unsatisfied that he didn’t have his eggs in the Magnificent Seven.
Finally, Lesson #12: Great Innovations Are Not Always Great Investment
James Parkyn: For that lesson, Larry Swedroe highlights the debacle of some high-profile companies that were once looked upon as pioneers of innovation. He goes on to list some of those companies. But closer to home I have a great example of this lesson. You only need to go back to 2018 when the federal government legalized marijuana. Everybody wanted a piece of the action. But most investors got burned. This said, the Marijuana Life Science ETF from Horizon, which was launched during the craze in 2017, never had a calendar year of positive performance. Its annualized performance since inception is a negative 16.21% per year as of January 31, 2024.
François Doyon La Rochelle: This is incredible, I was not expecting that. History is full of anecdotes like this, we must however learn from them and be cautious when the next investing fad comes along. To conclude, I think that all the lessons that Larry has shared in his article support what we believe as part of our investment philosophy.
James Parkyn: Francois, I would like to remind our Listeners that in last years’ podcast on Investing Lessons of 2022, we highlighted that no one can forecast the future. We recommended that listeners avoid paying attention to all the 2023 Forecasts and Outlooks. It’s safe to say with hindsight that has worked out well for Investors that ignored the noise and stayed the course in 2023. Investors are conditioned to believe that Financial Experts can forecast the future. The Investment Industry actively promotes this.
François Doyon La Rochelle: I think it would be useful James to repeat a quote from Morgan Housel the Author of the book “The Psychology of Money” is also from last year’s Podcast on Investing Lessons of 2022: “Pessimism always sounds smarter than optimism because optimism sounds like a sales pitch while pessimism sounds like someone trying to help you.” The Future is uncertain therefore it is scary.
James Parkyn: A look back at recent market history makes a case for sticking with a plan. Handsome rebounds like we saw in 2023 after steep declines in 2022 is a very powerful reminder that investors must remain disciplined and focused on the long-term and avoid being deterred by the short-term noise. This is the only reliable way to capture the long-term benefits that markets offer.
François Doyon La Rochelle: We also remind our listeners James that they should have an “Investor Mindset” and continue to buy and hold investments with an owner’s mentality.
That is our mantra.
3) BOOK REVIEW: “THE PRICE OF TIME” BY EDWARD CHANCELLOR:
Francois Doyon La Rochelle: Now for the next segment of our podcast, we will review a book that we highly recommend for all our listeners. So, James, would you like to start?
James Parkyn: Sure, Francois. I feel that one of the best books I’ve read is “The Price of Time: The Real Story of Interest” by British Economic Historian and financial journalist Edward Chancellor.
François Doyon La Rochelle: So, James, why do you feel that this is a must-read for our listeners?
James Parkyn: I enjoyed this book because it lays out the economic history of interest rates. More specifically, it addresses a key investment theme in current markets which is how artificially low interest rates over the course of human history have inflated all sorts of asset classes. As our listeners are well aware, since 2008, we have been in an ultra-low interest rate environment that ended in 2022. During this period, many asset classes became wildly overpriced. In this book, the author says and I quote him: “Never before in history has so many asset price bubbles inflated simultaneously,”
This book is a masterpiece on the topic of Interest and Rates over the history of human economic activity. He develops the thesis that “interest rates are the most important signal in a market-based economy, “the universal price” affecting all others. He affirms that Interest is best defined as the time value of money. It is the price that informs every key financial decision—saving, spending, investing.”
François Doyon La Rochelle: We have been saying this a lot in the last 18 months on our Podcast: current much higher interest rates are “normal”, and investors should not expect we will return to the ultra-low rates we experienced between 2008 and 2022. That is unless there are no other major economic or geopolitical shocks that we cannot foresee.
James Parkyn: That’s why I found this book so compelling. I should mention the book “The Price of Time”, which was a recommendation from Larry Swedroe.
Let me share an interesting passage in the book: After 2008, the author states, “Central bankers pushed interest rates to their lowest level in five millennia.” The move seemed like a success at first, averting deflation and mass unemployment. But behind this immediate result lurked structural problems that the bankers had left to fester. Low rates have compounded “our current woes,” the author says. These include “the collapse of productivity growth, unaffordable housing, rising inequality, the loss of market competition” and—as we may all feel right now— “financial fragility.”
François Doyon La Rochelle: I agree with this thinking. Artificially low rates distort the decentralized decision-making process of a market economy.
James Parkyn: Francois, without interest, Chancellor writes, “capital can’t be properly allocated and too little is saved.” Investors accept more risk in pursuit of higher returns, making future growth seem more attractive than current profits. And because interest is one of the chief costs in finance, low rates shift economic activity from “real world” enterprises to purely financial transactions.
François Doyon La Rochelle: As the Boston hedge-fund manager Seth Klarman has stated: “The idea of persistently low rates has wormed its way into everything: investor thinking, market forecasts, inflation expectations, valuation models.” Now we have investors and borrowers thinking current rates are too high. We have said often on our Podcast that these are normalized rates and as a result, capital can now be allocated more efficiently.
James Parkyn: I completely agree with you Francois. For our Listeners, I would like to share reviews from a couple of other very influential thought leaders we follow in the investing world. First, William Bernstein wrote a review in the CFA Blog.
François Doyon La Rochelle: For our Listeners, William Bernstein is the author of the classic must-read book “The Four Pillars of Investing” which he updated in 2023. We will review this book in a future Podcast.
James Parkyn: William Bernstein loved this book and recommended it as a must-read for students of Economics. I will quote him: “Perhaps the book’s most profound observation about low-interest rates is that while their salutary effects on asset prices are visible, the newly wealthy are far slower to perceive that the same thing has happened to the present value of their liabilities.
François Doyon La Rochelle: Bernstein also says that “One of this book’s joys is its relevance to both political policy and personal finance”. He does not, however, develop the theme in his book.
James Parkyn: The second review of this book was by Howard Marks. Howard Marks is a co-founder of Oaktree Capital Management with $189B USD of AUM and an Expert on High-yield Distressed Debt. In his most recent Memo titled “Easy Money” released on Jan. 9 of this year, he addresses the topic of low-interest rates after reading the book.
François Doyon La Rochelle: Howard Marks is widely read by Investment Professionals and known for his memos that he publishes multiple times per year.
James Parkyn: I should point out however that Howard Mark’s Memo is not a Book Review, but his memo was heavily inspired by his reading of the book. I will quote from his Memo: “What I so enjoy about Chancellor’s books is the way they illustrate the tendency of financial history themes to rhyme, and thus how behavior that took place 200 or 400 years ago is being repeated today and is sure to reappear again and again in the future.
What he tells is a never-ending story.
François Doyon La Rochelle: He goes on to say: “The lessons from past periods of easy money usually fall on deaf ears since they come up against (a) ignorance of history, (b) the dream of profit, (c) the fear of missing out, and (d) the ability of cognitive dissonance to make people dismiss information that is inconsistent with their beliefs or perceived self-interest.
These things are invariably enough to discourage prudence in times of low interest rates, despite the likely consequences.
James Parkyn: So Howard Marks then goes on to address the key question all Investors are now asking: Will We Go Back to Easy Money?
I quote: “I want to answer the one I’m asked most often these days: “Are you saying interest rates are going to be higher for longer?” My answer is that today’s rates aren’t high. They’re higher than we’ve seen in 20 years, but they’re not high in the absolute or relative to history. Rather, I consider them normal or even on the low side.”
François Doyon La Rochelle: I find it interesting that he goes back to the late sixties, I quote him: “In 1969, the year I started work, the fed funds rate averaged 8.2%. Over the next 20 years, it ranged from 4% to 20%.
Given this range, I certainly wouldn’t describe 5.25-5.50% as high. Between 1990 and 2000, which I would consider the last roughly normal period for rates, the Fed funds rate ranged from 3% to 8%, suggesting a median equal to today’s 5.25-5.50%.
James Parkyn: It’s pretty clear to me Francois, he is in the camp that today’s interest rates aren’t high. He has another great quote in his memo: “One of the quotes I return to most frequently is Mark Twain’s purported observation that “history doesn’t repeat itself, but it often rhymes.” For investors, cycles, along with their causes and effects, are among the influential matters that invariably rhyme from one period to the next.”
François Doyon La Rochelle: So, “The Price of Time: The Real Story of Interest” by British Economic Historian and financial journalist Edward Chancellor is an essential read for serious investors, who want to understand, with a very long-term perspective, how Interest rates work and how critical their levels are for sound economic policies to work their magic.
James Parkyn: I could not have said it any better. Thank you, Francois.”
4) CONCLUSION:
François Doyon La Rochelle: Thank you, James Parkyn for sharing your expertise and your knowledge.
James Parkyn: You are welcome, Francois.
François Doyon La Rochelle: That’s it for episode #60 of Capital Topics!
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