Investment curveballs in 2023: 4 important lessons to remember for 2024

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Sidebar: Wealth Editor, James Kirby and I recorded an episode of The Australia’s Money Puzzle podcast yesterday discussing our expectations for the property market in 2024: see here.

In this insightful podcast, Stuart Wemyss shares four key investment lessons gleaned from the tumultuous market of 2023, offering a compelling guide for potential listeners. Lesson one underscores the volatility of market expectations, urging investors to prioritise long-term goals over short-term forecasts. Lesson two explores the resilience required when faced with unexpected market deviations, emphasising the importance of maintaining confidence in established strategies. The third lesson advocates for steadfastness in the face of economic uncertainties, showcasing how minimal portfolio adjustments often lead to higher returns over time. Lesson four delves into the unpredictability of market conditions, cautioning against betting against prevailing trends and emphasising the potential risks of underestimating the duration of irrational market behavior.

Listeners can expect a thought-provoking discussion on the challenges and rewards of navigating the investment landscape, supported by real-world examples from 2023. The host's emphasis on data-driven decision-making, drawn from diverse sources including renowned economist John Keynes and Warren Buffett, adds a pragmatic touch to the narrative. As the podcast challenges conventional wisdom and encourages a critical examination of market insights, it promises to be an engaging resource for both seasoned and novice investors looking to refine their strategies in 2024.

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Transcript

Speaker 1: 0:01

Hi, my name is Stuart Weems and welcome to the Investopoly podcast. My goal is to share easy to understand, evidence-based holistic insights to help you master the game of building wealth. And welcome to the first episode of 2024. I hope you had a really lovely break over the Christmas New Year period and got to enjoy time with family and friends and have a rest and relax and recharge for the new year. I'm really excited. This year I've got some really interesting content to share with you and some enhancements to the podcast, including additional episodes where I'm going to share some case studies around clients that we have worked with for a number of years, how they've built wealth, what challenges they've come up against, how they've dealt with those challenges just to give you some kind of real world insights to how it all sort of plays out, how all the theory and methodology behind these podcast episodes plays out. So I'm excited to share that with you. Of course, I also had an interesting discussion with the editor at the Australian yesterday on their podcast called the Money Puzzle, so you can check that out. I'll put a link in the show notes to that episode where we talked about our expectations for the property market in 2024.

Speaker 1: 1:19

Okay, let's get into today's episode of the podcast. What I wanted to do is have a look back over 2023 and ask myself what did markets teach us? What did I learn? What learnings were there? For those that are open to receiving them, because I think there's always stuff that happens that we can learn from, and experience is the most important factor in terms of making sure you avoid costly investment mistakes. You know, most people learn from their experiences and other experiences, so if you've got someone with zero experience versus someone with two or 300 years of experience, of course they're going to be a better investor. It makes sense, right? So at the end of every year, I sort of look back over the previous year and ask myself what I learned, and there's four learnings that I'd like to talk about today and share with you. The first one is that expectations and forecasts can change on a dime. They can change very, very quickly. Now, if we think back over 2021 and 2022, I actually cautioned in this podcast a number of times that interest rate expectations can change very quickly In the second half of 2023, so last year, of course, many commentators forecast that interest rates would need to rise to such an extent that they're almost certainly going to cause a global recession and as such, in markets in September and October last year they had a terrible time.

Speaker 1: 2:50

They dropped around more than 10%, which is a technical correction. However, by year's end the market had kind of shift. The market was anticipating that inflation could be tamed without a recession and in fact, markets started pricing in significant interest rate cuts about 1.25% in the US and one or two interest rate cuts in Australia that might occur this year. That's how the market sort of changed over the course of a six month period Pretty significant.

Speaker 1: 3:21

The key takeaway is that forecasts and expectations often feel very compelling at the time, so much so that they almost resemble certainties rather than best guesses. But the truth is that short-term outcomes are completely unpredictable. No one has a proven methodology to reliably predict what markets will do in the short term. So therefore, the best thing to do is really disregard any forecasts that don't align with our investment horizon. So, for example, for long-term investors so 10-plus year investors then the only forecast that merit consideration are forecasts that are going out over decade long periods. So focusing on short-term forecasts may lead to costly errors, which is a great segue into the second learning for 2023.

Speaker 1: 4:15

So my second lesson was to resist the temptation to make changes to portfolios, and the bond market taught me, or reminded me, of this lesson, because in both 2021 and 2022, bonds experience significant declines the worst declines, really, since the inception of bond indexes in the mid-70s and this might outcome might not be surprising to some people, of course, considering the fact that central banks made some substantial monetary support during the COVID period in terms of very low interest rates and the central banks' persistent message through that period that interest rates would, in fact, remain low for many years. Of course, that wasn't the case and, despite being what's termed as a safe asset class certainly that's what's technically were taught at school and textbooks and so forth that bonds are a safe investment they certainly didn't exhibit those characteristics over those last couple of years. Normally, bonds' capital values are a lot less volatile than stocks and, secondly, bonds are usually negatively correlated with shares, which means that if shares fall like they did during COVID at the start of 2020, then bonds should rally. Bonds should actually move into a positive direction. However, over 2020, 2021 and 2022, those norms didn't hold true and bonds really failed us as an asset class or certainly didn't behave as they should have or as we would expect them to do, and this deviation really challenged, certainly, my belief and our belief within our firm around the traditional role of bonds in a portfolio. It really made us question if they haven't performed how we expected them to perform given that situation. And that's the whole reason we have bonds is to try and level out volatility in a portfolio. When stocks fall, we wanna have an asset that's going to appreciate, and it was tempting to think that we should make some permanent changes to portfolios. However, we resisted this temptation and 2023 presented a more typical sort of performance for bonds showing modest returns.

Speaker 1: 6:30

And I note that Chris Joy, which is really Australia's preeminent fixed income investment manager, anticipates or predicts that bonds will outperform stocks over the next two or three years, although it's worth noting that, of course, he's a fixed income investment manager and he has a vested interest in coming up with positive forecasts for fixed income markets. I'm not suggesting that that's the case. In fact, if I thought it was, I wouldn't be talking about it here. I respect Chris Joy's work greatly and believe I think he's probably true that there's gonna be a bit of main reversion there. So what 2023 really taught us is that maintaining confidence and resilience is really important.

Speaker 1: 7:13

As I said, during 2020, 2021 and 2022, we were really questioning whether bonds had merit in portfolios anymore. The reality is that extraordinary market occurrences are not uncommon. It's what triggers those market occurrences tend to be unique, but the market has navigated very similar situations before, and so, as investors, we must have the discipline not to react to these market events, which is exactly what we did as a result of bonds. But the bond market really reminded us of this very important lesson, and that sort of brings me into the third lesson that 2023 taught me, and that is almost nothing warrants a change in investment or strategy.

Speaker 1: 8:01

So, as I said, as 2023 began, most economists believed that there was gonna be a global recession. It was almost inevitable, and the thesis behind it was that surely a staggering 5.2% increasing interest rates of a very short period of time in the US would damage the world's largest developed economy and if it went into recession, the world economy would probably be dragged in to that recession. As also, and considering that outlook and really it was almost at the start of 23, it was almost certain that it was gonna be a recession and, given that outlook, I really asked myself. What adjustments should we be making to client portfolios? Because if a recession is very high probability of a global recession then surely we should make some adjustments to the portfolio. And despite the extensive consideration, analysis, discussions and so forth, we're ultimately opted to make no changes to portfolios. Our existing strategy already been to skew portfolios to two areas both to higher quality companies, so it's a quality factor index, and also to relatively undervalued or better valued companies, so value indexes. And theoretically, these two approaches not only will benefit from a bit of mean reversion but also provide better resilience during a recession. So we already kind of made those changes.

Speaker 1: 9:31

But the critical lesson here was that we need to have an unwavering discipline to stick to long-term investment approach, regardless of the severity of the event whether it's a global recession, a financial crisis, a global pandemic, very high interest rates, wars whatever it is studies consistently demonstrate that the investors that make fewer changes almost always generate higher returns. So, assuming that your investments are fundamentally sound, the only justifiable reason to modify your investment strategy or change those investments are a changing personal circumstances and goals. Otherwise, keep your hands off your investments. Stay true to them. So, looking back through that consideration over 2023, I'm really pleased that we had the discipline to not make changes to portfolios Now. That whole thing might not have played out yet. Maybe there will be a recession in the future, although I acknowledge that the probability is greatly reduced today. But the point being is that was a lesson that 2023 reminded us of and a lesson that I can bring in to 2024 and beyond, and I'm sure that faith will be challenged in the future in terms of it be tempting to make changes to the portfolio in the future as a result of completely different circumstances. But I'll be reminded of this lesson. And finally, lesson number four is that irrational market conditions can last longer than anyone else can anticipate.

Speaker 1: 11:09

So if I cast my mind again back to the start of 2023, I held the belief that higher interest rates would likely weigh negatively on growth stock valuations. So that is that those growth stocks would sort of come off that being stimulated by very low interest rate environments. And growth stocks like low interest rates because they typically aren't cash flow positive and they need to fund that either through debt or equity. And slow interest rates certainly helped them do that. And over the last decade and a half, growth has outperformed value on a five-year rolling basis really since 2007. So my expectation was that interest rates would be the trigger event to cause a resurgence in valuation, because if growth has outperformed value for almost 15 years, there's going to be some mean reversion eventually. Value stocks are the cheapest they've ever been relative to growth ever since at least 100 years of data, according to research affiliates. So that mean reversion should kick in at some point and I thought higher interest rates would be the impetus for that.

Speaker 1: 12:17

Now, of course, I was wrong. Surprisingly, seven the seven largest growth stocks in the US really drove almost all of the indexes returned last year. So the S&P 500 index appreciated by 24% over the 2023 calendar year. Seven stocks now account for. These. Seven stocks now account for 25% of the total indexes value. It's huge concentration risk and the the stocks of that 24% return. The stocks delivered about 18% of those. Just seven stocks delivered about 18%, which means if you took those seven stocks out of the index, the return would have only been around about 6% or around about that market. So I was really wrong. I was so wrong that, in fact, some stocks seven growth stocks in fact really improved their valuation significantly despite higher interest rates.

Speaker 1: 13:13

Now the central theme around why that occurred. Why are these growth stocks doing so well is really around the impact of AI. That's mostly what I think is that the market's contemplating Now. Of course, ai is likely to be a positive impact for the economy and stocks, but I would also argue that the its upside is well and truly reflected in the current prices of those stocks as well. So you know you're already paying for all the possible upside that AI might deliver.

Speaker 1: 13:42

And, quoting renowned economist John Keynes, he said that markets can remain irrational longer than you can remain solvent, which really means don't bet against rising markets Even when they appear irrational and you feel like they can't get more rational, because it can be risky. The stock's potential to increase is limitless. Of course, a $10 stock can go to $100 or $1000, while its downside is finite. It can only fall to zero, and so betting against a rising market is a full zero. Markets can rise longer and faster than anyone might anticipate. So really, despite almost a century of data indicating that value stocks usually produce better returns, the timing of their resurgence remains uncertain. We understand that value appears cheap today, and certainly the cheapest it's ever been, and it should eventually revert to the mean, which means that value should significantly outperform growth at some point, but what is uncertain is when that shift will occur. So the key takeaway from that fourth lesson is to avoid getting betting against the market. Embrace a long term approach, whilst acknowledging that reaping the benefits of that long term approach might take several years and that you need the patience to really stick with that long term strategy.

Speaker 1: 15:10

Now, to adapt to Warren Buffett quote, I will say journalists and forecasters will fill your ears, but never even wallet. You know, whilst you might listen to market insights, forecasts, predictions, advice, the reality is that much of the information doesn't significantly aid in making sound long term investment decision. Most commentary tends to be rooted in negativity and focus excessively on short term perspectives. I read a book recently, a really good book, called factfulness, and the book discusses why our instincts around data often lead to misconceptions, and so the author cites a couple of facts, for example, or share a couple here that are actually contrary to popular belief. So what he did is tested the market to say what do you think about this? Subjects matter, and people would say well, this is what I think it is, and often it's way off. And so here's a couple of facts, for example, to make that point.

Speaker 1: 16:11

So in the last 20 years, the proportion of people living in extreme poverty globally has nearly halved, and we would think it's it's not as good. Deaths from terrorism in developed countries were three times higher in the previous decade, so the decade between 97 and 2006 compared to 2007 and 2016. You know, the books are a couple of years old and that latter decade period included September 11, of course, but they're three times less. Contrary to concerns about overpopulation, by 2100, the year 2100, the world's population is projected to decline. So we talked a lot about the declining birth rates and so forth, and violent crime rates per capita in the US have almost halved over the last three decades. So, again, most people think, you know, the US is getting more violent. Well, in fact, that is not the case.

Speaker 1: 17:06

The data says that's not the case, and the author talks about many reasons why most people think the world is in a lot worse shape than it is. There's about 10 reasons, and the media being having a negativity bias is only one of those 10 reasons. By the way, it's surprising. There's a lot of other reasons why we form those opinions and the book reminded me really to always look back to the data so we can listen to the analysis and the insights, but really, in the day, the data is going to tell us the true story, as long as that data is reliable, of course. So there's a lot of information out there.

Speaker 1: 17:45

I guess the point is, if you put all those four lessons together, the point is don't listen to much of it. And when it comes to investing, ironically often the best course of action is to do nothing, and especially if your investments were your original investment decisions were well founded. You know, if your investments are fundamentally sound, even though you might think they don't perfectly suit current market conditions or the current mark flavor of sentiment in the market, if they're well founded, just stick with them. It tends to serve as a good thing to do and that's something that I'll take those reminders into 2024 and beyond, of course, when we're working with clients and helping clients. Okay, I hope you enjoyed the first episode for 2024. As I said, look forward to sharing with you lots of content and some improvements in the podcast this year and until next week. Bye for now.