Life After Santa

Santa came for Wall Street after all this year, lifting the market back to record territory and at least temporarily cutting through all the dread and dithering that made this such a stressful time for many investors.

We’ve spent months hearing about how the bulls are running out of room to rally as interest rates edge back to normal, the flood of free money slows down and year-over-year earnings comparisons get a little harder as we approach the third year of COVID.

Throw in the potential for shocks from left field . . . out-of-control inflation, sudden tax hikes, war in any of the world’s simmering hot spots, new strains of the pandemic virus . . . and we’ve all had a lot on our minds.

And if you’re tired of volatility, you have good reason. The VIX spent most of the three-year period leading up to the COVID lockdowns trading in a quiet 10-15 range. People got comfortable in that zone.

But the last time the “fear index” dropped below 15 was February 14, 2020 . . . nearly two years ago. Every single day since then has been somewhere between uneasy and frenetic.

I have a feeling 2022 will bring us more of this, so take a deep breath now while you can bask in the Santa glow.

No Guts, No Glory

In extended periods of volatility, I remind myself that we pay a price for elevated investment performance. It’s called risk.

You can always hide your money under the bed or in FDIC-insured bank accounts if you don’t want to take any risk. Thanks to the Fed, those instruments currently pay about 6% less than inflation . . . at best.

Unless you have high conviction that everything else in the financial markets is going to drop farther than that in the coming year, there is zero rational reason to settle for that negative real return. Zero.

And I don’t know about you, but I think I can find something that can do at least a little better than a 6% loss. A casual screen reveals that 90% of the S&P 500, all but three of the elite Dow industrials and about 65% of the overall stock market hit that low bar this year.

We can’t be sure which ones will go the right way in a volatile environment. They often zig on days when our best research suggests that they should zag. But on the whole, they’re priced to compensate us for the random walk.

But here’s the thing: when investors are feeling good and even overconfident, prices climb because enough people are convinced that nothing can go wrong that they’ll pay more to get the stocks they want. As reality sinks in, they get nervous.

Nervousness leads to frustration. Frustration leads to fear. Weak hands fold, often liquidating stocks that they paid too much to buy in the first place. And in the process, frothy valuations revert to something more realistic.

My point is that stocks will always be at least a little too expensive for some people. Even when they like the monetary price, the emotional price can get too high.

Some people don’t have a robust appetite for risk. That’s okay. But those of us who have tolerated the entire cycle of froth, frustration and fear know that there will be good years and bad years.

And we know from experience that the good years more than adequately compensate for the bad ones. In other words, it’s worth gritting our teeth when the bears are in control to avoid running to the sidelines and missing a minute of the good times.

Never forget that on average the S&P 500 has delivered a net return of around 10-11% counting dividends. We can’t predict any given year, but across decades and generations, that’s what history says you can expect to get.

The 2008 crash didn’t bend that long-term number at all. Neither did World War II . . . or the Great Depression . . . or the recent pandemic. Do the math, and 10-11% a year means you have a pretty good shot at doubling your money in a 7-year period.

All you have to do is hold on for up to seven years. If you’re lucky, you’ll rack up profit faster. Even in the worst economic disasters on record, the returns still make the risks worthwhile.

Now I work every day to bend that math in our favor. We look for cheap stocks and those that are growing faster than the market as a whole.

Growth may be decelerating, but there’s still a lot of value on Wall Street. Even if we limited ourselves to the stocks that have lagged cash in the past year, there are hundreds of names to choose from.

And as it turns out, 2021, despite all the fear and trembling, has been a much better-than-average year. Stocks have doubled their usual returns. If not for all the noise, you could hear Wall Street cheering.

We didn’t need “Santa” to give us that. Record earnings deserve record prices. That’s what keeps the bull alive, decade after decade.

The bull runs on hope and realism. I look forward to keeping your hope and realism fires lit in the coming year . . . and beyond. Merry Christmas to all!