What in the World Happened – Fourth Quarter (video transcript)
Hello, and welcome. My name is Josh Wolberg, and this is the fourth quarter update of 2020, or what we like to call, “What in the World Happened”.
So, if you’re a client your performance reports are available on the portal. What we're going to talk about today:
• An update on investment markets for 2020 and the fourth quarter
• The economy and Covid-19.
• Government policy and updates from the results of the election.
For 2020, these are annual results for major asset classes around the world. You'll notice most things are quite positive and also higher than their average returns over the last 20 years on an annual basis. The one notable exception is Global Real Estate, which was down for full year 2020. Now I will mention with this, there has been some changes in Global Real Estate, especially commercial real estate - retail space, office space like this, across the world. There have been some changes and rethinking of how we might use that in the future. We don't think long-term that completely changes the investment prospects for commercial real estate - it's just going to change what types of commercial real estate does better in the future versus in the past. You already saw this happen a little bit in the fourth quarter of 2020. These are just fourth quarter results. Global Real Estate bounced back very nicely, over double digits, as well as all stocks were up over double digits in the fourth quarter of 2020. Bonds were a little bit above zero as well, so fourth quarter results were quite positive around the world.
Let's talk about a question I've got a lot this year, which is basically, “How can the markets have done so well when the economy has struggled and there's been so much personal struggle in individual’s lives?”.
So, when we look at it in aggregate; this comes from a New York Times article and I really liked these graphics. When we look at income. Income increased by more than a trillion dollars year over year from 2019 to 2020. Now where did that come from? First, wages were down $43 billion in aggregate. Obviously, there's lots of individuals that had financial hardship in 2020, but in aggregate, wages just didn't go down near as much is originally expected. The stimulus from CARES Act led to more unemployment benefits, stimulus checks, as well as the Payroll Protection Program. Those loans, and the forgiveness of those loans, helped small business owners to have their profits and not crater. Basically, it went sideways year over year because that would have affected overall income in the country. All other income was up about $265 billion, so a trillion all told. That's a big number, right? At the same time spending decreased. There was a little bit of an uptick in durable goods and non-durable goods, but, services went down dramatically; less travel, less eating out, all those types of services. Even things like massage parlors - I'm thinking there's one in the mini mall across the street. Interest payments in outlays on interest went down because interest rates went down, too, so think about credit card payments and things like that - interest rates went down. So that led to about a half a trillion dollars less spending, overall, even though income was up. When we add those two together, it was about one and a half trillion dollars of additional cash available for things like saving. So, deposits at banks have gone up, savings rates have gone up dramatically, and some of that money went into investment markets. You think about one and a half trillion dollars, even if a small portion of that ended up in markets, it would make a difference.
Let's talk about some different components of the market, not just international versus US, or bonds versus stocks, but within US stocks, and really stocks around the world. This happened a lot of places, not just in the US. When we compare and contrast large companies - think Apple, Facebook things like that, as well as small companies – startups, regional textile manufacturer or something like that. Large companies over the last few years, their prices of the top 10 companies - Apple, Microsoft and Amazon, companies you've heard of - have gone up dramatically. Where companies that are not in that top 10, so the other 490 in the S&P 500, have gone up, but not near as much. So, large has outperformed small over the last few years. Now that's different than historical returns where small has outperformed large, when you look at the last hundred years. It's also true when we look at low relative price - that's low relative PE ratio, so price divided by earnings versus high relative price, so low price or value (getting a good deal on it) and high price are growth stocks, which you're paying up because you think they're going to grow faster than the average market. Now back in about 2015 that growth part of the market, or high price companies, were relatively cheap compared to value. What's happened over the last, basically, five years is value has gotten cheaper and cheaper and growth has gotten more expensive, so that's led to large companies and growth companies having done better than small and value. In 2020, aggregate growth has done much, much better than value and large has done a little bit better than small - when you look at the entire year. When we look at just the fourth quarter that's reversed dramatically. It's part of the signal that makes us think the economy is going to recover because small value tends to lead the recovery and large growth tends to do best when markets are choppy because people want to buy something that's a name brand like Amazon. You'll notice small went up almost 20% more just in the fourth quarter than large companies did in the US. When you look at large growth versus small value it’s up three times as much just in the fourth quarter alone. That's really helpful for how we manage money because the funds we use tend to have a little bit less in large growth companies than just a pure index fund, and it has a little bit more in small value - it still owns more Apple than it does a small startup company, but it owns a little bit less Apple than the index (than the benchmark) and a little bit more of these small companies then the index. That led to our performance in the fourth quarter of small and value over large and growth, which is good thing.
I want to introduce the idea of the Pareto Principle. The idea of the Pareto Principle is you can get 80% of the benefits with only 20% of the inputs. That's really key when we think about vaccine rollout. It's a wonderful thing. The vaccine is being rolled out, healthcare workers are starting to get it and some and our seniors. That's really important, because when we think about fatalities in 2020 even though people age 65 and older only makeup about 16.5% of our total population in the US, they were more than 80% of the fatalities. This is a tragic statistic none of us wish was true. We all wish this would have been different; it's a challenge, but it's also an opportunity that if we can vaccinate these folks first, and as quickly as possible, 80% of the future fatalities can be reduced just by hitting less than 20% of the population with vaccines, and with people who have had the disease and recovered. That's really important, and when we're looking at the number of people who have received at least one dose - this is one day change from February 9 to February 10 – basically, almost a million people received at least one dose in that one day. So somewhere between 750,000 and a million is typically what we're seeing at least one dose. Now people who have received two doses already are 10 and a half million people, so we're getting there. If we're doing close to a million people per day, by the end of March we're going to have a lot more people who have been vaccinated. If 80% of the fatalities are over age 65, and we can get most of those by the end of March, and it's something like 50%, 60%, 70% (I've heard different numbers) of the people who are hospitalized with Covid 19 are over age 65, we can cut the hospital pressure and the number of future fatalities down dramatically. There's hopeful news on Covid 19. It's more hopeful from a society standpoint than it is from economics, but if flows through to economics, as well.
When we talked last quarter, we thought there might be a split government, where the Senate would remain in the Republican hands and Democrat for Presidency and the House. That didn't happen. Single party control across the board, could make stimulus and spending increases more likely – could. Because it's a real slight majority and there's some disagreement within the party itself (this would be true if it was all Republicans, too), as there's as much disagreement in the parties as between the moderates in the two parties. This could make increases in spending more likely. I've heard a lot of people say, “Well, this means taxes have to go up”, not necessarily. Taxes may go up on the highest earners, as there's general agreement on that, but not necessarily on most of the middle class. If you think about the bottom 95% there may not be tax increases unless there's increases in inflation and in interest rates. If you look at interest rates from 1981 all the way until now there's been a pretty consistent decline, even though we have way more debt as a percentage of our GDP now than we did in 1981. If we look at other countries in the world - first let's look at ourselves in the past. In 2001 we had about $6 trillion worth of national debt and we were paying about $360 billion dollars of annual interest every year on that. Interest rates during that time were between 2.5% - 6%. Interest rates came down during that recession. If you roll it forward to 2019, the national debt had grown to $23 trillion, or thereabouts, almost four times as high as it was in 2001. However, the national interest that we were paying didn't even double. It’s because interest rates came down. In 2019 the average interest rate was about 2%, right now it's about 1%; even though our national debt is over $27 trillion dollars now (at the end of 2020) the annual interest repaid in 2020 was actually lower than it was in 2019. You see this around the world - it's not just the US that has lower interest rates and can afford higher amounts of debt. If you look at Japan, they have more than twice as much debt as we do and they increased their percentage of debt versus GDP more than we did in 2020.
If you look at the US versus other advanced economies you'll notice our level of debt is very similar, and increased a very similar amount, to other countries that have advanced economies. We have some of the highest interest rates and highest inflation in the world - everywhere else is basically going down. The point here is, unless there's an increase in debt service costs by the government there may not be an impetus to have across the board tax cuts. It might be directed just at people with income above $400,000, or something along those lines. Interest rates are going to be, probably, the canary in the coal mine when it comes to taxes.
What's next? We're going to continue to monitor the economy, investment markets and Covid-19. We're going to do these updates every quarter. We're going to rebalance portfolios, as needed, and manage to make sure you have enough cash, if you're in distribution to have between four and seven months’ worth of cash for your monthly distributions.
I'm Josh Wolberg. Thanks for watching. Stay curious my friends.