Monthly Outlook: December 2021
Are you getting tired of endless opinions and guesses? The more news I watch and read, the more it just blends together. I’ve wished for a long time that the TV networks would have a running tape below the pundit’s face that lists their last guesses and how those worked out to keep them accountable. Then we would know how seriously to take their current view. What if there was a better way? What if we could block out the nonsense and just look at facts? I know that even facts are debated these days, but facts are facts. If the thermometer says it’s 54 degrees, I’d agree that it’s 54 degrees. I’m talking about facts like this. At least as far as investing goes, at Ryan Investments we can (and do) look at facts and make decisions, accordingly.
What Do We Know for Sure?
Most investors categorize investments into several categories. We have Cash for liquidity, Bonds for stability and income, and Stocks for growth. Let’s just focus on Stocks for now, since that’s where the opportunities exist. Below, I’ll discuss three facts that we know for sure.
First, there are about 5,000 stocks in the U.S. and another 5,000 stocks outside the U.S. They range in size (market capitalization or “market cap”) from $50 million to over $2 trillion. And size matters in stocks because that’s how we weight them in stock indexes. For example, the S&P500 is a basket (index) of 500 stocks, but they’re weighted based on their market cap. Microsoft, Apple, Google, Amazon, and Tesla are the Top 5 and they add up to nearly 25% of the whole S&P500 index! If one of these stocks has a big day, it really matters to the S&P500, and you’ll hear about it on the news. But if one of the bottom 100 stocks in the S&P500 has a big day, it won’t even budge the S&P500. So, here’s the fact: When the news says, “the market,” it’s usually talking about the S&P500 and, in turn, it’s really talking about the biggest stocks. Recently, these Top 5 have accounted for over half of the S&P500’s gains. But, in some years, smaller or foreign companies do better. As investors, we look for investments in all stock markets, large and small, U.S. and non-U.S. Be careful to not compare a diversified portfolio to the Top 5 tech stocks.
Second, valuation metrics like “Price to Sales” or “Market cap to GDP” are facts and are as measurable as the temperature. We have these valuation metrics going back 100 years. The fact is that valuation metrics today are in the upper 0.5% of the past 100-year range. In other words, the market is very expensive and highly valued if not over-valued (a judgement call). It’s logical, then, to analyze what happened to markets at other expensive valuation peaks. Those include 1929, 1999, 2007, and a few other years. Each of those peaks led to market corrections within a year or two. Perhaps we should expect the same today, given peak valuations. The challenge is that we can’t know if a correction will come in one month, one year, or maybe not at all. But we know, as a fact, that peak valuations add risk and so investors need a downside protection plan in place…now.
Third, moving average trendlines are a factual computation that simply calculate the average price for the past “x” days. It’s math. A 200-day moving average is considered a long-term trendline and is the one we use to determine if any investment is trending higher or lower. When we say “ETF X is trending higher” we mean it’s factually above its 200-day moving average. We’re not guessing that it will go higher, it is going higher. A corollary fact, therefore, is that no investment can lose big until it first falls below its 200-day moving average trendline. Using this fact, we buy ETFs as they cross above the trendline and sell ETFs as they cross below the trendline. It’s a disciplined approach to capture growth and avoid losses.
Our iFolios strategy is a fact-based, common-sense approach to investing. We use these three facts, above, to manage portfolios. To summarize, we 1) diversify across many markets to capture opportunities worldwide, 2) consider valuations as a level of risk, and 3) use moving-average trendlines to know when to buy and sell each holding. We see a few sell signals occurring right now, so we’ve sold some of our stock ETF positions for protection. Our strength is in our discipline—it’s no time for guessing.