We are on to 2021

Following an embarrassing loss in 2015, Patriot’s Coach Bill Belichick famously quipped, “We’re on to Cincinnati.” Coach Belichick refused to entertain any questions about the past, instead he and the team were focused on the future. The coach later explained he was not ignoring the lessons learned in that game, but was firmly ready to take those lessons into the next week’s game plan.

 

Just like in football, a good investment plan requires looking forward rather than backwards. It requires learning from the lessons of the past to prepare for what lies ahead, but not getting bogged down either. 2020 provided a valuable and vivid lesson that investor psychology matters more than fundamentals at extremes. Think back to last March; fear was the predominant emotion affecting investor’s psyches. The U.S. economy was forcibly shut down and in a severe recession, stock markets globally were falling, and corporate earnings were set to collapse. At the time, it was very easy to expect a dire outcome, and difficult to foresee an optimistic future. Similar cases could be made in the depths of the financial crisis following September 11, and the bursting of the internet bubble, and so on and so on. It was “rational” to act to avoid or reduce risk. Rational, but wrong with the benefit of hindsight.

 

How does this relate to today? Instead of fear, greed and optimism have reached another psychological extreme. This extreme presents an increased risk for disappointing investment results. Since early November, following positive clinical trial readouts of Covid-19 vaccines, optimism for the future has soared. Citigroup compiles an index that tracks investor sentiment they dub their “Panic/Euphoria Model” (see Figure 1 below). The index is made up of a collection of individual metrics including margin debt, options trading, and bullishness in investor newsletters. The latest reading has eclipsed any point in time on record, including the late 1990s. Citi’s analysis of historical patterns using this data suggest a high probability of poor forward equity returns.

In addition to the broad-based optimism permeating markets, we note many signs of excessive risk-taking. Retail trading activity on new low-cost trading platforms such as Robinhood have soared. Returns in riskier indices including small and micro capitalization stocks, (read small and unproven companies), have skyrocketed over the last several months. Similarly, stocks of companies with significant financial debt have vastly outperformed companies with much safer balance sheets. A handful of “story stocks” have garnered significant interest and outsized returns relative to their fundamental value and results. The flavor-of-the-month stocks play to themes such as alternative energy, innovation, and cannabis. We have witnessed many similar frenzies over the years, where ultimately the combination of no/low profits, gaudy valuations, and excessive optimism have disappointed investors who had such high hopes. Additionally, initial public offerings for Special Purpose Acquisition Companies (“SPAC”s) have increased dramatically. These so-called blank check companies that carry little more than a business plan, have seen their shares rise dramatically. Just last week, the shares of little thought of companies like GameStop and AMC Entertainment made headlines rising and falling in extreme volatility, with dramatic short squeezes, as bands of retail traders in unison plowed into the shares of companies that had been bet heavily against by large professional hedge funds. While excessive sentiment can persist despite these concerning signs, we advise clients to proceed with additional caution. When other investors behave with less caution, it makes sense to take stock of where your investments stand with respect to your mix of riskier and safer investments. While we rarely advocate for dramatic shifts against long-term plans, we do advocate for smart asset allocation and regular rebalancing. Now seems an opportune time to reassess those levels.

 

Against this backdrop, the shares of dependable, profitable, and conservatively financed companies have lagged the broader indices. This is not surprising, but this is creating compelling prices for the securities of the companies we favor. In fact, our domestic equity strategies (High Quality Dividend Appreciation and High Quality Midcap) are both trading at their most attractive multiples of profit relative to their assigned benchmarks than at any time under our management. Even more encouraging, our companies’ fundamental results vastly exceeded the results of the broader universe in the most difficult year on memory. Our companies grew sales and profits at a much stronger clip than the average company as represented by the S&P 500 (See Figure 2 below). We did not predict the Coronavirus and ensuing impacts and we will not be able to predict future recessions and calamities. We do, however, feel very confident that our companies and their leadership teams will manage through whatever may come and those companies will come out stronger competitively on the other side. We are on to 2021 with a team of amazing companies that we expect to deliver attractive results for clients for many years to come.

The team at Boston Financial Management is always available to answer your questions. Please do not hesitate to contact your Wealth Manager directly, or call our main line at 617-338-8108.

This publication is for informational purposes only and should not be considered investment advice or a recommendation of any particular security, strategy or investment product. The information contained herein is the opinion of Boston Financial Management and is subject to change at any time based upon unforeseen events or market conditions.