A Sample Year-End Letter for Clients

Wayne has identified the following historical data regarding recovering from down markets:

Since 1871, market downturns have recovered as follows:

• 33% of market downturns recover within a month
• 50% of market downturns recover within two months
• 80% of market downturns recover within one year
• 95% of the time those big "once or twice in a lifetime drops" return to even in three to four years.
• Collectively, since 1871, the time it takes for the market to recover (top to trough to top again) is a mere 7.9 months!

Having a sense of the history of down market recoveries can help you decide how much "safe" money you need to set aside as an insurance policy.

Last year, 2019, was interesting in the tales it told and the lessons imbedded therein. If there was ever a year where a lesson could be learned on why not to follow the wisdom of market soothsayers, economic forecasters, newspaper headlines and talking heads in the media, this one was it. Please see this article by Larry Swedroe if you need more reasons.

Recall how the year 2019 started. The end of 2018 was frightful, as the three major indices used to track the U.S. stock market all came within basis points (100ths of a percent) of a "bear" market that would have ended the "bull" market that started on March 10, 2009. A bear market is arbitrarily defined as a market that falls 20% or more from its previous high.

In fact, the NASDAQ index did fall over 20% from its high, while the S&P 500 came within 0.2 percentage points (20 basis points) of falling 20%. In my humble opinion, the bull market of the last 10 years ended at the end of 2018. To believe otherwise is simply splitting hairs. 2019 marked the beginning of a new bull market, so don't let talk of an aging bull market frighten you; this one is a newborn baby. I realize I am essentially alone in this position, but I'm used to bucking the crowd.

For an index to recover from a 20% drop, it must gain 25%; keep this in mind as we review 2019 returns. In a vacuum, 2019 returns seem astounding and on a current year earnings growth basis are entirely unjustified. However, in context, they are not astounding, but quite normal when we look at the longer term of two years.

We'll use the S&P 500 index as a proxy for the U.S. equity (stock) market. In reality, all three of the major market indices, the Dow, the NASDAQ and the S&P 500 are heavily weighted to large-cap growth-type companies, which include companies such as Facebook, Amazon, Apple, Netflix and Google (or Alphabet). This small handful of tech companies are responsible for over 20% of the index due to their size and a far greater percentage of the index price gains during the year.

The S&P 500 ended 2018 down 13.5% for the quarter and down 4.4% for the year (and again, -19.8% off its high). Small-company stocks fared far worse; the Russell 2000 benchmark of smaller company stocks was down -0.2% for the quarter and down 11.0% for the year, while the Russell Mid-Cap index were down 15.4% and 9.1% respectively. It is interesting to see how 2019 unfolded after a year in which the market was up +17.9% for the 12-month period at the end of the third quarter 2018, then ended the calendar year 2018 down 4.4 – a swing of 22.3% in three months!

To understand how truly remarkable the final outcome of the 2019 market was, let's review how the Wall Street Journal recorded the events of the year in the market:

January: After much hand wringing at the end of 2018, on January 8th this headline "Signs Point to Strong January in Stocks." Then January 22, "From Overoptimistic to Sort of Pessimistic ... investors are gloomier than a year ago." January 23rd – "Stocks Slide on Growth Worries." January 24 "Strong Earnings Power Stocks," then at the end of the month "Stocks Rally – but Worries Linger!"

The stock market closed January up 8.0%.

February: Through the month of February, these headlines: "Nasdaq Nears Bear-Market Exit;" " Bull Market's Test: An Earnings Slump;" "Most Stocks Are Up and Yet Some Worry; " "Late Rally for Dow Keeps Streak Alive;" "Bullish Signals Bolster Investors;" "Dow Gains 1.5% to Break Losing Streak;" " Stocks Gain as Shutdown, Trade Fears Abate;" "Dow Falls on Weak Data, Earnings;" "Nasdaq Climbs in a New Bull Run;" "Stocks Surge to Start Year:"

The market closed up +3.2% for the month and +11.62 year-to-date.

March: The first week of March ended with "Slow Growth Prods Central Banks;" "New Growth Worries Sink Stocks;" and "Economic Worries Weigh on Stocks." By the middle of the month, on March 16th things are looking up with "Tech Shares Lift Up Stock Prices." Then days later "Stocks, Oil Head for Crossroads'' as rallies reach critical levels, some say economic uncertainty may be a damper." By the beginning of the third week, "Growth Fears to Keep Fed on Hold," and "Fed Slowdown Signal Hits Stocks." The month ended with "Inverted Yield Curve Is Telling Investors What They Already Know ... Long term bond yields plunging below short-term ones is a good predictor of Fed rate cuts and an economic slowdown ..."

The market the month +1.9%, with the first quarter ending +13.7% led by tech, industrials and energy.

April: April started with bad news and good news – April 1st & 2nd: "Second Quarter Pause Often Follows Rally ... fears of slowing global growth and trade worries could make it difficult to repeat performance in the second quarter" and "Factories Pick Up, Calming Investors in U.S." On the 3rd, "Investors Turn to Safety of Treasurys" then the 11th – "Treasury Yields Feel Downward Pressure" then the very next day "Treasury Prices Decline on Jobs Data, Inflation;" (Note that investors buying Treasurys at a higher than normal rate would cause prices to go up and rates to fall, and yields going down also indicate rising prices; followed then by prices going down and rates going up). On the 15th "Global Rally in Stocks Gathers Momentum" then the very next day "Weak Earnings Depress Stocks" and "Treasurys Steady as Traders Await Data." On 4/22 this concern "Investors Gauge if Rally Is Near Its End ... Some worry about having large holdings of stocks in case volatility returns ... The index's surge surprised many Wall Street banks that had expected a much slower rebound from 2018's turbulent finish." At the end of the month, on the 25th, "Treasurys Rise Amid Economic Worries" and "Stocks Edge Down From Records," but ending on a high note April 29th with "Low Inflation Reading Keeps Rally Alive."

April ended up +4.1% with the year-to-date number now at +18.3%.

May: Small company stocks begin to make a comeback -"Fed Pause, Dollar Feed Small Cap Hopes" and "Stocks Set Milestone For Start To the Year ... Major U.S. stock indexes enjoyed their best four months start to a year since 1999." Then by the middle of the month "Weaker Inflation Views Stir Fed Fears and "This May Not be Another Dip to Buy ... The problems behind stocks' recent tumble aren't the kind the Federal Reserve has the power to fix ... this latest dip really might be reason to worry" and on the 21st "Investors Wager on More Stock Turmoil ... A growing number of investors are betting that markets will stay erratic as a renewed bout of trade worries roils global markets." The month wrapped up with "GDP Growth Held Firm in the Quarter."

The market ended the month down 6.4%! They finally got one right.

June: The month begins with bad news – "Nasdaq Hits Correction Territory (a "correction" is a 10% or more drop off the last high). By the end of the first week, the news was clear "Stock ETFs Shed Record $20 Billion in May," stock investors panicked in May and many bailed out during that rocky month. But the same day, this news "Dow Soars on Hope of Rate Cuts" & "Stocks Rally on Rate-Cut Prospects." On 6/15 "Stocks Take Breather But Log Weekly Gain." On 6/18 this telling news: Share price gains for tech are as follows – Facebook +44.2%, Microsoft +30.8%, Twitter +26.8%, Amazon +25.6%, Apple +22.9%, while the S&P 500 is up a mere +15.3%. If you aren't heavily invested in huge tech companies you're missing the rally as it's these stocks pulling up the average, given their very significant weight in the index. "Stocks Cap Best First Half Since '97."

June ended up +7.1% and the year-to-date return is now at a healthy +18.5%. Financials, Materials and Information Tech lead the S&P 500. "For Better or Worse, Tech is Still Leading the Market ... The S&P 500 Information Tech Sector finished the quarter up 5.6%, extending its 2019 advance to 26%.

July: "Investors Buy Bonds Even as Shares Rally ... Investors are piling into bonds at a record pace, a sign that caution remains despite stocks pushing toward records. Dimmer expectations for global growth have pushed S&P 500 companies to cut their forecasts, pushing the estimated earnings growth rate for the year to 1.6% down from 3.0% in late March."

July ended with the market up +1.4%. Year-to-date the stock market is now up +20.2%.

August: Friday, 8/9 "Dow Jumps as Beijing Eases Fear ... The U.S.-China trade war entered a new phase this week after the Chinese currency depreciated ... after the U.S. threatened to expand tariffs. That pushed stocks sharply lower on Monday, with all three major indexes suffering their biggest single day pullbacks of the year. " "The Turn in the Yield Curve ... that tends to happen ahead of recessions." August 15th, "Stocks, Bonds Flash Warning Signs ... Dow has worst drop in 2019 as Treasury yields flag dangers to economic outlook" and "Global Economic Slowdown Deepens." But by the end of the month "Stocks Up on New Trade Optimism," however, "Tech Giants Lose Luster For Investors."

August ended down a mere -1.6% after all the doom and gloom about recessions.

September: On 9/4 this warning – "Don't Ignore This Recession Sign ... Signs of a possible recession keep stacking up. At some point it no longer makes sense to keep explaining them away. The latest grim omen came Tuesday as the Institute for Supply Management's manufacturing Index fell to 49.1 in August ..." Then on 9/10 – "Investors Bet on Big Gains for Gold* & Silver ... The precious metals market ... has come roaring back in 2019 ... with the U.S. in the midst of the longest economic expansion on record, recession worries have escalated." Then, surprisingly, on 9/14 this revelation – "Stocks Rise for Third Week In a Row" and 9/16 "Growth Refuels Stock Rally." On 9/24 this bad news "U.S. Manufacturing Joins Global Retreat ... Investors flocked to government bonds and gold as they fled riskier assets such as stocks." But two days later "Trade-Deal Hopes Lift Stocks." At the end of the month, just two days later on 9/28 this ominous news "Slowdown Spreads Across U.S. Economy." [*Note that gold ended the year up +18.87% vs +31.5% for the S&P 500.]

The market ended the month up +1.9% and year-to-date up +20.6%.

October: October started with more concerns about the economy and the market – 9/1 "Investors Search for Yield as Outlook Darkens on Growth" and 9/2 "Treasurys Soar Amid Slowdown Concerns" and 10/3 "Stocks Slide Amid Downturn Fears" and 10/4 "Stocks Start Quarter on Shaky Ground." A few days later, on 10/7 "Earnings Outlook Threatens Stocks" and 10/9 "U.S. Earnings Flash Worrying Signal." But wait! The very next day on 10/10 "Stocks Rally, Led by Tech Sector!" and 10/11 "Stocks Get Lift From Improving Outlook For Trade." Sadly, this next news just demonstrates the danger many investors face who do not have a realistic plan for their long term investment goals "Stock-Fund Outflows Are Biggest in Decade!" Where did this money go? "Investors flocked to bond funds and plowed a record amount into cash in the latest quarter amid U.S. China trade tension, ... Brexit, and mounting concerns about the global economy." Then on 10/16 "Stocks Jump On Strong Start to Earnings" but the very next day "Stocks Weaken As Retail Sales Slip." Wow. Anyone getting a headache yet? Then 10/21 "Global Risks Send Investors on [Safe] Haven Search ... some investors are boosting holdings of cash and other assets that tend to hold their value when markets turn rocky." On 10/22 this surprisingly good news: "Stocks and Bonds Stage Biggest Simultaneous Rally in Decades!" Nonetheless, the naysayers refuse to give up on the bad economic news. On 10/25 was this headline: "Economic Growth in U.S. Feels Pinch ... Business activity continued to slow around the world heading into the fall, with the U.S. showing signs of tepid growth ..." Then, finally, October ended and not a minute too soon, with this headline "Stock Market Rallies in Measured Fashion."

October closed with the market up 2.2% for the month and +23.2% for the year-to-date.

November: Let's take a break for November and just say that November was more of the same, and ended up for the month by +3.6%.

December (whew, finally!): Believe it or not, December began with "Stocks Projected to Slow! ... Analysts see no repeat of 2019's gains in 2020." Well, given their track record I'd say that's no real cause for alarm. The headlines continue to ignore 2019 and want to focus on next year. On 12/4 this headline "Good U.S. Economy Isn't a Given in 2020." Ever get the feeling that bad news sells better than good news? Well, here ya go: "Dow Falls 28 Points on Tariff Fear" and "Tariff's Loom Over Investors' Hopeful Picture." By the start of the second half of December, this good news: "Growth Outlook Improves As Trade Fears Ebb." And four days later, "Stocks End Week at Fresh Highs" but by 12/18 "Relief Rally Shows Signs of Weakening." But hey, that's just Thursday; by Friday, the very next day, this observation is made in Monday's paper: "Bullish Attitude On Stocks Picks Up." On the day before Christmas, "Gold Rallies as Economic, Trade Worries Linger" yet the very same day "Markets Rally Like It's the '80s." Believe it or not, on the day after Christmas, in an article titled "Lessons Learned in 2019" this observation is thrown out there "An Easy Year to Make Money." Are you kidding me? This is an inside joke I'm sure, but it is put out there as a serious conclusion to a year that could not have been confusing, angst filled and frightening for most investors.

Staying the course in a year like 2019 takes nerves of steel and the temerity of James Bond, or a well thought out plan to stay committed no matter how gut wrenching the news of trade crises, economic collapse, weak manufacturing numbers, earnings surprises, etc. And the reward? A mere stock market increase of +31.5% for the year.

Summary

There is an old saying on Wall Street – "The market climbs a wall of worry." Indeed. And 2019 was one of the best examples of how all the hand wringing and worry and speculating and pessimism can mask what is really going on in the economy and the stock market. Throughout the entire year, the economists I listen to remained staunchly positive on the economic fundamentals and rationally optimistic that the year would end well given all the hard data.

In fact it did just that, ending the year up +31.5%. They continue to point to very positive factors driving this economy. Real wages are up, especially among lower paid workers who tend to spend a greater percentage of their increased wages. And though spending is on the rise at a healthy pace, so is saving. The expansion still has room to run, and if there is a real hurdle out there it is running out of enough hands to get the jobs done that need to get done in an expansion; a worker shortage is likely. Inflation remains in check even as money remains cheap and available, unemployment is historically low and real wages have increased. Corporations are sitting on piles of cash and lower tax rates will continue to have a positive effect on after-tax earnings.

Markets are driven in the long term by earnings growth and the signs of increased earnings in 2020 are there. According to Fritz Meyer, one of my favorite economists, S&P 500 earnings are expected to grow 10%. And though a +31.4% increase over one year is amazingly good, over two years the return is a more reasonable +12.1% for the S&P 500, +10.0% for the Dow and +14.0% for the Nasdaq. These are good returns for sure, but not crazy, out of whack with reality. Historically, large company returns have averaged just under 10% and small company returns just under 12%.

Here is what I want you to take away from this exercise: When you read those headlines that strike fear in the hearts of mortal humans, just remember 2019. Remember the over-hyped concerns and pessimism constantly promoted in the news. Then smile a little and rest easy knowing that doing nothing, with intent and purpose, is in fact doing something. Yes, the next time could end up worse for the year, but a year is arbitrary. And always remember this – if it hasn't ended well then it isn't over yet. Optimism is a far better approach to investing than pessimism, though pessimists do get more attention and somehow sound more believable than optimists. A reality I can't really explain, but there you go.

We look forward to working with you this coming year and commit always to act in your best interest and strive to earn the trust and confidence you have placed in us.

Happy New Year!

Clark M. Blackman II, CFA, CPA*/PFS, CGMA, CFP, Accredited Investment Fiduciary, is president and C.E.O. of Alpha Wealth Strategies, LLC, a fee-only RIA based in Houston, TX.

Read more articles by Clark M. Blackman II