1) INTRODUCTION:
François Doyon La Rochelle:
You’re listening to Capital Topics, episode #65!
This is a monthly podcast about passive asset management and financial and tax planning ideas for the long-term investor.
Your hosts for this podcast are James Parkyn and me François Doyon La Rochelle, both portfolio managers with PWL Capital.
In this episode, we will discuss the following points:
In first topic, we discuss what investors should be doing when markets are making new all-time highs.
And next, in our second topic, we Review the UBS Global Investment Returns Yearbook for 2024
Enjoy!
2) MARKETS ARE MAKING NEW ALL-TIME HIGHS, WHAT SHOULD INVESTORS DO? :
François Doyon La Rochelle:
In our first topic today, we will try to help our listeners deal with the anxiety brought on by the fact that markets are reaching new record highs. The headlines in the financial media are often alarming when this happens, suggesting that the markets have nowhere to go from here but down. Such headlines negatively impact investors’ emotional behaviors, influencing their decision-making process.
James Parkyn:
Indeed, François, this type of market often triggers questions from clients. On the one hand, clients are happy that the markets are up but on the other hand, they wonder if they should be selling assets to avoid the inevitable upcoming downturn. Also, when markets are making new highs, it is emotionally more difficult for investors to take the plunge and deploy new funds. These are typical investor behavioral challenges when markets are setting new highs, that often lead to mistakes that reduce their long-term returns.
François Doyon La Rochelle:
Exactly, so before we tell you how to deal with such events here is some context. Year-to-date, as of June 24th, the S&P500 Index is up roughly 14%. During that period, the S&P500 Index has reached new record highs on 32 occasions. However, before this strong sequence of record highs, you must go back, two and a half years, to January 4th, 2022, for the last record high on the S&P500 Index. Meaning, there were more than 2 years without the S&P500 Index making new highs. This was the longest stretch since 2008.
James Parkyn:
Markets making new highs is a normal occurrence. Investors should expect that markets will make regular new highs. Why? Because stocks over the long run must have positive expected returns. This is also true every trading day regardless of what the markets have done yesterday, the week, or the month before. According to research from RBC Global Asset Management, from January 1950 to March 2024, that is 74 years of data, the S&P500 Index has made more than 1,250 new all-time highs. This equates to an average of about 17 new all-time highs every year. This comes out to 6% of all trading days. We will add a link to this research on the podcast page.
François Doyon La Rochelle:
Correct, but I must add, James, that the number of new markets high in rising markets must be higher than 17 per year because the data surveyed also includes all the bear markets and corrections that occurred since 1950. Our listeners will understand that the markets aren’t making new highs during downturns. There have been as many as 11 bear markets on the SP500 Index since 1950 and more than double that amount in market corrections.
James Parkyn:
Well said François. Logically new market highs are reached in bull markets. Consequently, new market highs will be a lot more concentrated. This said François, do you have any data to help investors dispel their fear of investing when the markets hit all-time highs?
François Doyon La Rochelle:
Yes, I do. Let’s go back to the data from RBC Global Asset Management research, if an investor had invested in the S&P500 Index only at all-time highs from 1950 to 2023, their performance would still be close to the average of the index over one, three, and five years. If we look at the details, the average 1-year return for investing only at all-time highs was 11.2% and if invested on all the other days the return was 12.6%. For the 3 years, the returns are closer with 10.9% for investing only at all-time highs compared to 11.5% on all other dates. Finally, for the 5 years, the return difference is similar, with 10.3% for investing only at all-time highs versus 11.3% on all other dates.
James Parkyn:
So, François, based on this data can we say that there is a difference in performance?
François Doyon La Rochelle:
Yes, there is, but it’s relatively small. Remember, the study from RBC looked only at investing on the days the S&P500 Index reached a new all-time high. You need to be very unlucky if you have deployed your funds only on those days or you must have done it deliberately.
There is also similar research from Dimensional that looks at the data but every month rather than daily. They come to comparable results. Their conclusion, based on data on the S&P500 Index from 1926 to 2023, finds and I quote “the average returns one, three, and five years after a new month-end market high are similar to those after months that ended at any level”.
The results for the 1-year return are even in favor of investing after months that ended at a record high. The return was 13.7% compared to 12.3% for investing after months ended at any level. For the 5 years, the returns are almost the same at 10.2% for months ending at a record high compared to 10.3% for all other months. Again, we will add a link to these numbers from Dimensional on the podcast page.
James Parkyn:
That’s interesting François but I think that for most investors it’s still counterintuitive to invest at market highs especially when behaviorally they are following the old mantra of buy low and sell high. Investors need to change their mindset.
François Doyon La Rochelle:
James, you’re correct in saying that we want to buy low and sell high, but as I have demonstrated if you are in for the long term, it does not make that much difference whether you have invested at the market highs or not. However, if you are actively trading and have short-term objectives it can make a big difference.
James Parkyn:
I understand François, but investors are never comfortable investing at market highs. They believe in another mantra that markets will correct at some point giving them a better buying opportunity. In our jargon, this is called reversion to the mean.
François Doyon La Rochelle:
Investors know markets are cyclical; they will generate returns above their long-term average for a period and they will eventually pull back and generate returns below their long-term average. The problem is we don’t know when those cycles start and end, no one knows unless they have a crystal ball.
James Parkyn:
So, François, what would you say to investors who are afraid that the markets are high and that they will eventually correct?
François Doyon La Rochelle:
First, I think investors need to realize they are market timing, and that market timing is a loser’s game. Whether you’re trying to time your exit point when the markets are high during a bull market or trying to time your entry point after a severe correction or bear market, the odds of getting it right are very slim and you could miss out on some good returns. Market timing does not work in the long term, period.
James Parkyn:
I completely agree François. We have, over the years, been very consistent on our podcast, it’s time in the market that counts and not timing the market.
François Doyon La Rochelle:
Second, investors need to realize that not all stock markets are making new highs. The focus right now is all on the main U.S. indices, the S&P500 Index, the Dow, and the Nasdaq which are making new all-time highs but other markets internationally and sub-indices in the U.S. such as the small caps are not.
James Parkyn:
I think the message for our listeners here François is, that diversification is the only solution. There are other cheaper asset classes out there than U.S. large-cap growth equities. “The market” is more than just the S&P500 Index. There are other asset classes like fixed income, REITs, Canadian, international, and emerging market equities.
François Doyon La Rochelle:
Absolutely James. Third, investors don’t have to predict when the markets will stop going up and correct, but they need to prepare for that possibility. As always, they need to keep rebalancing their portfolios. You sell what has gone up the most, in this market it's likely the U.S. equities, to rebalance and buy other asset classes in your portfolio that have not done as well.
James Parkyn:
Rebalancing your portfolio in a rising market to reflect your long-term asset allocation is essentially a form of selling high and buying low. By doing so, in a disciplined fashion, you are effectively de-risking your portfolio by removing the overweight in this asset class.
François Doyon La Rochelle:
Once the portfolios are rebalanced, if an investor is still uncomfortable with the markets, the next question to ask is, is there too much risk in the portfolio for him? If you are nervous and stressed about the likelihood of a correction maybe you should review your long-term asset allocation to reduce your allocation to risky assets. The best time to reduce your asset allocation to equities is when the markets are doing well and not during a market downturn.
James Parkyn:
Francois, is there a different message for someone who wants to deploy fresh cash in this type of market?
François Doyon La Rochelle:
Keeping cash on the sidelines feels safe but it’s not a good investment, there is an opportunity cost for doing so. It’s not because markets are high that they can’t go higher. As we have said before, you need to look at the long term, not the short term. If you are in your 30s, 40s, and even in your 50s if there is a market correction after you have invested your fresh cash it will be very unpleasant, but down the road, it will feel like a speed bump. Remember that this cash will be invested for at least the next 30 years if you are currently in your 50s.
James Parkyn:
The next question François is, should investors deploy their fresh cash all at once or feather it in multiple tranches?
François Doyon La Rochelle:
Well, James, evidence shows that investing in one lump sum is the best option. Our research department issued a paper in 2020 titled “Dollar Cost Averaging vs. Lump Sum Investing” and in that paper, they demonstrated that lump sum investing beats dollar cost averaging 65% of the time, and that the average annualized overperformance is 0.38% over 10 years. For periods when the markets are expensive, they also conclude that lump sum investing still comes out ahead of dollar cost averaging.
James Parkyn:
In our team, investing in tranches is done for large amounts of new capital. It is done mainly for behavioural management such as minimizing regret avoidance. We want to minimize the likelihood of a negative event like 9/11 or other unforecastable events that can materially impact your newly invested dollars. But I will add for our listeners, that we feather in these new large amounts over a short period.
François Doyon La Rochelle:
To conclude, market highs are normal, you should embrace them as an investor. What’s important however is to be mindful of the risk you are taking in your portfolio because there will eventually be a correction. The timing of the next correction is impossible but remember the markets are down on average 1 year out of 3. This means you need to be prepared. There is no way of knowing what the markets will do next, you can’t control them, but you can control what you can. This means having a long-term investment strategy that reflects your risk tolerance and objectives and having the discipline to stick to it in good and bad times.
3) UBS 2024 YEARBOOK ON ASSET CLASSES:
François Doyon La Rochelle:
I will start this off for our Listeners. Our second topic today is a Review of the 25th edition of The UBS Global Investment Returns Yearbook 2024 Summary Edition. Reviewing the Yearbook is an annual ritual for our Podcast. This is the first year it has been published under the UBS Brand. This change came about because of the merger of Credit Suisse and UBS. We recommend to our Listeners to go back and listen to our Podcasts #38 and #52, in which we reviewed the 2022 and 2023 editions of the Global Investment Returns Yearbook. The content is still very relevant to what is happening in financial markets now.
I would also like to highlight that the Yearbook is produced in collaboration with Professors Paul Marsh and Mike Staunton of London Business School and Professor Elroy Dimson of Cambridge University. They have been involved for 25 years.
This all being said, James, could you give our Listeners an Intro about the Yearbook and explain its purpose?
James Parkyn:
Ok, Francois. First off, we are very happy that UBS has decided to continue to publish the Annual Yearbook after the merger with Credit Suisse. The purpose of the Yearbook has not changed. I will quote directly from both the Executive summary and Chapter 1: “The Yearbook presents a historical record of the real returns from equities, bonds, cash, and currencies for 35 markets, spanning developed and emerging markets and stretching back to 1900. Its purpose is not to make forecasts, but instead to inform investors about long-run performance, to interpret it, analyze it, learn from it, and help illuminate current concerns.”
I think it is fair to say Francois that the geopolitical and economic developments of recent years make this Yearbook extremely relevant to helping investors make smart decisions with their long-term money. The Yearbook content always comes back to the anchor of risk and reward, and the importance of diversification and asset allocation. This, as our Regular Listeners know, is core to our Investment Philosophy.
François Doyon La Rochelle:
OK so now James, I’m going to start today’s review by asking you the same two questions as in prior years. First, why do you as a Portfolio Manager find the Yearbook useful?
James Parkyn:
Francois, my answer is the same as in prior years. Our discipline, as our regular Listeners know well, is to invest with “an Investor Mindset, focused on the long term”. We don’t want to be led astray by short-term noise in the financial media and recent financial market volatility. This challenge is daunting and applies to all Investors including us Professionals. We have said it often on our Podcast: “It is simple to say but not easy to do: We must always be cognizant that we can fall into a trap of trying to “Forecast the Future”. This is why the Yearbook is so useful to us as portfolio managers. The Yearbook helps put current financial market events into context by comparing them to long-term capital market history.
François Doyon La Rochelle:
I agree James. I would also add the re-emergence of inflation and the central bank's monetary responses plus all the major economic and geopolitical challenges that are still with us make a historical perspective even more relevant. The Yearbook is the perfect tool for us portfolio managers to get that perspective. And this exercise helps us to never forget the importance of risk management.
James Parkyn:
Francois, the 2024 Yearbook does not disappoint on this front. Like the ones before, it addresses the importance of having a long-term perspective to understand risk and return in stocks and bonds. In our Podcast #52 last year, we stated “The events of 2022 should have reminded investors to fear complacency. As mentioned François earlier, equities are setting new all-time highs. Now we see a lot of complacency with Equities.
François Doyon La Rochelle:
Now for my second question James: what are the main themes in the 2024 Yearbook Summary?
James Parkyn:
The 2024 Yearbook Summary has four themes. The first theme is about the current concentration of markets. I quote: “The concentration of the equity market, both geographically and at the individual company level, makes for an interesting backdrop against which to consider long-term trends and less popular investment themes.” The Yearbook puts into context the geographical market concentration in US Equities and concludes it is a function of underperformance in other Equity Markets.
François Doyon La Rochelle:
Well, James, this is very timely in the sense that we discussed the concentration question concerning U.S. equities when we reviewed The Magnificent Seven on our podcast #64. And today we just covered the U.S. markets making new all-time highs. So what is the second theme, James?
James Parkyn:
The second theme is historical drawdowns. I will go into more detail about this later in our Podcast when I cover the main takeaways from this year’s yearbook for our listeners.
François Doyon La Rochelle:
The strong performance of Equity markets in 2023 and YTD in 2024 after 2022’s dramatic pullback in both stocks and bonds, provides reason enough to re-visit the history books about historical drawdowns.
James Parkyn:
The third theme François in the Yearbook is about inflation. As our Listeners know, inflation is still dominating the news. The 2024 Yearbook reiterates the case made in 2022 and 2023 and I quote: “Equities have enjoyed excellent long-run returns, they are not and never have been the hedge against inflation that many observers have suggested. Rather, stocks should be seen as excellent inflation beaters due to the equity risk premium.”
François Doyon La Rochelle:
This is a very important point, James. The 2024 Yearbook also makes another important point and I quote: “With central banks potentially poised to begin rate cutting cycles, we demonstrate the majority of long-run asset returns are earned during easing cycles.”
James Parkyn:
The fourth theme is a deep dive into corporate bonds and the credit premium. The 2024 Yearbook adds a long-term perspective on this major asset class with an outstanding value of some USD 44 trillion, almost half the value of global equities, and two-thirds of sovereign debt. The Yearbook highlights that in the long run, investment-grade corporate bonds have offered a significant credit risk premium over equivalent government bonds of around one percent, and the premium from High Yield Bonds is an additional two percent higher.
François Doyon La Rochelle:
This is very timely as the return to a higher interest rate environment has led many investors to reconsider the merits of corporate bond allocations.
So, James for Listeners what are the key takeaways from the 2024 Yearbook?
James Parkyn:
Well, Francois, I will start with Expected Returns. The Yearbook still projects that returns on stocks and bonds will remain lower than before but will also be about 2% higher than could have been expected two years ago when interest rates were much lower. The increase in interest rates implies higher expected returns on bonds. This in turn impacts expected returns on stocks.
François Doyon La Rochelle:
This is not news for our regular listeners. We know from our own PWL FP Assumptions Paper discussed in Podcast #61. Higher nominal and real interest rates mean higher expected returns from stocks. What’s the next takeaway James?
James Parkyn:
The next takeaway is about the current situation regarding Inflation. The Yearbook has a great line about children asking during a long car journey, “Are we there yet?”. I quote the Yearbook: “Investors are saying, Are we nearly there yet? Is inflation under control, when will rate hikes be replaced by cuts, and are markets returning to normal?
The yearbook shows that “Are we there yet?” is the wrong question. Rather they make the point that financial history shows that, while there are long-run averages, there is no such thing as “normal”.
François Doyon La Rochelle:
James, I believe that the Yearbook then covers historical market volatility. How volatile are stock and bond returns?
James Parkyn:
The Yearbook covers global equities. For simplicity, I will focus on the U.S. and UK market history. Since 1900, in an average year, the real return on US equities was 8.4%. The worst performance over a single year was in 1931; the best in 1933. In an average year, the real return on UK equities was 7.1%. The worst performance was in 1974; the best in 1975.
For both countries, stock-market returns typically averaged around 0%–20% in real terms. They were however below –20% in 11 out of 124 years in the US. And in seven out of 124 years in the UK. For many countries, the distribution of real equity returns was wider than in the US or UK. Simply said, equity returns have been volatile throughout history.
François Doyon La Rochelle:
What does the Yearbook tell us about downside risk during really bad times?
James Parkyn:
The six worst episodes for global equity investors were the two world wars and the four great bear markets: the Wall Street Crash and Great Depression, the first oil shock and world recession of 1973–74, the 2000-02 bear market that followed the internet bubble, and the Global Financial Crisis that was centered in 2008.
François Doyon La Rochelle:
So James, talking about the 2008 Global Financial Crisis, how bad was it?
James Parkyn:
On a strict calendar-year basis, 2008 was the worst year on record for the world index. In its 24-year life, the 21st century already has the dubious honor of hosting four bear markets, two of which ranked among the four worst in history.
François Doyon La Rochelle:
What does the Yearbook tell us about time to recovery?
James Parkyn:
Well, François, it can take a very long time or it can happen very quickly. Let’s start with The Wall Street Crash of 1929. It took over 15 years for stocks to recover. This was a long time ago for investors. Contrast that with the COVID-19 bear market which began on 20 February 2020. The Global Equity Markets hit bottom at -35% one month later, and then fully recovered within five months. So we can say that the time to recovery is unpredictable.
François Doyon La Rochelle:
Yes, I agree, that recovery time is unpredictable. Now James, what does the Yearbook say about historical Bond market returns and volatility?
James Parkyn:
Well, Francois, the Yearbook states that bonds have been much less volatile than equities. They experienced some periods of very low or high returns. Predictably the worst periods for bond investors occurred during episodes of very high inflation or hyperinflation.
François Doyon La Rochelle:
This is stuff we already know. After the bull market in bonds that lasted many years, I think our listeners will remember the bond meltdown of 2022 due to the spike in inflation. What does the Yearbook say about that?
James Parkyn:
Well, François, the Yearbook says that the period from 1982 to 2014 was a golden age for bonds. The world bond index provided a real return of 7.4% per annum. World bonds gave positive real returns in 28 of the 33 years. During the two major stock bear markets of the early 21st century, the Global Financial Crisis and the COVID-19 pandemic, bonds benefited from their perceived safe-haven status and from policy interest rates being kept low to support national economies.
François Doyon La Rochelle:
If I understood correctly, bonds produced equity-like performance, but with much lower volatility in an apparent violation of the law of risk and return. These high real bond returns happened because of factors that are not going to continue indefinitely.
James Parkyn:
I would add François, that the Yearbook states that from 2015 onward, the annualized return has been -1.7%, with poor returns in 2021, followed by a dire performance in 2022. Future real bond returns are likely to be far lower than during the golden age of bonds.
This is another example of the importance of looking at very long periods of history to understand markets. As we discussed last year on Podcast #52, even periods as long as 20 years are too short. The 2024 Yearbook states periods as long as three or four decades can be quite misleading if naively extrapolated.
François Doyon La Rochelle:
I would add James, another key takeaway about bonds in the Yearbook, which was made in last year’s report as well. The Yearbook makes it clear that stocks and Bonds have a historically positive correlation and that the last 20 years of negative correlation before 2022, were not the norm.
So, James, what is the next takeaway for our Listeners?
James Parkyn:
The Yearbook asks the question: how well do bonds protect an investor’s wealth? As we discussed in our Podcast #61 when you measure Bonds based on real returns, the historical data is eye-opening. The Yearbook states historically, bond market drawdowns have been larger and/or longer than for equities.
François Doyon La Rochelle:
Wow, this is scary given it is supposed to be a secure asset class.
James Parkyn:
The Yearbook highlights recent bond market carnage starting in 2020. Because of Inflation, the drawdown began in July 2020, proving to be the second deepest drawdown on record with a real loss of 51%. At the end of 2023, real bond returns were still 42% below their 2020 peak.
François Doyon La Rochelle:
So from this real return data, bonds are not always foolproof “safe” assets, and their real value can be destroyed by inflation.
Now James, what does the Yearbook say about investing for the long term and mean reversion?
James Parkyn:
We all know that stocks are for the long term. In other words, the risk of investing in stocks declines when the investment horizon is long. In our jargon, we say after bad periods of large drawdowns, stock returns will revert to the mean. The expectation is that mean reversion would not only reduce risk but could provide timing signals that allow investors to boost returns. The Yearbook goes back to 2013 and highlights the conclusion that the popular evidence for mean reversion is an “optical illusion” that employs hindsight. I quote: “We found that the evidence on mean reversion is weak. Market-timing strategies based on mean reversion typically gave lower, not higher, returns. There is insufficient predictability to make equity investing “safe” over any horizon.”
François Doyon La Rochelle:
Finally, James, what takeaways does the Yearbook have for our Listeners concerning Global diversification?
James Parkyn:
Diversification is a topic we have often discussed as a key part of our investment discipline. The power of diversification across stocks, markets, and asset classes helps to reduce but not eliminate risk.
Over the last 50 years, for investors in most countries, investing globally led to better risk-adjusted returns than investing only in their home markets.
François Doyon La Rochelle:
But James, exceptionally, this is not true for U.S. investors. The Yearbook highlights that from the perspective of a US-based investor, the real return on the World ex-US equity index was 4.3% per year, which is 2.2% per year below what they would’ve earned investing only in the U.S. markets.
James Parkyn:
Yes, that is accurate François. The Yearbook confirms US investors would have been better off remaining in domestic stocks. But the Yearbook concludes, and I quote: “Prospectively, our advice to investors from all countries, including the US, is that they should invest globally. This is likely (but not guaranteed) to reduce risk and increase Sharpe ratios.”
Reaping the benefits of diversification is also a long-term concept and can let you down in the short term. The historically extreme negative returns in 2022 of the classic balanced 60/40 equity/bond allocation are the perfect recent example.
François Doyon La Rochelle:
This brings us back, James, to the importance of a long-term perspective and with it an appreciation of the laws of risk and return. I recommend that our listeners always consider their long-term goals, their risk profile, their ability to take risks, and their time horizon when building their portfolios.
James Parkyn:
As our Listeners well know, we have experienced four equity bear markets since 2000 and we need to be paid for taking risks. The risk premium for investing in stocks exists for a reason. It is a necessary payment for the risk of volatility and drawdown.
François Doyon La Rochelle:
I hope our Listeners have found our review of the UBS 2024 Global Returns Yearbook useful in helping them make smart decisions with their long-term money. We will make sure to put a link to the UBS Yearbook on this podcast’s page. And as we said at the outset of this Podcast, the value of the Yearbook is that it always comes back to the perspective of risk and reward, and the importance of diversification and asset allocation. This, as our Regular Listeners know, is core to our Investment Philosophy.
4) CONCLUSION
François Doyon La Rochelle:
Thank you, James Parkyn: for sharing your expertise and your knowledge again today.
James Parkyn:
My pleasure. François.
François Doyon La Rochelle:
That’s it for episode #65 of Capital Topics!
Do not forget, if you would like to submit questions or suggestions for the show, please email us at: capitaltopics@pwlcapital.com
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