1) INTRODUCTION:
François Doyon La Rochelle:
You’re listening to Capital Topics, episode #72!
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 our podcast today we will discuss the investing lessons of 2024.
Enjoy!
2) INVESTING LESSONS FROM 2024
François Doyon La Rochelle:
I will start. In our last Podcast #71, we reviewed the capital markets results for 2024 and by doing so we underlined the main economic and geopolitical events that we believe shaped the capital markets results last year. Every year brings valuable lessons to investors that remind us of the importance of staying disciplined and focused on the long term and avoiding being deterred by short-term noise. So, James, let’s continue our annual tradition of sharing Investing Lessons of the prior year … 2024.
James Parkyn:
François, as you well know every year the markets provide us with lessons. As our Friend and author Larry Swedroe often states: “With great frequency, markets offer remedial courses covering lessons they taught in previous years. That’s why one of my favorite sayings is that there’s nothing new in investing, only investment history you don’t know.” Today we will share our five main lessons from 2024. In preparing this year’s list, we reviewed our Lessons from 2022 and 2023. It should come as no surprise François, all of this year’s lessons can be found in our lessons from those two prior years.
François Doyon La Rochelle:
Unfortunately, James, too many investors fail to learn the lessons. They keep making the same mistakes.
OK so let’s start with this year’s lessons.
Lesson #1 is: No One Is Very Good at Consistently Getting Market Forecasts Right.
We highlighted this in our last Podcast about 2024 Market results and how market forecasters from major financial institutions did last year. Their forecasts were terrible.
In 2022 and 2023 we also said no one can forecast the future. We can’t say it strongly enough: avoid paying attention to all the 2025 Forecasts and Outlooks.
James Parkyn:
I will repeat a quote from last year's Podcast to help our listeners. Jason Zweig from a December 16th, 2023 WSJ Article titled “Mirror, Mirror on the Wall who knew Stocks would fall?” said: “Countless hunches and gut feelings flicker through our consciousness over a year. We naturally remember the ones that turn out to be right. The multitude of other hunches that turn out to be wrong goes into our mental garbage can.”
François Doyon La Rochelle:
This is a classic. Many investors today need to do a reality check. They should make it an annual ritual. Another way of saying this is to tune out the noise. By doing this you will give yourself the best chance for long-term investing success. There will always be uncertainty in markets and headlines encouraging investors to engage in trading that may not be in your best interest.
James Parkyn:
Jason Zweig goes on to say: “This pattern, which psychologists call hindsight bias, makes us feel that we foresaw the future all along, what happened was inevitable and anybody who didn’t see it coming is a dope. It’s close to irresistible—and it’s an illusion.”
David Booth co-founder at Dimensional wrote recently that: “Even with a Clear Crystal Ball, Markets Are Unpredictable. Against a backdrop of geopolitical tensions, economic challenges, and electoral uncertainty, 2024 proved the resilience of public financial markets and the power of human ingenuity once again. Markets continued to do what they do best: efficiently process information and set fair prices, rewarding long-term investors with positive returns.
François Doyon La Rochelle:
This leads us to our lesson #2: The Valuations Cannot Be Used to Time Markets
Larry Swedroe wrote an article recently for Morningstar titled “US Stocks Have Outperformed the World. History Shows That Success Can Be Fleeting”. I quote him: “With that said, it is worth noting the US is now trading at about 2.7 times sales and 4 times book, the same multiple Japan traded at the height of the 1980s bubble. And international markets, in turn, trade at much lower valuations: about 1.2 times sales and 1.6 times book.
James Parkyn:
For many listeners that may be a lot of jargon. What this means is that US stocks are expensive compared to international stocks in addition, Larry is saying that about 75% of the US relative outperformance has come from valuation changes. With only a small percentage of the outperformance coming from the fundamentals.
François Doyon La Rochelle:
Most of the US Market outperformance is a result of investors becoming more optimistic about US equities. We can say that hindsight bias is at play and investors continue to project based on recent superior historical performance. But Investor sentiment can change rapidly.
James Parkyn:
While rising valuations lead to higher realized returns, they may also result in lower future expected returns, at the same time when other regions with comparatively lower valuations can expect to achieve higher future returns, causing the pendulum to swing back again.
François Doyon La Rochelle:
Larry goes on to say “While these cycles of out- and underperformance are predictable at a high level, there are no crystal balls allowing us to foresee exactly when each shift will occur. The logical conclusion is that investors should be diversified internationally, holding a mix of both US and international asset classes rather than betting on one to outperform the other—to capture the swings in valuation whenever they occur.
James Parkyn:
Unfortunately, Francois, being subject to recency bias, many investors tend to buy what has performed best in the most recent period (at higher valuations and thus lower expected returns) and sell what has underperformed (at lower valuations and thus higher expected returns).
François Doyon La Rochelle:
The exact opposite of the Investing fundamental of “buy low, sell high.”
Now for Lesson #3: Active Management Is a Loser’s Game in Bull or Bear Markets
James Parkyn:
Vanguard founder Jack C. Bogle captured the power of indexing with a simple analogy, “Don’t look for the needle, buy the haystack.”
By looking back at capital market history as a guide, Investors can see that concentration – think MAG 7 stocks – has happened before in equity markets. A small percentage (4 %) of companies have been responsible for half of equity market returns over the past nearly 100 years. We covered this in our Podcast # 67 based on Research by Prof. Bessembinder.
François Doyon La Rochelle:
Another way of expressing what Jack Bogle is saying is, to take advantage of the benefits of owning the haystack, that is the broad market, and each of the needles, the individual stocks, in their market-cap weights.
James Parkyn:
When he first coined this saying François, most investors were either index or active and overwhelmingly active. This allocation of capital by investors resulted in material differences in the exposures and weightings of companies and sectors. Active investors typically held a smaller subset of stocks (fewer needles).
By owning the haystack or the broad market, investors have the highest probability that they will have market-cap weightings that are derived by the consensus of all investors. This has been historically a very very tough benchmark to beat.
François Doyon La Rochelle:
James, I have another great quote from David Booth co-founder of Dimensional that also supports the Jack Bogle saying. I quote: “Despite the overwhelming evidence and compelling story to the contrary. When economist Michael Jensen published his landmark 1968 paper, which showed that active stock pickers added no consistent value, other academics soon confirmed his insights. More than five decades and 50 years of data later, the theory still holds up. Some stock pickers experience success, but we don’t know how to identify them before the fact. We can’t separate skill from luck. Picking stocks is more like gambling than investing.”
James Parkyn:
Larry makes the case that 2024 was another year when active managers had a terrific opportunity to generate alpha – jargon for beating the market - through the large dispersion in returns between the year’s best-performing and worst-performing stocks. He cites as an example, the S&P 500 Index that returned 25.0% in USD for the year, including dividends, the stocks of the five best-performing companies were up at least 135%. To outperform, all an active manager had to do was overweight those big winners, each of which outperformed the index by at least 110 percentage points.
François Doyon La Rochelle:
But unfortunately, James, investors in active funds continue to pay for the triumph of hope over wisdom and experience.
Now for Lesson #4: Diversification Is Always Working; Sometimes You Like the Results, and Sometimes You Don’t
James Parkyn:
This gets back to what you were mentioning François in our last podcast about the outperformance of the U.S. equity markets. To be specific the overperformance of US Equities relative to Canadian, internationally developed, and emerging markets over the last decade and especially last year makes us question the benefits of diversification. However, there will always be a sector, a country, or something else that outperforms your portfolio in any given year.
François Doyon La Rochelle:
Yes, and when that happens, when your discipline and patience are being tested, remember the reasons why you have properly diversified your portfolio in the first place. It’s all about reducing risk without reducing long-term expected returns. Even in years like 2023 and 2024, a U.S. equity investor could be unsatisfied he didn’t have all his eggs invested in the Magnificent Seven.
James Parkyn:
So François, while economic theory and empirical evidence suggest that the most prudent strategy is to diversify globally, it must be acknowledged that for many investors international diversification can be challenging. The reason for this is that even a well-thought-out, diversified portfolio will inevitably go through periods of poor performance. Larry Swedroe says, and I quote “The noise of the media will then test your ability to adhere to your strategy. And sadly, when it comes to judging performance, it is my experience that most investors believe three years is a long time, five years is a very long time, and 10 years is an eternity.”
François Doyon La Rochelle:
James, our Listeners must understand the logic and benefits of global diversification and the “risks of diversification”. There will always be what we call a “tracking error” risk. Being aware you will have tracking errors; will help you be better prepared to stay disciplined.
James Parkyn:
I agree with you Francois, investors cannot run away from risks, they can only choose which risks they take. Failing to diversify globally creates the risk that US equities might follow in Japan’s footsteps and be the next country to underperform for the next 30 years. Putting all your eggs in one basket is not a prudent strategy, no matter how familiar you are with it, or how closely you watch that basket. Another classic quote comes to mind: “Before making the mistake of confusing the familiar with the safe, no one knows which country or countries will experience a prolonged period of over or underperformance.”
François Doyon La Rochelle:
For investors, weighing recent results over historical evidence would have resulted in poor decisions based on recency bias. For instance, overweighting international stocks in 1990, US stocks at the peak of the tech bubble in March 2000, and international stocks again in 2008.
James Parkyn:
I would add to that the latest academic evidence. Authors Asness, Israelov, and Liew, in their 2023 Journal of Portfolio Management paper, titled “International Diversification—Still Not Crazy After All These Years,” updated the data from the previous paper through 2022 and concluded that “international diversification does a pretty great job of protecting investors over the long term.” As we know, the long-term in the academic world is much longer than 10 years.
François Doyon La Rochelle:
Our final lesson # 5 of 2024 is: Stick with a Plan and maintain your Investor Mindset.
There’s no way to know where markets may be headed, and it can be hard to imagine an upturn when prices have fallen or when there is a lot of uncertainty about the direction of the economy. But history argues for persistence and patience.
James Parkyn:
I will again quote David Booth of Dimensional: “Market performance in 2024 reflected the power of human ingenuity. The S&P 500 returned a robust 35.6% (in CAD), while the global stock market, as measured by the MSCI All Country World Index, was up 26.8% (in CAD). Even bonds, after struggling earlier in the decade, delivered solid returns (6.6% in CAD as measured by the Bloomberg Global Aggregate Index).
François Doyon La Rochelle:
The evidence is clear: Investors with broadly diversified portfolios who stayed invested through the volatility of recent years were rewarded for their patience and discipline.
A look back at recent market history makes a case for sticking with a plan. Handsome rebounds like we saw in 2023 and another strong year in 2024 after a difficult 2022 are a very powerful reminder that investors must remain disciplined and focused on the long-term and avoid being deterred by short-term noise. This is the only reliable way to capture the long-term benefits that markets offer.
James Parkyn:
This is why François, investors may need an advisor more than ever—to help keep them from jumping from one thing to another.
I think it would be useful to repeat a quote from Morgan Housel the Author of the book “The Psychology of Money” which we shared with our Listeners in the Lessons of 2022 Podcast: “Pessimism always sounds smarter than optimism because optimism sounds like a sales pitch while pessimism sounds like someone trying to help you.” The Future is uncertain therefore it is scary.
François Doyon La Rochelle:
We also remind our listeners James of our mantra that they should have an “Investor Mindset” and continue to buy and hold investments with an owner’s mentality.
3) 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 #72 of Capital Topics!
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