Bill Nygren Market Commentary | 1Q19
March 31, 2019
“I see trees of green, red roses too, I see them bloom for me and you, and I think to myself what a wonderful world.”
-Bob Thiele and George David Weiss, sung by Louis Armstrong
“It’s gonna be cold, it’s gonna be grey and it’s gonna last you for the rest of your life.”
-Weatherman Phil Connors played by Bill Murray in “Groundhog Day”
Turn on the TV today, and on one news channel, a Democratic spokesperson is saying how stupid the Republicans are, and on the other, a Republican is saying the same about Democrats. The political division is as stark as I’ve ever seen. And it’s affecting investor outlooks for the economy and the stock market. A decade ago, it seemed like 40 percent of the population was reluctant to believe that President Obama could lead the country out of the Great Recession, and today, it seems like 40 percent don’t want to believe that the economy has grown even faster under President Trump. At Oakmark, we take the view that economic forces are stronger than political ones, which gives us the luxury of largely ignoring politics when making long-term forecasts for the businesses we own.
For those who believe political forces trump those that are economic (pardon the pun), political beliefs form the foundation for expectations regarding the economy and the stock market. So, like the news channels, a typical CNBC panel has one investor projecting a strong stock market due to the benefits of lower corporate taxes and another projecting a weak market because of tariffs that will reduce global trade. We’ve heard the partisan talking points so many times that we could finish their sentences.
In the past two quarterly commentaries, I’ve focused on the reasons our portfolios underperformed in 2018 and why we were, and still are, excited about the values in our portfolios in 2019. But as we discussed those commentaries with shareholders, we learned that they were struggling with a more basic question: “Why should we even invest in stocks?”
After a recent CNBC interview where I outlined our positive long-term case for equities, an investor protested, “Of course you’re bullish; you’ve always been bullish on the stock market.” And that’s largely true. Our position at Oakmark, consistent with historical returns by asset class, is that stocks will produce the highest long-term returns. Therefore, the only market timing that investors can reliably benefit from is periodic rebalancing — moving portfolios back to their target asset allocations after the market has moved them away. But the investor’s comment implied that we deserve no credit for being positive on the long-term outlook for stocks unless we are also sometimes negative.
Standard and Poor’s has performance data going back to 1926 — first, as the S&P Composite of 90 stocks, and, since 1957, the S&P 500, which has become the standard measure of stock market performance. Since 1926, stocks have produced a positive return in nearly three-quarters of years — 73%, to be exact.
Consider a gambling analogy: A roulette wheel has 18 black and 18 red numbers, so after enough spins, each color comes up equally. If an “investment advisor” was always suggesting to invest in black, it would be fair to be dismissive of that advice. But what if a roulette wheel had 26 black numbers and only 10 red, and the payout was the same on both colors?
The roulette ball randomly landing on red one-quarter of the time wouldn’t mean the advisor should suggest investing in red one-quarter of the time. The right advice would be to invest in black as often as the casino would allow. Yet despite the stock market performing like the lopsided roulette wheel, investors, advisors and the media still create a constant flow of bearish advice, saying that now is the time to bet red because the market is going to decline.
Let’s go deeper into the 93 years of S&P return data and take the perspective of a truly long-term investor. Ignore politics, next week’s Fed meeting and first quarter’s slowing earnings growth, and instead look at investing for real world, long-term personal financial needs. Consider a young couple who is thinking of having children and saving for college, or imagine a 40-year old worker saving for retirement. These are goals that require a 25-year timeframe. So let’s look past the short-term noise and examine stock market performance over that period.
If we consider an investment at the beginning of each year, 93 years of data creates 69 twenty-five year periods to examine. Investors in January of 1929 fared the worst, immediately enduring four consecutive down years (an event which, thankfully, has not been repeated), resulting in their initial capital declining by nearly two-thirds. But by the end of 1953, those investors not only recouped their losses, but amassed more than four times their initial investment. And remember, that was the worst 25-year period. The median result of buying and holding for 25 years was a 12-fold increase in capital, the mean was almost 16-fold and the best, with an initial investment in 1975, ended with more than 53 times the original capital.
Despite those amazing numbers, market timers consistently try to guess when to sell equities. To us, that’s a losing battle given the market had a positive return about three-quarters of the time. One of the arguments we hear for selling stocks today is that it has been “too good” since the market bottom in 2009. According to that version of history, investors who enjoyed a decade-long rally without having to endure a bear market have become oblivious to the risks of owning equities and are ill-prepared for an inevitable downturn. This thinking doesn’t influence our investment decisions, but it’s something we hear so often, I think it is worth addressing.
Market historians generally define a “correction” as a 10% decline in the S&P 500 and a “bear market” as 20%. Using those definitions, a correction occurs about once every two years and a bear market every five years. A 10-year run without a bear market is nearly unprecedented, so they believe we are due.
But have investors really enjoyed 10 consecutive years of smooth sailing? In 2011, the S&P 500 lost 19.4% from its close on April 29 to its close on October 3. The decline was just a fraction of a percent short of meeting the standard definition of a bear market. But from the intraday high in May to the intraday low in October, the loss was 21.2%. Additionally, over 50% of the stocks in the S&P 500 declined by over 20%, and small-cap stocks performed even worse. To most investors, it seemed like a bear market.
Last year, the S&P 500 lost 19.8% from September 20 through Christmas Eve, and measured from September’s highest intraday peak to December’s lowest intraday trough, it lost 20.2%. As in 2011, more than half of the stocks in the S&P 500 lost over 20% of their value, and again, small caps performed even worse.
When the historians go to the replay booth, they might decide we had two bear markets over this decade, which would be consistent with history. But whatever labels they use doesn’t really matter. I’ve been in the investment business for 38 years, and those steep declines felt like bear markets to me. Further, mutual fund investors behaved as they typically behave in bear markets: Instead of rebalancing—buying stocks to restore their equity allocation—they sold stocks that had already declined, further reducing their exposure to equities. Granted, it wasn’t as bleak as the bear market of 2008-09, and investors didn’t redeem their funds as aggressively. But just as a normal recession isn’t as deep as the Great Recession, a normal bear market isn’t as severe as was 2008-09. Have times been “too good” for the past decade? We sure don’t think so.
Spring is a great time to be in Chicago. Trees turn green, baseball returns to Wrigley Field and unlike Bill Murray in “Groundhog Day,” we realize the long grey winter isn’t going to last forever. At Oakmark, we don’t have an opinion about how equities will perform this year, if a recession will start or if the political parties will produce pro-growth candidates for 2020. As long-term investors, we don’t think it matters. P/E ratios look to be in a normal range and GDP doesn’t look extended relative to its trend line. That makes it hard to argue that equities are crazily priced, and gives us confidence that returns in the future should rhyme with the past. We fully expect that investors who buy equities in 2019 and hold them for 25 years will look back and be pleased with their decision.
William C. Nygren, CFA
View other commentary and letters from Bill here.
Intraday returns referenced for the S&P 500 Index are for the price only index, not the total return index.
The Price-Earnings Ratio (“P/E”) is the most common measure of the expensiveness of a stock.
The S&P 500 Total Return Index is a float-adjusted, capitalization-weighted index of 500 U.S. large capitalization stocks representing all major industries. It is a widely recognized index of broad, U.S. equity market performance. Returns reflect the reinvestment of dividends. This index is unmanaged and investors cannot invest directly in this index.
The Oakmark Fund’s portfolio tends to be invested in a relatively small number of stocks. As a result, the appreciation or depreciation of any one security held by the Fund will have a greater impact on the Fund’s net asset value than it would if the Fund invested in a larger number of securities. Although that strategy has the potential to generate attractive returns over time, it also increases the Fund’s volatility.
Oakmark Select Fund: The stocks of medium-sized companies tend to be more volatile than those of large companies and have underperformed the stocks of small and large companies during some periods.
Because the Oakmark Select Fund is non-diversified, the performance of each holding will have a greater impact on the Fund’s total return, and may make the Fund’s returns more volatile than a more diversified fund.
The discussion of the Funds’ investments and investment strategy (including current investment themes, the portfolio managers' research and investment process, and portfolio characteristics) represents the Funds’ investments and the views of the portfolio managers and Harris Associates L.P., the Funds' investment adviser, at the time of this letter, and are subject to change without notice.
All information provided is as of 03/31/2019 unless otherwise specified.