Auld Lang Syne
We wish everyone Merry Christmas, Happy Chanukah, and a Happy New Year. It’s hard to believe not only another year, but another decade, is almost in the books. Let’s all sing along to that classic song that rings in the New Year;
Should Auld Acquaintance be forgot, and never thought upon; The flames of Love extinguished, and fully past and gone: Is thy sweet Heart now grown so cold, that loving Breast of thine; That thou canst never once reflect On auld lang syne. On auld lang syne my Jo, On auld lang syne, That thou canst never once reflect, On auld lang syne.
There are differing opinions about the meaning of the opening line in Robert Burns’ Scottish Poem. Is the great poet suggesting we forget about the past and blindly march into the future? Or, is he posing a rhetorical question; is it right that old times be forgotten? Most poetic scholars conclude that Mr. Burns is suggesting that before moving forward, we should reflect and celebrate relationships from the past. Being poetic scholars ourselves, we agree with the latter. We also suspect the inspiration behind Mr. Burns’ plea to remember past relationships is the long-standing and consistent relationship between stocks and interest rates (bonds). Bonds may not keep up with stocks most years, but bonds are an incredibly loyal friend to stocks during the difficult years. In 2008 bonds rallied 20% when stocks fell 35%. Whenever stocks are going through a difficult time, bonds are there to help out.
The foundation of GreenPort’s investment process is that past relationships repeat themselves. This is true when forecasting asset class returns and also true when we combine asset classes to construct portfolios. Before moving onto 2020, let’s take time to reflect on the importance of the historical relationship between stocks and bonds. Without proper reflection and appreciation of this negatively correlated relationship, investors sometimes mistake their lust for stocks as true love. Domestic stock markets are up about 30% in 2019. Our frameworks, which forecast where we believe stock prices should be based on their relationship to certain variables, were very bullish on stocks at the beginning of 2019. Therefore, we aggressively re-allocated the Core Portfolios so that each portfolio held more stocks, and by default, fewer bonds. While bonds did okay this year, stocks were by far the superior asset class.
Being overweight stocks added quite a bit of value this year, so why didn’t we re-allocate the entire portfolio to stocks during 2019? The answer is simple, sometimes we are wrong. More specifically, over shorter-term periods it is much more difficult to forecast asset class returns. Our frameworks have the ability to explain roughly 20% of the short-term variance in financial markets. Inversely, this means we are unable to explain 80% of short-term market movements. Geopolitical events, the Fed, and even tweets move markets on a daily basis, yet they are mostly unpredictable. What is predictable, even in the short term, is that a drop in stock prices is usually offset by an increase in bond prices. By not forgetting this auld acquaintance, we are able to cushion the decrease in portfolio values over the short-term, so that investors are able to maintain their exposure and profit long-term. In 2008, a portfolio of all stocks lost nearly half it's value, while a portfolio split between stocks and bonds was only down 18%.
100% Stock Portfolio
50% Stock - 50% Bond Portfolio
That thou canst never once reflect, On auld lang syne, is indeed quite dangerous. Stocks rose 30% in 2019, but it was only a little more than a year ago that stocks fell 20%, bottoming on Christmas Eve of 2018. We spend time with each of you discussing the importance of properly aligning your portfolio with your risk profile. A well-diversified portfolio, that accounted for uncertainty, was critical during the 4th quarter of 2018. It allowed investors to maintain their long-term exposure and enjoy a year like 2019. So, while we should all be happy and even raise a toast to the outsized returns from stocks, and your portfolios in 2019, it’s only one year. A successful investment experience is a longer-term and constant commitment that involves both investing and financial planning. We will continue to reach out to you for your periodic reviews, be sure to reach out to us if you have any questions in the interim. On to 2020. Happy New Year, The GreenPort Team