Stick to the Plan

2020 was a very strange year for markets.  Over the past year we likely set a record for the use of the word “unprecedented” on earnings calls.  I suppose a pandemic combined with meaningful amounts of global monetary and fiscal support will do that.  Going into 2020 analysts expected 5% revenue growth and 9% EPS growth, leading to an approximate 5% increase in the S&P 500.  This was not particularly noteworthy, as the default estimate for growth in the S&P every year is a mid- to high-single-digit percentage gain.  Though the final numbers for 2020 have yet to be counted, expectations are for a 1% revenue decline accompanied by a 13% drop in EPS, well below initial expectations.  Meanwhile, the S&P 500 advanced by a better-than-expected mid-teens percentage.  This goes to show the extreme difficulty in making forecasts, yet Wall Street continues to try.

Warren Buffett’s partner, Charlie Munger, is usually good for a colorful quote and he once again delivers, saying, “People have always had this craving to have someone tell them the future.  Long ago, kings would hire people to read sheep guts.  There’s always been a market for people who pretend to know the future.  Listening to today’s forecasters is just as crazy as when the king hired the guy to look at the sheep guts.”  To be fair, it is hard to blame the prognosticators as Wall Street simply steps up to meet demand.  This is also not to say nobody can forecast the big picture accurately, but it is significantly more challenging than believed.  It is also not the way Provident approaches things, as we do not feel we have any edge playing that game.  We believe it is more productive to focus our efforts on “bottom-up” analysis seeking out growing, quality companies trading at reasonable prices.

Going beyond the difficulty in forecasting the big picture, the past year offers an opportunity to try a modest thought experiment.  If you had the 2020 news headlines ahead of time (excluding stock prices, of course) could you have profitably traded that news?  I have serious doubts I would have been able to.  Often the direction of the economy and spread of the virus contrasted with the direction of the market.  Having this information ahead of time would have likely led to getting out of the market before the downturn that began in February, but also may have resulted in missing much of the sharp snapback.  I don’t think this is necessarily unique to 2020 either, as markets frequently do strange things relative to what one might believe given a piece of news.  Lack of clairvoyance as it relates to headlines is less of a hinderance that one might expect.

Rather than relying on forecasts or short-term trading, it is more important to have a long-term investment plan and stick to it.  We tend to repeat this frequently, but it is worth doing so.  A long-term plan typically involves a decision to allocate a certain amount of one’s portfolio to equities and fixed income based on one’s financial goals.  Setting this plan, ideally in tranquil times with a clear head, helps with adherence when times are more stressful.  Inevitably this will happen at some point.  The market is quite accommodating in providing things to worry about.  Appropriate portfolio allocations and a focus on the long run should help investors meet market volatility with a certain level of equanimity.

More important than short-term forecasting is to simply be ready when opportunity presents itself.  Successful investing is rarely an act of imposing your will on the market.  It is more about assessing the current situation and taking advantage of opportunities the market presents.  For sports fans, this is akin to taking what the defense gives you.  Deep knowledge of a roster of companies results in the opportunity to act with conviction when the chance presents itself.  Given the meaningful selloff in Q1 of 2020 we were offered the ability to acquire high quality names at particularly attractive prices.  Opportunities such as these are scarce, and we are happy to have had some recent success in taking advantage of that.

So, following such a strange year, where are we today?  P/E ratios are elevated but low interest rates help justify that.  As a whole, valuations don’t appear absurd, but they also appear to assume interest rates will remain favorable for some time.  This is far from a given.  Unquestionably, there are pockets of frothiness.  In December, gaming platform Roblox pulled its planned initial public offering.  Usually this happens if the markets are suffering a soft patch.  Instead, Roblox pulled its offering because the huge one-day jumps of recent IPOs Airbnb and DoorDash made it too challenging to determine the right price.  What a world when IPOs are delayed because the market is too hot!

The special-purpose acquisition company (SPAC) market has also been lively.  SPACs provide an alternative way for companies to go public, and they make sense in certain circumstances.  However, the proliferation of SPACs over the past year is a warning sign.  Furthermore, many of the companies going public via this route sport multi-billion valuations despite having yet to book a single dollar of revenue or even make a product.

Then you have Lindsay Lohan recently putting out a video on Cameo, where people pay celebrities to deliver custom messages, predicting Bitcoin will reach $100,000.  She said, “I hope you all get to drive your Lambos (Lamborghinis) to the moon!”  Ignoring the logistical challenges involved in such a journey, this does not seem like a market overflowing with caution.

To better understand what is going on in parts of the market that appear detached from fundamentals, I dusted off Reminiscences of a Stock Operator by Edwin Lefevre.  This classic covers the story of Jesse Livermore, one of the most famous traders during the early 1900s.  Livermore had his ups and downs, making and losing tens of millions of dollars, but was known as a particularly astute reader of market prices.  His methodology is far removed from the way Provident operates, but there is more than one way to make a buck in the market, and it can’t hurt to gain greater insight into what might be motivating other market participants.  The book is filled with interesting lessons and Livermore leaves us with this classic quote, “There is nothing new in Wall Street.  There can’t be because speculation is as old as the hills.  Whatever has happened in the stock market today has happened before and will happen again.”  Based on history, we suspect we know what will ultimately happen in some of these areas that appear overheated.  However, when that occurs is anyone’s guess.

The takeaway as we enter 2021 is have a plan and stick to it.  The future is hard to predict, so position yourself by investing in quality, growing companies at reasonable valuations.  Avoid areas where seemingly irrational behavior rules the day.  Finally, be on the lookout for rare opportunities like those we saw in 2020.  Happy New Year, and here is to a healthy and prosperous 2021.

James M. Skubik, CFA