As I crawled into bed on a recent Friday night I found a messily scrawled note from my son Charlie (13) on my pillow. It said, “Set alarm for 5:30 a.m.. Don’t forget!” Groaning, I remembered that I had promised Charlie I would get up early to go hunting with him. This was probably the seventh or eighth time this fall I had gotten up early to join him in this new favorite activity of his. Until this year, I had not been much of a hunter, especially not one who enjoyed getting up before 6 a.m.. Sure, I’d go to an annual dove shoot or even duck hunt occasionally, but it was mostly just a social activity for me. But things are different now. Charlie has become obsessed with hunting. Due to his age, it’s not something he can do alone. And let me tell you, his new passion is wearing me out! I’m 52 years old and three of my four children are either in college or almost in college. My expectations of a slightly slower pace with regard to homelife have not materialized. What happened to relaxing on the sideline at a 10 a.m. Saturday morning soccer game?
It started with turkey season last spring. 5 a.m.! We went every other day for two weeks! Then it was crow hunting, coyote hunting and frog gigging over the summer. Yes, frog gigging. Dove hunting proved to be only a brief Labor Day weekend diversion as Charlie got us prepared for deer season this fall. Setting up deer stands, installing ground blinds, checking deer cameras and planting wildlife plots occupied much of my September. And the gear! We have face paint, duck calls, crow calls, turkey calls, bows, arrows, rifles, shotguns, deer stands, bags of corn, buck grunt tubes, waders, rubber boots, doe urine, deer cameras, and decoys. And yes, lots of camouflage.
Charlie’s obsession doesn’t stop in the great outdoors. Camped out at his mother’s computer in the middle of the kitchen, Charlie watches endless YouTube instructional videos about tracking deer, masking his scent, calling in ducks, planting food plots, skinning squirrels, frying frog legs, using his turkey call, and of course, training his black lab to retrieve doves and ducks. When Charlie is ready for his parents to tuck him in at night he “calls” us upstairs with his favorite “Buck Commander” duck call. WHAAAAA, WHA-WHA-WHA, WHAAAA! As his 17-year-old sister will tell you, “It’s really annoying!”
Speaking of ducks, were you aware that duck season opened in North Carolina this week? Charlie made sure I knew. And brother, are we ready. Back in August Charlie hatched a plan to build a duck blind in the middle of his Uncle Steve’s pond on our farm. Job one? Butter up dad to get his help with the budget and the construction. I tried my best to persuade him to table these plans. I said, “No way we’re wading out there at 6 a.m. in the dark when it’s 25 degrees, Charlie. Why can’t we just hunt from the bank? And I can’t stand waders…they always leak.” Charlie stood his ground. Three trips to Lowe’s and four afternoons spent waist-deep in the pond and the blind is finished!
Yes, Charlie has worked me over this year, but I’m all too aware that in a blink, he’ll be grown and gone, just like his siblings. So, count me in, little man. I may be worn out, but as long as you’ll have me, I’ll get up in the dark, pull on those waders and trudge into that cold, murky water with you. Before I know it, you’ll leave home, and daddy will have to find something else to write about.
Speaking of being worn out, aren’t we all worn out from this virus mess? Hasn’t this gone on long enough? Haven’t we paid our dues in the loss of life, health, relationships and routines? Unfortunately, it isn’t over yet and tragically, the worst of the infections and resulting deaths are hitting us right now. With the vaccine slowly rolling out, it seems it’s darkest before dawn. I’m just an investment guy but I do want to encourage you to hang in there for a little bit longer. Prepare yourself and your loved ones for several more months of living this way and for the distressing headlines to come.
As for investing, what can I say? What a humbling experience the last ten months has been. That the market could notch a positive return in 2020 seemed unthinkable back in March. That the S&P was actually up over 18% for the year is simply mind-blowing. For me 2020 was more humbling than both the tech crash of 2000-2002 and the financial crisis of 2008-2009. At a recent meeting of our Bragg Investment Committee, we discussed lessons learned in 2020. Our conclusion was that the two most important contributors to our good investment results in 2020 were humility and discipline. Humility forced us to admit we did not know what the future held and therefore helped us avoid making investment decisions based on emotions or our gut. In 2020 the market did what no one predicted. It did the opposite of what most experts and certainly what I thought it might do. Never have I felt a greater sense of simply not knowing what was going to happen next. Repeatedly during 2020, in reaction to being surprised by what the market did, I found myself asking, “What do I know?” Truly, what do I know? Did I mention that it has been humbling? Admitting that we can’t see the future is half the battle in investing.
Discipline is the other contributor to our investment results this year. Staying true to our long-held philosophy and process meant we were rebalancing portfolios even as we humbly admitted that we didn’t know what the future held. In early 2020 we were trimming stocks and buying bonds as the market was hitting all-time highs. We were doing this even as it seemed things were going well for the economy. Then the virus arrived, the economy was shut down and the market fell 34% in 22 trading days. We absolutely didn’t see it coming. In March, April and May we were trimming bonds and buying stocks even when the outlook for the economy was truly horrible. It didn’t feel good to be selling stocks in January and February and it felt even worse to be buying stocks in March and April. Remaining humble and sticking to our discipline led us to follow the course we did, and hindsight demonstrates that this was the right thing to do. Following your gut (emotion) in 2020 turned out to be expensive for investors. As someone on our investment committee put it, “The best thing we did in 2020 was stay the heck out of our own way. We ignored our emotions and followed the rule book.” Thank goodness we did. Lesson learned.
What now? The one-direction market we’ve enjoyed since September (the S&P is up 16% from September 23 through year end) has created complacency on the part of some investors. Parts of the market have gotten so frothy that first-time investors are jumping in to chase stocks that have done well. I’m reminded of the day-traders of 1999. My 20-year old son asked me last week what I thought about Tesla and the digital currency, Bitcoin. That might be a “sell” signal. I suggested that there was only one reason he was asking the question—their prices have gone up a lot. No other reason. Had their prices not gone up so much, he wouldn’t have asked. He had to admit I was right. And no, he won’t be joining the Bragg Investment Committee any time soon. If you watch CNBC business news, you might have noticed that they are fanning the flames. In addition to displaying graphics for the S&P, the Dow and the Nasdaq, they recently added a graphic for the price of Bitcoin. Not a good sign.
So yes, it is getting a bit frothy. But is the market overvalued? We’ll suggest that on the whole, it is not. The primary driver of today’s seemingly high valuations is the low level of interest rates. The yield on a 10-year Treasury bond remains below 1% and this drives yields and valuations on all other earning assets or risk assets including corporate bonds, municipal bonds, stocks, and real estate. There are several reasons why low interest rates have such an impact on the economy and therefore market prices. First, low rates stimulate the economy and therefore corporate earnings. It is cheaper to finance the purchase of everything from cars to homes to flat screen TVs. Second, low rates increase the present value of future cash flows. If I demand a return of 6%, I’ll pay $56 today for the promise of receiving $100 ten years from today. If, due to a lower rate environment, I’ll accept a lower return of 4%, I’ll pay $68 today for the promise of receiving the same $100 ten years from today. You can see that this relationship results in investors accepting lower returns and therefore being willing to pay higher prices to purchase any asset. The Fed has indicated that rates will remain low for as long as it takes for the economy to return to full employment and this could take several years. We have learned over time that it doesn’t pay to “fight the Fed.”
How long can this go on? How long can the Fed support market prices? Common sense says there is a limit with interest rates already very close to zero. And as we discussed in earlier letters, the Fed’s actions of 2020 are distortive to a functioning market. When the Fed steps in to buy municipal bonds, corporate bonds and other risk assets, it bails out investors who took on too much risk and signals that the Fed will always be there as a backstop. This encourages excessive risk taking and increases leverage in the financial system. This is not sustainable in the long term and we look forward to a healthier economy with lower levels of debt and less involvement by the Fed.
Finally, with rates low and asset values high, we expect market returns for stocks and bonds to be lower in the future. Specifically, government and high quality corporate bonds are priced to yield 1-2% and that is what we should expect from our bonds. Stocks have historically provided a risk premium of 3-4% over bonds in the long term. This would imply that stocks might earn 4-6% over the long term. Again, these are long-term projections. It’s anyone’s guess what the market will do in the short term, and we think it makes sense to stick with a long-term investment plan that is driven by your financial plan. Please let us know if you would like to review your plans.
As for politics, the votes are being counted in the Georgia Senate run-off election as we go to print. It appears that the Democrats may take both Senate seats, thereby gaining control of all three branches of government. Please refer to my October letter, The Republic Will Stand, for our thoughts about the turmoil surrounding the 2020 election. As covered in that letter, we are living through an unprecedented and disconcerting time and yet we look to the future with confidence that our country will move forward.
You are probably worn out if you’ve read this far. I’m worn out too and it’s time to go find my waders. Thanks for your interest and thank you for trusting Bragg Financial.