Year-End ReCap

Say it with me … Stocks only go up. Only losers take profits."

-Dave Portnoy (founder BarStool Sports)

​​The Portfolio Performance

The portfolio is down -4.39% YTD

House Keeping

The 2021 portfolio is now in the archive and locked down. You can see the final results here (PORTFOLIO). You can also see all results from 2016-2021 here (ARCHIVES).

The Stay Invested portfolio finished out the year with a gain of $57,313.76 or +5.02%. The disappointment was that the S&P 500 index gained +26.60%. Let's not forget that in 2018 our index fund portfolio was down -12% while our actively managed stock portfolio was up +39.39%. The 2018 index fund portfolio replicated a traditional 60/40 portfolio that most advisers sell their clients. I simply used ETFs in place of any individual stocks. Fortunes in the market can change dramatically from year to year, but as long-term investors, I like to focus on the overall gains since inception, which are just over 241% today. We start the year in the red, giving back most of our 2021 gains which break Rule #1, don't lose money. The losses we're seeing are not the result of bad companies but rather a fear trade around the interpretation of the Federal Reserve's accelerated tightening plans. Note that I held an exceptional amount of cash in 2021 and plan to deploy that cash opportunistically in companies with great balance sheets, making stuff and delivering profits. I haven't decided yet if I will rebalance positions with significant gains, mainly because I don't like to sell when the market is selling.

2022 will present even more volatility due to several factors. Greater volatility means individual investors need to be better stock pickers or get some help from someone with a very steady hand. Here are just a few of the big themes that will make 2022 more volatile:

  • Rising interest rates and investor sentiment that rates will rise too fast

  • Housing shortage which should deliver more cash to stocks from retail investors

  • Employment data (employment participation declines, open positions, rising wages)

  • Federal Reserve 3 new member nominations could be overly progressive

  • Mid-Term Elections in November could see unexpected seat flips

  • Supply chain disruptions continue causing inflation to rise for longer

Wednesday Sell-Off

Days like Wednesday feel like the market blindsides you. There's no getting around the pain and frustration that the constant selling causes. What's worse is the fear it creates. I feel the pain too, maybe a little more publicly than most when I put my ideas out there, and the broader market of investors sells them off, regardless of quality, growth prospects, or any other metric. These are the days when average investors look up and scream, "Why did I ever put my money in the market"?

What Happened?

The short answer, the Federal Reserve delivered a triple threat. Everyone has known for a long time that the Federal Reserve is slowing the pace of asset purchases, which is a tool they use to slow the rate of adding liquidity (money) into the economy. So, the market began pricing in the less accommodative policy by selling the growth stocks that thrive in a low-interest-rate environment. The expectation was that after asset purchases ended, the committee would start discussions about raising rates and at what pace.

The market was having a mild ‘taper tantrum’ but was dealing with the less accommodative environment. The Federal Reserve has moved relatively quickly from a position of “We are not thinking about thinking about raising rates” to a position of possibly pulling all their policy levers at one time. On Wednesday, the Fed’s December meeting minutes revealed that members are ready to be far more aggressive at cooling the economy down. Some members of the FOMC appear prepared to start raising interest rates, tapering bond-buying, and reducing holdings of Treasurys and mortgage-backed securities. The last item is known as reducing the balance sheet.

Year-To-Date, the S&P 500 is down -1.87%, the DOW is off -0.29%, the technology heavy NASDAQ is down a whopping -4.53% in just five days, and the small-cap Russell is down -2.82%. Looking at the growth stocks that were hot in 2020 and 2021, there are a lot of companies that have sold off 50% and more.

What To Expect?

The most important takeaway is that the Fed minutes are not policy. We should expect that the Fed will continue to reduce asset purchases and eventually raise rates in 0.25% increments. By year-end, I would look for rates to hover around the 2.0% mark. Janet Yellen tried to reduce the balance sheet and experienced financial trauma that eventually did an about-turn, increasing the balance sheet by several trillion dollars. The balance sheet is currently about $9 trillion. I think Powell will have similar challenges and won’t reduce the balance sheet by any meaningful amount without throwing the economy into a prolonged recession.

"...the Fed minutes are not policy"

What Does This Mean for Investing?

When interest rates go up, valuations for stocks have to come down. Valuations for growth stocks that aren’t profitable and have exceptionally high Price/Earnings and Price/Sales ratios have been getting sold off first. Ultimately the market will sell everything down to a level where valuations are more reasonable. Investable growth companies will be the ones that have growth in revenues, are profitable or will be soon, and have pricing power. A company like Snowflake (SNOW) is a high-growth company with pricing power, is growing revenues fast, and is essential. Others in this quality growth segment include Amazon, Microsoft, Apple, Meta, Marvell, Nvidia, and AMD. There are others, but use these as proxies for quality. The value stocks that many investors retreated to are getting a little pricey but continue to get bought because they are ‘short duration’ stocks, meaning that investors will see profits, earnings, and dividends now, not ten years from now.

The pendulum always swings too far in both directions, so don’t view the current market as a referendum on growth stocks. This is not a repeat of the DOTCOM bubble burst or the financial crisis. What we’re experiencing is simply a repricing of stock prices to account for higher costs of capital. The key takeaway is that investors will get this wrong by creating a raft of oversold growth stocks, new opportunities in value stocks that will have above-average growth prospects, or more commonly known as GARP, growth at reasonable prices.

I like most of the Stay Invested portfolio; I will continue to watch for opportunities to add to positions that are not yet at 100%. I may trim some over-bought positions and where we have significant gains. Of course, I’ll continue looking for new opportunities that can work in 2022 and beyond.

Keep Me Honest 2021

  1. The S&P 500 will achieve year-end earnings of $170-$175 (1-1-2021).

  2. I underestimated the growth in earnings by a wide margin. My estimate was low by at least 20%. The year looks like it will close with S&P earnings in the $205-$210 range.

  3. We are likely to have a significant pull-back during the 1st quarter, about 5%-10% (1-1-2021).

  4. February 12 through March 4 saw a 5.75% decline. The following bull market swamped that decline. I should have updated this call with my new perspective, which was that we would continue to have a bull market into year-end but with several more pullbacks. We got seven pullbacks.

  5. Stock picking will outperform algorithmic trading again as it did in 2020 (1-1-2021).

  6. This call has turned out to be harder to measure with any accuracy. I have data showing that the best long equity hedge fund consistently outperforms the short-term trading funds, but I’m not sure that’s the best means of measuring this call. I’ll have to wait until a good analyst writes about this.

  7. S&P 500 will reach 5,000 by year-end.