“The future belongs to those who see possibilities before they become obvious.”
John Sculley, 1939 – present; Former CEO of PepsiCo and Apple
FED RATE-CUT HOPES FUEL FESTIVE CHEER FOR MARKETS. WILL IT LAST?
From the time he was a boy growing up in Kent, England in the 1860s in what he deemed in his autobiography as ‘not a highly educative atmosphere’, Herbert George Wells was envisioning alternative futures. Hailed as a genius and clairvoyant writer, he was an early science- fiction pioneer and impacted futurism and fantasy in a profound and noticeable way. Prolific in many genres, he wrote more than fifty novels and seemed to have an uncanny ability to anticipate the future.
Almost 70 years before the Apollo 11 moon landing in 1969, Wells’ characters traveled to the planetary satellite via the Cavorite Sphere anti-gravity spaceship in the 1901 story “The First Men in the Moon” (okay, he was wrong about a society living beneath the moon’s surface).
In 1937, the writer laid out a vision for something truly utopian: the coming of a ‘world brain.’ It was to be a universal encyclopedia of human knowledge and information that could be accessed by anyone and anywhere around the world. He also visualized that people would be employed to continuously update the information.
Wells’ idea may have first appeared an outlandish utopian concept, but by the 1960s, people were already beginning to imagine that his ‘world brain’ would look something like a giant supercomputer. By the ‘90s, the concept of a massive, universal web of documents came to fruition through the innovation that defines our lives today: the World Wide Web.
The accomplished author, who was called ‘the man who invented tomorrow,’ had a remarkable ability to accurately foresee the future. Other efforts through time to predict the future have been much less impressive:
- “The horse is here to stay but the automobile is only a novelty - a fad.” So said the president of the Michigan Savings Bank in 1903 when Henry Ford was looking for investment funds.
- On the eve of the Great Depression, the U.S. Department of Labor insisted, “1930 will be a splendid employment year.”
- In 1977, Ken Olsen, founder of Digital Equipment Corp. said that, “There is no reason an individual would ever want a computer in their home.”
- And the worst technology prediction ever was made by Steve Ballmer, the former CEO of Microsoft, who literally laughed at the iPhone when it came out in June 2007, telling USA Today, “There’s no chance that the iPhone is going to get any significant market share. No chance!” 16 years later, the iPhone generates $200 billion in annual revenues – roughly the size of Microsoft’s entire revenue base. His ‘crystal ball’ was so wildly inaccurate as to be comical in hindsight.
The following quote, attributed to baseball-playing philosopher Yogi Berra, captures the essence of the problem with predictions: “It’s tough to make predictions, especially about the future.” That truth is evident every day in the world of finance and the economy, yet that doesn’t stop experts from trying. After all, ‘Tis the season for legions of economists, strategists, analysts and other purveyors of wisdom to fire up their algorithms and release streams of projections that will tell you precisely where the S&P 500 will close in 2024. But at all costs, don’t take them at face value! Given that economies and markets are extremely complex and that a small change in a few variables can make predictions almost impossibly complex, forecasting market returns in advance in 12-month increments is a mug’s game. If you can ignore them, it generally behooves you to do so.
Consider their forecasts for 2023. Twelve months ago, the median forecast on Wall Street was predicting a 2.7% decline for stocks in 2023, the first time this century that they had predicted a loss, according to BCA Research (see graph below). At year-end 2023, the S&P 500 closed at 4,770, a gain of 24 percent. Wall Street predictions missed the actual return by almost 27 percentage points! So, while shareholders had a remarkably good year, forecasters had a terrible one.
What’s more, the median Wall Street forecast from 2000 through 2023 missed its target by an average 13.8 percentage points annually – more than double the actual average annual performance of the stock market, according to Bespoke Investment Group. Stock markets may not be a perfectly random walk, but they come quite close.
2023 was also a dreadful year for economists who despite a widely predicted ‘inevitable’ recession were forced by the resilient U.S. economy to revise their growth forecast higher and higher due to a surprisingly robust labor market and remarkably resilient consumers that likely propelled real GDP growth to 2.4% last year.
Forecasts are predictions about what will happen in the future based on historical data and current trends. As such, they are rarely correct and have little predictive value. In the words of Ian Wilson, a former executive at GE, “no amount of sophistication is going to allay the fact that all of your knowledge is about the past and all your decisions are about the future.”
Fortunately, we don’t have to know these things to be successful investors! In a world where algorithms and fads dominate, investing legend Charlie Munger didn’t place much stock in experts’ predictions either. The former vice chairman of Berkshire Hathaway and Warren Buffett’s longtime business partner, who passed away in November just a few weeks short of his 100th birthday, once said that “forecasting the markets is as hit-and-miss as forecasting the weather, and you should carry on investing regardless.” Known for his pithy zingers, he aptly summarized this when he remarked, “if people weren’t so often wrong, we wouldn’t be so rich.”
Given Berkshire Hathaway’s great success, you’d think that Munger and Buffett had an uncanny ability to predict the future. But the opposite is true: Munger has noted that he’s “never been able to predict accurately. I don’t make money predicting accurately. We just tend to get into good businesses and stay there.”
He didn’t have quite the household name as his more folksy and outgoing business partner, but Munger, a lifelong learner and voracious reader, proved himself to be a sage in his own right, offering a bevy of wisdom about investing, business, and living a good life. In fact, the Oracle of Omaha credits Munger with teaching him some of his most important investing lessons. His quotations and succinct comments have come to be known as ‘Mungerisms.’ Read on to discover some of his timeless wisdom that applies not only to our investing journeys, but to life in general.
Invest in businesses you understand: One of the foundational rules of any good investment is to understand how the company operates, what it sells, and what its target markets are. At Telos, we strive to invest in high-quality companies with strong brands, competitive advantages, and the ability to raise prices, which were core components to Munger’s approach to investing as well. By following Munger’s mantra: “Forget what you know about buying fair businesses at wonderful prices, instead, buy wonderful businesses at fair prices,” Berkshire’s version of value investing became phenomenally successful.
The power of long-term thinking:For Munger, another vital trait for successful investors was patience. “The big money is not in the buying and selling,” he said, “but in the waiting.” He stressed the need to have patience and focus on the bigger picture rather than getting caught up in short-term market fluctuations. Understand that successful investing is a journey that requires time and patience. Develop a disciplined approach, stick to your investment plan, and resist the urge to chase short-term trends or panic during market downturns. That was Munger’s DNA, and it will serve any investor well.
Know your circle of competence: Munger believed that investors should stick to what they know and understand, rather than trying to invest in sectors or assets that they are not familiar with. “It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.” One of the ways Munger tried to avoid making stupid decisions was by sticking to what he called his ‘circle of competence.’ By that he meant that savvy investors should focus on areas within their expertise, skills, and knowledge in order to avoid making mistakes and reduce the risk of loss. He argued that the ability to learn from mistakes - to be consistently not stupid - often outweighs the pursuit of brilliance. As a consequence, Munger and Buffett both missed the technology boom, but also avoided the dot-com bubble that subsequently crashed. Importantly, your circle of competence is not fixed. It can (and should!) expand as you learn and grow!
Be willing to change your mind: “Part of the reason I’ve been a little more successful than most people,” Munger said in an interview with the Wall Street Journal in 2019, “is I’m good at destroying my own best-loved ideas… And most people aren’t.” Success in investing, and in life in general, means being open to the fact that you might be wrong and to changing course when new facts change the odds, no matter how painful it is. Be willing to destroy your own favorite ideas.
Always be learning: Munger was famous for his curiosity and believed the best way to do this was by reading books. Right until the end of his life, he would read around 500 pages a day! “In my whole life, I have known no wise people (over a broad subject matter area) who didn’t read all the time - none, zero! … My children laugh at me. They think I’m a book with a couple of legs sticking out.” He thought it was important for anyone trying to succeed in a profession - whether in investing or any other industry – to go to bed a little smarter than they woke up.
Develop a trusted circle: Munger believed that the ‘old values’ of honor, trust, hard work and saving were the best way to live life. “We want people where every aspect about their personality makes you want to be around them. Trust first, ability second.” He recognized the importance of surrounding himself with talented and trustworthy individuals and advocated for investors to seek out mentors, partners, and advisors who can provide valuable guidance and contribute unique perspectives.
Do the right thing: Munger continually stressed the importance of integrity, honesty, and a sense of fairness in running a business. Above all, he exemplified ethical leadership: “Always take the high road. It’s less crowded.” His unwavering integrity and adherence to moral principles conveyed the message that true leadership goes beyond achieving goals and being successful – it also entails doing the right thing and setting a moral example for others to follow. It takes years to build up trust, just seconds to destroy it, and forever to repair it!
Charlie Munger was brilliant at being able to condense important ideas into very few words. His work, philosophy, and core tenets made an enduring impact on the field of finance. His emphasis on continuous learning, simplicity, ethical behavior, and long-term thinking are principles that reach beyond investing to life itself and helped shape our investment philosophy at Telos. Munger’s impact can be best summed up by something Warren Buffett said about him: “Charlie has given me the ultimate gift that a person can give to someone else – he’s made me a better person than I would have otherwise been… I’ve lived a better life because of Charlie.” Munger’s life and teachings offer invaluable lessons for anyone not only aspiring to be a better investor, but a better person. While he will be sorely missed, his principles will continue to shape the way we make decisions, approach challenges, and seek enduring success.
Markets and the Economy
Financial markets will always produce surprises. After all, by the time a consensus has formed, people will have bought or sold accordingly. The move has already happened; the future has something else in store.
Even accounting for this, 2023 may go down in history as the year that defied all odds. Heading into 2023, most Wall Street soothsayers had abandoned their usual bullishness, warning investors that higher interest rates would trigger a recession and crater the stock market. Instead, the S&P 500 soared 24% last year and entered a new bull market, defying the naysayers amid continued economic momentum and an artificial-intelligence (AI) frenzy that drove technology shares to outsized gains, while humbling those who expected the bear market of 2022 to persist. Equity market performance was dominated by seven stocks (now widely termed the ‘Magnificent 7’), with the proportion of stocks within the S&P 500 that outperformed the index being the lowest since the Technology Bubble (see graph above).
The stock market moved through various mini-cycles throughout 2023. From January through July, the benchmark S&P 500 index was up more than 20% on a total return basis. By the end of October, the index surrendered nearly half of those gains before rebounding in November and December with a rally that left the S&P 500 less than 1% below its January 3, 2022 record high. The Dow Jones Industrial Average advanced 14% to top 37,000 for the first time in the final days of 2023.
In the face of continued Fed tightening, a banking crisis in March, a debt ceiling and government shutdown drama, a continuing war in Ukraine and fresh conflict in Israel, the U.S. economy finished last year with low unemployment, steady economic growth, and significantly lower inflation.
The November unemployment rate of 3.7% was just 0.3 percentage points above its five-decade low of 3.4% in April. U.S gross domestic product (GDP) is on track to rise at nearly pre-pandemic levels, far faster than the minimal or even negative growth projected by scores of economists. Real GDP rose at an annual rate of 4.9% in the third quarter and is projected to have grown by 2.4% in 2023. The annual inflation rate also plunged to 3.1% in November from a high of 9.1% in June 2022, according to the Labor Department’s consumer price index (CPI). While inflation is no longer running wild, it is not yet fully tamed, with services inflation proving persistent.
The economy posted these strong topline numbers in the face of rapid Federal Reserve rate hikes, which bank officials admitted could tank the economy into recession. Policymakers raised interest rates 11 times since March 2022 and opted to hold them steady at a 22-year high for the third consecutive meeting in December at 5.25%-5.50%. While Fed Chair Powell said that “it’s far too early to declare victory just yet and there are certainly risks,” he did share that their forecasts imply they expect three quarter-point rate cuts in 2024 – a more dovish outlook for rates than in previous projections. It was an acknowledgement that growth “has slowed from its strong pace in the third quarter” and that “inflation has eased over the past year.”
Markets, though, are pricing in a significantly more aggressive rate-cut path this year, betting on six quarter-point cuts in 2024, worth a cumulative 1.5 percentage points of reductions in the Fed’s target beginning in March. Those projections for a steeper pace of rate cuts led to investor exuberance that triggered a broad rally in stocks and a sharp fall in Treasury yields, fueled by optimism the world’s largest economy will be able to avoid a recession.
The U.S. 10-year Treasury yield, which moves inversely to prices, has dropped 46 bps in December after falling 53 bps in November, ending the year with a 3.85% yield after briefly touching 5% in October. Its two-month decline rescued fixed income markets from an almost unheard-of third straight year of declines and was the biggest drop since 2008, when the Fed slashed rates during the global financial crisis.
Takeaways for 2024
For investors, 2023 was a far cry from the doom and gloom many were bracing for at the start of the year, and we are the first to admit that both, stocks and bonds exceeded our expectations as higher interest rates didn’t cause the broad economic weakness experienced in previous cycles.
Heading into the new year, the economy continues to send mixed signals, which complicates the Fed’s effort to bring down inflation while averting a recession, an outcome known as a ‘soft landing.’ But achieving a soft landing is exceptionally challenging. As noted MIT economist Rudi Durnbusch famously quipped: “None of the post-war expansions died of old age. They were all murdered by the Fed.”
Central bank tightening has most likely peaked for this cycle as inflation should continue to moderate amid a slowing economy. Uncertainty surrounds the timing and scale of future easing, but we anticipate some Fed easing this year, although slower and shallower than currently expected by financial markets.
The stock market enters the new year with the wind of a stellar 2023 at its back and a strong corporate earnings rebound could be the tailwind that drives stock prices this year. Following three quarters of decline, earnings growth forecasts over the next twelve months has moved higher, with consensus expectations for close to 11% even with the economy heading for a sharp slowdown. As a result, the price-to-earnings (P/E) multiple for the S&P 500 has risen to a historically elevated level of nearly 20 times forward earnings on spirited investor optimism. Although lower interest rates could indeed support higher valuations, they tend to be a symptom of slower economic growth, which implies a less attractive outlook for the economy and the markets.
We have seen markets interpret ‘bad news’ for the economy as ‘good news’ for stocks before. However, bad news for the economy may indeed become bad news for the markets, as slowing growth weighs on labor markets and corporate earnings. An outcome other than a soft landing would definitely be a problem for markets!
One thing is certain: the Fed will continue to dominate the markets in 2024. Therefore, understanding the economic cycle and the role of the central bank is crucial for investors who want to navigate the financial markets successfully. We believe that it’s essential for investors to remain vigilant, monitor economic indicators, and focus on opportunities that uncertainty and volatility can create. As monetary policy changes, investors should focus on resilient portfolios that can adapt to changing conditions and withstand those uncertainties. In this environment, diversification and active management are more critical than ever.
We are grateful to be on this journey with you and look forward to continue helping you pursue your financial goals in 2024. As always, we value your trust and are here to help in any way we can. We wish you a happy, fulfilling and prosperous New Year!