Writing about the stock market at this point in history seems like a fool’s errand. The same year that saw a pandemic kill over 1.9 million people worldwide and brought the global economy to its knees also saw the Dow and S&P 500 close at record high levels by the end of that year. Those bare facts, at first glance, defy explanation. But since stopping there would make for a pretty boring article, we’ll try to do a little explaining anyway.
To fully appreciate how far we’ve come, let’s recap the journey that investors have been on for the last year. From its peak on February 19, 2020, the S&P 500 fell 34% in just 33 days - the fastest drop and the shortest Bear Market on record for the index. What followed has been nothing less than astonishing. Referred to as an “Everything Rally” by the Wall Street Journal, most segments of the financial markets, from crypto-currency to emerging markets, have increased dramatically in value since the bottom on March 23, 2020. As we discussed in our Q2 2020 newsletter, this rally has been driven in large part by actions of the Federal Reserve. Their short-term interest rate policy and bond buying programs have pushed interest rates so low that fixed income and cash are unattractive investments, driving investors into stocks.
This “Everything Rally” did not happen all at once, however. Instead, it transitioned its way through industries and different sized companies. The first to recover were large technology stocks, as investors realized that retail was shifting online and that remote working would be in place for the foreseeable future. Small US stocks, on the other hand, stayed at a level about 10% below their pre-pandemic peak through November. From November through year end, however, small company stocks gained a whopping 27%.
In addition to small cap stocks, “value” stocks (companies that have a low price relative to their earnings), which had underperformed “growth” stocks for most of the past 10 years, had their biggest one-day gain in history (over 6%) on November 9, the day the Pfizer vaccine was announced. Since then, value stocks outperformed growth in all but two weeks during the fourth quarter. This is probably due, at least in part, to the anticipation that banks, energy companies and traditional retail companies will start to recover as the vaccine is more widely distributed.
When stocks from economically sensitive industries (like those just mentioned) increase in value, it generally means that the market is anticipating a significant economic recovery (often referred to as a “reflation trade”). It could be the first sign of stronger results in manufacturing, technology, and retail. On the other hand, it also means that investors have already priced in such a recovery, which means in turn that stock prices could drop if such a recovery doesn’t materialize or if it is weaker than anticipated. What the latter statement illustrates is that economic data describes what is, while stock prices describe what might be. Current events matter to stock prices only to the extent that they provide clues as to what might happen later. Right now, market investors are looking at a significant recovery in the coming year. Economists at Goldman Sachs, for instance, recently raised their forecast for U.S. economic growth to 8%, based in part on the additional $1.9 trillion stimulus from the new Democratic administration and Congress.
Can any conclusions be drawn from this information? An intelligent investor should consider the following:
Sure, this is the same advice we’ve been giving forever. But despite the awful times we are living through, such advice is all that is reliable. And it provides some small measure of comfort to know that it still works in bad times as well as good.
On Thursday, March 11, 2021, the American Rescue Plan Act of 2021 (ARPA 2021) was signed into law. This is a $1.9 trillion emergency relief package that includes payments to individuals and funding for federal programs, vaccines and testing, state and local governments, and schools. It is intended to assist individuals and businesses during the ongoing coronavirus pandemic and accompanying economic crisis. Major relief provisions are summarized here, including some tax provisions.
Recovery rebates (stimulus checks)
Many individuals will receive another direct payment from the federal government. Technically a 2021 refundable income tax credit, the rebate amount will be calculated based on 2019 tax returns filed (or on 2020 tax returns if filed and processed by the IRS at the time of determination) and sent automatically via check, direct deposit, or debit card to qualifying individuals. To qualify for a payment, individuals generally must have a Social Security number and must not qualify as the dependent of another individual.
The amount of the recovery rebate is $1,400 ($2,800 if married filing a joint return) plus $1,400 for each dependent. Recovery rebates start to phase out for those with an adjusted gross income (AGI) exceeding $75,000 ($150,000 if married filing a joint return, $112,500 for those filing as head of household). Recovery rebates are completely phased out for those with an AGI of $80,000 ($160,000 if married filing a joint return, $120,000 for those filing as head of household).
The legislation extends unemployment benefit assistance:
For 2020, the legislation also makes the first $10,200 (per spouse for joint returns) of unemployment benefits nontaxable if the taxpayer’s modified adjusted gross income is less than $150,000. If a 2020 tax return has already been filed, an amended return may be needed.
Health insurance relief
Student loan tax relief
For student loans forgiven or cancelled between January 1, 2021, and December 31, 2025, discharged amounts are not included in taxable income.
Child tax credit
Child and dependent care tax credit
Earned income tax credit
For 2021 only:
For 2021 and later years:
Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances.
To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.
These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
Stocks had very strong fourth quarter performance as a result of positive developments on the Covid-19 vaccine, leading investors to begin anticipating the broader reopening of the economy in 2021.
Equity markets around the globe posted positive returns in the fourth quarter. Looking at broad market indices, emerging markets outperformed non-US developed markets and US equities.
Value outperformed growth across regions. Small caps outperformed large caps across regions as well.
REIT indices underperformed equity market indices in both the US and non-US developed markets.
MSCI All Country World Index with selected headlines from past 12 months
These headlines are not offered to explain market returns. Instead, they serve as a reminder that investors should view daily events from a long-term perspective and avoid making investment decisions based solely on the news.
As you know, we follow the writings of Jason Zweig from The Wall Street Journal pretty closely. Last year, he reported in one of his columns that young men were using low-cost online trading platforms to make "investments" that were really more akin to gambling. Following the initial economic carnage of the pandemic, these people would place large bets on stocks (often in the travel and entertainment businesses) that were in financial distress. They would then brag online to their friends about their outsized results, whether positive or negative. It didn’t seem to matter whether they had large gains or large losses, as long as they were large. Such ego-driven behavior may have artificially inflated stock prices for a time.
I had Zweig’s column in mind when I read Ego is the Enemy, a 2016 book from Ryan Holiday. In it, Holiday explored the ill effects of ego on himself, his friends and colleagues, and on important figures throughout history. Holiday uses the term "ego" not in the Freudian sense but rather as the "unhealthy belief in our own importance." In other words, arrogance and self-centered ambition. Ego is the enemy of mastering a craft, of working well with others, of achieving real creative insight. Although a problem throughout history, our culture in particular "fans the flames of ego."
The book looks at historical figures who have either succumbed to or have overcome ego. What these examples demonstrate is that,
[w]hen we remove ego, we are left with what is real. What replaces ego is humility, yes – but rock-hard humility and confidence. Whereas ego is artificial, this type of confidence can hold weight. Ego is stolen. Confidence is earned. Ego is self–appointed, its swagger is artifice. One is girding yourself, the other gaslighting. It’s the difference between potent and poisonous.
It is arranged in three sections: Aspiration, Success and Failure. Its goals are to help us be "humble in our aspirations, gracious in our success, resilient in our failures."
Rather than paraphrase Holiday’s insights, this review will provide some of his best insights directly, organized in those three sections.
Historically, our greatest thinkers have promoted being ruled by principle. However, our current cultural values make us dependent on validation, entitled, and ruled by our emotions. We are inspired, encouraged and assured by society that we can do whatever we want. We create our aspirations accordingly.
But the ability to evaluate our own ability is the most important skill of all for implementing those aspirations, because without it, improvement is not possible. Ego makes such self-evaluation difficult "every step of the way." It leads us to talk about things rather than do them; and social media encourages us to tell the world how wonderful we are. "The only relationship between work and chatter is that one kills the other." Ego leads us to want to "be," rather than to "do." Holiday recommends asking of ourselves "what is it that I want to accomplish in life," rather than "who do I want to be in life?"
Similarly, ego leads us to promote how good we already are, rather than how much better we might be through study; "the pretense of knowledge is our most dangerous vice, because it prevents us from getting any better. Studious self-assessment is the antidote." Put another way, "you will not find the answers if you’re too conceited and self-assured to ask the questions. You cannot get better if you’re convinced you are the best." If we are to fulfill our aspirations, we must learn not only to take harsh feedback but to actively solicit it. This is something that the ego will work hard to avoid.
Holiday recommends not being passionate, a sentiment that runs counter to our cultural imperative of finding our passion. "Passion typically masks the weakness. Its breathlessness and impetuousness and franticness are poor substitutes for discipline, for mastery, for strength and purpose and perseverance." Passionate people "can tell you all the things they’re going to do, or have even begun, but they cannot show you their progress. Because there rarely is any." Holiday recommends purpose and realism instead of passion. "Purpose, you could say, is like passion with boundaries. Realism is detachment and perspective." Put another way, passion "is form over function. Purpose is function, function, function."
As you pursue your aspirations, you also must exercise restraint. "When someone doesn’t reckon you with the seriousness that you’d like, the impulse is to correct them. (As we all wish to say: do you know who I am?!). You want to remind them of what they’ve forgotten; your ego screams for you to indulge it. But you can’t react. Instead, when someone doesn’t value you as you think you should be, "[t]ake it. Eat it until you’re sick. Endure it. Quietly brush it off and work harder. Play the game. Ignore the noise; for the love of God, do not let it distract you." It is a "timeless fact of life that the up-and-coming must endure the abuses of the entrenched."
One area that needs particular restraint is pride. "Pride blunts the very instrument we need to own in order to succeed: our mind. Our ability to learn, to adapt, to be flexible, to build relationships, all of this is dulled by pride. Most dangerously, this tends to happen either early in life or in the process – when we’re flushed with beginner’s conceit." Instead, it should be about the work alone. "Our ego wants the ideas and the fact that we aspire to do something about them to be enough. Wants the hours we spent planning and attending conferences or chatting with impressed friends to count toward the tally that success seems to require. It wants to be paid well for its time and it wants to do the fun stuff – the stuff that gets attention, credit, or glory." In other words, "to get where we want to go isn’t about brilliance, but continual effort."
In conclusion, as we address our aspirations, we can face what Ira Glass calls the "Taste/Talent Gap," which occurs when your ability to conceive of a great idea is not matched by your ability to execute on it, so that the end product is "really not that great." Whereas ego wants us to avoid facing this harsh truth, "we can face our shortcomings honestly and put the time in. We can let this humble us, see clearly where we are talented and where we need to improve, and then put in the work to bridge that gap."
If we find ourselves able to work hard and achieve the things to which we aspire, we start to gain some measure of success. However, this is success can simply plant the seeds for our next challenge: "as we first succeed, we will find ourselves in new situations, facing new problems. The freshly promoted soldier must learn the art of politics. The salesman, how to manage. The founder how to delegate. The writer how to edit others." Each advancement bumps you into situations you’ve never encountered before. "With accomplishment comes a growing pressure to pretend that we know more than we do. To pretend we already know everything."
As you face these new challenges, ego can tempt you to focus on "some grand division or power trip" rather than "instilling excellence." The story that you build out of your own success can delude you. "Narrative is when you look back at an improbable or unlikely path to your success and say: I knew it all along. Instead of: I hoped. I worked. I got some good breaks. Or even: I thought this could happen." This shows itself in the narratives of investment managers whose claims about what they’re doing in the market are not really to be trusted. "The founding of a company, making money in the market, or the formation of an idea is messy. Reducing it to a narrative retroactively creates a clarity that never was and never will be there."
One way to avoid self-congratulating narratives is to stay on our own path "without getting distracted by all the others that intersect it. In other words, it’s not about beating the other guy. It’s not about having more than the others. It’s about being what you are, and being as good as possible at it, without succumbing to all the things that draw you away from it." Importantly for our purposes, "[t]his is especially true with money. If you don’t know how much you need, the default easily becomes: more. And so without thinking, critical energy is diverted from a person’s calling and toward filling a bank account."
Indeed, an ego-driven success narrative created after the fact can lead a person to entitlement, a need for control and in the end paranoia. "Entitlement assumes: This is mine. I’ve earned it. At the same time, entitlement nickels and dimes other people because it can’t conceive of valuing another person’s time as highly as its own." Control says that everything must be done my way, "even inconsequential things. It can become paralyzing perfection or a million pointless battles fought merely for the sake of exerting its say." Finally, paranoia kicks in when the successful person believes that he or she can’t trust anyone. "It says, focusing on my work, my obligations, myself is not enough. I also have to be orchestrating various machinations behind the scenes – to get them before they get me; to get them back for the slides I perceive."
Again, the key to avoiding these pitfalls is to avoid being driven by ego. Let your confidence be more important than honors or recognition. "Ego needs honors in order to be validated. Confidence, on the other hand, is able to wait and focus on the task at hand regardless of external recognition." Easy to say, but very difficult to achieve after reaching some level of success.
No one succeeds forever. Even the most successful people have faced major setbacks in their journey. So properly handling failure involves managing the ego. Adam Smith said that "It is because mankind are disposed to sympathize more entirely with our joy and with our sorrow, that we make parade of our riches, and conceal our poverty." The ego-driven narrative can only tolerate a successful storyline. It can’t handle the notion that life isn’t fair. So instead, ego "loves this notion, the idea that something is ‘fair’ or not. Psychologists call it narcissistic injury when we take personally totally indifferent and objective events."
This leads the egotist to wallow in "dead time," under which problems are simply not dealt with. "That’s what so many of us do when we fail or get ourselves into trouble. Lacking the ability to examine ourselves, we reinvest our energy into exactly the patterns of behavior that caused our problems to begin with. It comes in many forms. Idly dreaming about the future. Plotting revenge. Finding refuge and distraction. Refusing to consider that our choices are a reflection of our character. We’d rather do basically anything else." In short, dead time occurs when we are controlled by ego.
The solution to dead time is to do the right thing, regardless of outcome. "In life, there will be times when we do everything right, perhaps even perfectly. Yet the results will somehow be negative: failure, disrespect, jealousy, or even a resounding yawn from the world." We must face the question "[w]ill we invest time and energy even if an outcome is not guaranteed? With the right motives we are willing to proceed. With ego, were not." To handle failure in a healthy way, doing good work in itself must be sufficient. "In other words, the less attached we are to outcomes the better. When fulfilling our own standards is what fills us with pride and self-respect. When the effort – not the results, good or bad – is enough."
And when doing the work is enough, failure won’t last. "Most trouble is temporary . . . Unless you make that not so. Recovery is not grand, it’s one step in front of the other. Unless your cure is more of the disease. Only ego thinks embarrassment or failure are more than what they are. History is full of people who suffered abject humiliations yet recovered to have a long and impressive careers."
Put another way, the internal scoreboard rather than the external one is what sees us through difficult times. Ego can only see what’s going well, not what isn’t. "Your potential, the absolute best you’re capable of – that’s the metric to measure yourself against. Your standards are. Winning is not enough. People can get lucky and win. People can be assholes and win. Anyone can win. But not everyone is the best possible version of themselves."
Holiday concludes with the thought that "it’s admirable to want to be better businessmen or businesswomen, better athletes, better conquerors. We should want to be better informed, better off financially . . . We should want, as I’ve said a few times in this book, to do great things. I know that I do.
"But no less impressive an accomplishment: being better people, being happier people, being balanced people, being content people, being humble and selfless people. Or better yet, all of these traits together."
* * * * *
As always, the books we review have (we hope) a connection to our clients’ financial lives, to their views about money, and to the ways we try to hone our craft. Good investment choices involve studiously examining data, testing your own assumptions, not giving into superficial and retrospective narratives, self-discipline. Bad investment choices almost always result from ego. This book tells us so much that we already know, and yet always seem to ignore.
IMPORTANT DISCLOSURE INFORMATION
INVESTMENT AND INSURANCE PRODUCTS ARE: NOT FDIC Insured | NOT Bank Guaranteed | MAY Lose Value.
Past performance is not a guarantee of future results. Asset allocation does not guarantee better performance and cannot eliminate the risk of investment losses. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio.
Market segment (index representation) as follows: US Stock Market (Russell 3000 Index), International Developed Stocks (MSCI World ex USA Index [net div.]), Emerging Markets (MSCI Emerging Markets Index [net div.]), Global Real Estate (S&P Global REIT Index [net div.]), US Bond Market (Bloomberg Barclays US Aggregate Bond Index), and Global Bond ex US Market (Citi WGBI ex USA 1−30 Years [Hedged to USD]).
The S&P data are provided by Standard & Poor’s Index Services Group. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. MSCI data © MSCI 2017, all rights reserved. Bloomberg Barclays data provided by Bloomberg. Citi fixed income indices copyright 2017 by Citigroup. Dow Jones data (formerly Dow Jones Wilshire) provided by Dow Jones Indices. Bloomberg Barclays data provided by Bloomberg. Treasury bills © Stocks, Bonds, Bills, and Inflation Yearbook™, Ibbotson Associates, Chicago (annually updated work by Roger G. Ibbotson and Rex A. Sinquefield).