January 25, 2024

“In order to succeed you must first survive.” - Warren Buffettⁱ

Mr. Buffett explained the importance of resilience this way – “If we investors fixate on downside protection, the upside, in many cases, takes care of itself. If you can put floors on the downside, then you’ve got a huge advantage.” That is true not only for all entrepreneurs, but it is also true of families that have achieved enough wealth that with prudence they can more effectively ensure their long-term well-being. Most wealthy families can remain wealthy for generations. The reason that some lose that enviable status is typically not because of excessive spending (although living beyond one’s means is seldom helpful). Rather, it is because they experience a catastrophic decline in their portfolio value (i.e., due to significant concentrations in a finite number of stocks or real estate that experience more or less permanent declines in value). Declines in value along the way are inevitable, but the key is to withstand the lean times so that wealth can recover and endure through market cycles. It is not so much a question of thriving in the best of times but in surviving the worst of times. We believe a key to long-term wealth endurance entails the deliberate meaningful allocation into market segments that will likely perform differently over time.

“Investors are wise to plan for what may happen rather than predict what will.”^{ii iii}

U.S. large caps (both S&P 500 and NASDAQ) are leading performance at the start of this new year. That’s not at all surprising because they were carrying a lot of momentum and investor confidence into this new year. It is hard to know how markets, market segments, let alone individual stocks will perform in short periods including a year or two. Just look at the volatility we have seen since early 2020. That’s because there are often external shocks (positive or negative) that are inherently hard to predict. These include domestic and international surprises on the economic, geopolitical, and/or healthcare front that surprise markets/investors. They can be positive or negative. Ben Graham, Warren Buffett’s mentor said, “In the short-term the market is a voting machine, but in the long run it is a weighing machine.” We believe it can be easier to make estimates of longerterm return prospects (although this too is difficult) than what will happen in the weeks, months or year ahead. As you may know, market firms like JP Morgan, Vanguard, Goldman Sachs and many others periodically update their Long-term Capital Market Assumptions (LTCMAs). You may recall my sharing these longer-term estimates in letters I have written in prior years. We review these LTCMAs from time to time – not because we think they are ‘pinpoint reliable,’ but rather because we want to understand what goes into these longer-term projections. With respect to U.S. stock market segments, the underlying variables are EPS growth, their expectations for change in PE and dividends, etc. In international forecasts, it is these factors plus their expectations for change in the value of the U.S. $ versus other currencies. In fixed income markets, the estimates are based upon things like the current yield and whether they think yields will likely increase or decrease (due to underlying inflation and FED/other central banks’ policy) and whether ‘credit spreads’ will likely expand or contract. Obviously, there are many underlying determinants that factor into these longer-term estimates. Each is subject to change based upon what actually happens along the way. As Yogi Berra said, “It’s tough to make predictions, especially about the future.”

To help you understand how these forecasts are made and why they can provide benefit to investors, I want to share one firm’s estimates for major market segments in the equity and bond markets. That firm is Vanguard.

Some of these projections above may surprise you. Specifically, in contrast to what has occurred since March 2009 and more recent time frames, they believe returns over the next 10 years may be higher for international market equities than for the U.S. stock segments. Within the U.S. they expect that small cap returns may be higher than those for large caps and within large caps that ‘value’ returns may exceed those of ‘growth’. I believe that is largely attributable to the fact that international and U.S. small cap segments have much lower current valuations (e.g. PE and price to book ratios), while U.S. growth stocks are selling near the top of their historical ranges. If U.S. small caps and international stocks experience an increase in valuation over the next 10 years that would aid price gains. The reverse would be true for U.S. growth stocks if their PE ratios decrease over the next 10 years. They are forecasting a ‘reversion to the mean’ with respect to equity market valuations. With respect to U.S. and international bonds, they expect investment returns to generally be in the mid-single digits and in some instances competitive with equity returns. That would be a nice departure from recent years and is largely attributable to the fact that interest rates have moved appreciably higher than had been the case before the FED raised short-term rates to combat inflation. Time will tell, but this could mean that there will be more asset classes that provide real returns in excess of underlying inflation. We certainly hope so. Lastly, notice that each asset class has a 1% to 2% range from the forecasted high to low. Those differences are material and of course the actual results could easily fall outside those projections.

Historically, investors have tendency to be overly bullish at or near what prove to be market cycle tops and too bearish at market cycle lows. It seems to be part of our innate nature. Here is what some noteworthy people have shared --

“And it never failed that during the dry years the people forgot about the rich years, and during the wet years they lost all memory of the dry years. It was always that way.” –

John Steinbeck, “East of Eden”, 1952.

I believe the same is true for many investors with respect to bull and bear markets. Many envision favorable trends in particular market segments and develop a belief that the good years will carry on for many years to come and vice versa. It’s always like that, but cycles occur when they are often least expected.

Here are some other quotes that I consider worthy of consideration –

“Science has not mastered prophecy. We predict too much for the next year and yet far too little for the next 10.” – Neil Armstrong. This was the opening from my letter on June 5, 2018.

“There is no asset class that too much capital can’t spoil.” This is from Barton Biggs who was a long-time partner and strategist at Morgan Stanley. I would only add that during lean times, companies fail and exit industries and economic sectors which helps pave the way for survivors to thrive in ensuing up cycles.

In agreement with Yogi Berra, I would only add that identifying the winners is easy looking backwards, but predicting which will be winners in the future is a much tougher task. If a stock is up 10x, 20x or more in a relatively short time (i.e., 5, 10 or 15 years), it's wise to ask, why was it only $10 per share and now it's $100 or $200? Obviously, investors collectively had difficulty anticipating the huge run-up – otherwise the price would likely not been as low/fallen as much before the bull run. Conversely, some once leading, highly admired stocks experience a peak in prices that they fail to ever re-capture. By considering things like current valuation and sentiment (as opposed to just price change), we believe investors can better stay the course during lean periods and avoid the temptation to invest aggressively after large run-ups in price.

We recognize that presently there are completely rational concerns about the prospects for GDP growth in Europe, China, etc. This reminds me of the lack of visibility and confidence in the U.S. during the GFC (Global Financial Crisis). Economic growth was at best anemic, and markets were under pressure. Valuations were way below long-term historical averages. However, it is wise to remember that lean periods often pave the way for recovery in fundamental growth in economies, corporate profits, and investor and consumer confidence.

In summation, we are hopeful that many, if not most, most major asset classes may provide returns that exceed inflation over the next 10 years. We note that the range of forecasts across equity segments vary considerably (as is the case over many 10-year periods), and some will likely come in ahead and below the ranges in Vanguard’s long-term estimates. In addition, longer-term forecasts for asset class returns from other major investment firms also provide reason for optimism. Of course, they are not universally the same. Actual returns may come in higher and lower than any individual market segment return estimates – some likely by wide margins. We can’t predict, but we can adopt and adhere to sensible strategies. While we are comfortable ‘letting the winners run’, we also like to ‘lean in’ and add to segments that are out-of-favor and attractively priced. We will continue our long-standing practice of adopting and maintaining significant allocations in all major market segments. Doing so can help ensure you have meaningful ownership of whatever segments perform best over the short, intermediate and long-term. Lastly, we are optimistic that numerous asset classes are capable of generating returns that exceed inflation. In other words, there appears to be ice cream in lots of dishes!

Richard Jones, CFA

Partner, Harmony Wealth Partners

1. This calls mind another Buffett quote – “The stock market is a device for transferring money from the impatient to the patient.”
2. David Booth shared this advice in an essay entitled How to Invest Better – and Live Better on September 22, 2022. He is the Chairman and Founder of Dimensional Fund Advisors. You can read this essay and many other interesting essays at dimensional.com
3. Booth’s quote calls to mind one from Benjamin Graham who was Warren Buffett’s mentor. He said, “Forget about what the stock market is going to do. Instead, focus on what you, as an investor, ought to do …”

Any opinions are those of W. Richard Jones and not necessarily those of Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance is not indicative of future results. Diversification and asset allocation do not ensure a profit or protect against a loss. International investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility. Investing in commodities is generally considered speculative because of significant potential for investment loss. Their markets are unlikely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising. Any charts are for illustration purposes only. Dividends are not guaranteed and must be authorized by the firm's board of directors. Investing in oil involves special risks, including the potential adverse effects of state and federal regulation and may not be suitable for all investors. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. Market. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns.

Securities offered through Raymond James Financial Services, Inc., Member FINRA/SIPC. Investment advisory services offered through Raymond James Financial Services Advisors, Inc. Harmony Wealth Partners is not a registered broker/dealer and is independent of Raymond James Financial Services.