Knowing What We Know; Knowing What We Don’t Know
As it turns out, 2023 was a terrific year for stock market investors, and a very good one for investors in bonds. Who knew? Pretty much nobody. Forecasts a year ago showed that about 85% of economists and professional analysts expected a recession in 2023, and the usual mediocre to bad returns that go along with an economic slowdown. Had you listened to the overwhelming majority opinion you might have sold all your stocks and bonds and gone into cash or GICs. You would have missed out.
All of us crave certainty, or at least, relative certainty. The beginning of investing wisdom is to acknowledge that you can’t have it. Life is uncertain. There are simply too many variables. Just look at the last three years which have featured all of: a global pandemic, a long-lasting and horrible war in central Europe, disruptions in the demand and supply for oil (which briefly saw its price fall to zero), and disruptions in supply chains for everything from medicines to machine parts. Sadly, 2024 presents many issues which could cause significant stress in financial markets, and it’s only January 1st. So what is any investor to do?
We believe that as long as you know what you know, and know what you don’t know, you can invest with good success over time. Maybe not over any one year or even three-year period, but almost certainly over periods of say five to ten years, and almost without a doubt over twenty years. Here are a few of the things we know, and some of the things we don’t know, as we start another year.
We don’t know if the stock markets will go up or down. Nobody does. When we talk about “the stock market” it is shorthand for the various indexes that aggregate the results of a number of companies. The best index is the U.S. S&P 500 which includes the shares of the leading companies in the United States. It had an outstanding year in 2023, rising 24.2%, after falling 19.4% in 2022. Whether the stock market as a whole goes up or down matters if you have invested in a passive mutual fund or exchange traded fund (ETF) that mirrors the performance of an index. We don’t do that. We believe that active management, in which the investor picks individual companies rather than the whole market, is a better strategy. Of course, we care if the markets rise or fall, since many stocks tend to follow the trend of the index (in statistical jargon they are “highly correlated”). But not all do, and it is possible to do better or worse than the market depending on the quality of the stocks selected.
We don’t know if interest rates will rise or fall. Entering the year there is a strong consensus that interest rates will come down during 2024. We tend to agree, but lots of things could happen to upset that forecast. Current tensions in the Middle East could lead Iran to block the Straits of Hormuz, through which 20% of the world’s crude oil travels. China could invade Taiwan which, among other things, is the supplier of 60% of all the microchips used in everything from your computer to your coffee maker. As well, lots of things we can’t even imagine can also happen (things that then-Secretary of Defense Donald Rumsfeld called “the unknown unknowns”). Raise your hand if, at the start of 2020, you predicted a two- year global pandemic causing over 7 million deaths. We have managed risk in our fixed income portfolios by keeping maturities short in order to maximize flexibility and reduce risk from rising rates. We have moved to lock in the higher yields that became available starting last summer. We continue to emphasize quality and safety to ensure the steady flow of income that is the goal of this asset class.
We know the highest quality stocks will be highly valued. When we invest in a stock we are, of course, investing in a company that produces goods or services and sells them, hopefully at a profit. Perhaps the most important thing we do at Baskin Wealth Management is look for the highest quality companies we can find. For us that means companies that consistently produce a high return on their capital by growing sales and profits. Great companies tend to dominate their industry or sector, tend to be insulated from competition and are what we call “price makers” rather than “price takers.” Following the advice of Warren Buffett, we would rather invest in great companies at a good price than invest in good companies at a great price. A core belief in our firm is that value is always recognized over time, and that stock prices will vary in the short term but will always follow value in the long term.
We know our own behavior is the biggest obstacle to our success. Pretty much everyone agrees that Apple is one of the greatest, if not THE greatest, companies in the world. That has not stopped its stock price from fluctuating pretty widely. In 2022 Apple shares fell 27% from their all-time high. The shares then rose by 48% in 2023. The emerging field of Behavioral Economics has provided many insights into why investors sell a great company like Apple when its price is low, only to buy it back after it has gone up. Our cognitive biases are too many to list, and the reality is that each of us has many of them imbedded in our investment behavior. One of the most important jobs of an investment manager like Baskin Wealth Management is to identify and block harmful behaviors. We attempt to be as rational as possible in our decision making, although we know that as humans, we are subject to emotion and irrationality like everyone else. We have built and maintained a rigorous investment process that helps us avoid acting on our feelings of fear or exuberance; this has proven to be highly successful as a strategy.
We approach the new year with optimism, with the core belief that sound analysis backed up by well thought-out behavior will lead to very solid returns over time. We have over 25 years of experience to back up that opinion. We wish all our clients a happy, healthy, and prosperous 2024, and we hope for a world that is more peaceful and safer for us and our children.
David Baskin, Chairman.
Barry Schwartz on BNN’s The Street: Long term investing strategy from Charlie Munger – December 6, 2023
David Baskin on BNN’s The Street: Timing is still tentative but market is pricing in Fed rate cuts of 75 bps by spring – December 18, 2023
David Baskin on BNN’s The Street: Locking in yields before rates go down – December 18, 2023
Long Term Investing with Barry Schwartz & Ernest Wong
Episode 33 – December 4th, 2023
Episode 34 – December 21, 2023
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