Unloved Bull Markets. Craig Callahan
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of equity exposure. Plan annual return was only 4.47% versus the S&P 500 Index of 15.26%.
Barron's covered institutional low-equity exposure in “The Case for Stocks,” by Andrew Bary, July 22, 2019. “Many big public pension funds like Calpers and endowments, which have big investments in alternative assets such as private equity and hedge funds, failed to beat the S&P 500 or even a 75%/25% mix of stocks and bonds the decade that ended June 2018. The Yale endowment, led by David Swensen, has just 3% of its portfolio in U.S. stocks and as a result has failed to participate fully in the huge market gains of the past ten years.”
An article by Barry Ritholtz on Bloomberg News, October 9, 2019, titled “Ivy League Endowments Make the Same Old Mistakes,” stated,
The latest university endowment return data dribbling out for the fiscal year ended June 30 is not pretty. Harvard's endowment gained 6.5%; while Yale's had an increase of just 5.7%; the University of Pennsylvania endowment gained 6.5%; Dartmouth yielded 7.5%. During the same time period, investors in the Standard & Poor's 500 Index had total returns, which includes dividends, of 10.4%; a portfolio of 60% stocks and 40% bonds returned 9.9%. This performance is consistent with the record of the past decade, with none of the Ivy endowments beating a 60–40 portfolio in the 2008–2018 period, though a couple did come close.
The article then continues, “The biggest contributors to the weak performance of the endowments were high exposure to hedge funds (2019 returns = 1.1%) and natural resources (2019 returns= −6.8%).”
An article in Barron's, October 14, 2019, with the title “Bull Market Beats Yale,” stated in its tag line, “U.S. university endowments, heavy in alternatives, again underperform stocks and bonds. Time for a change in the model.” The author, Nicholas Jasinski then pointed out, “The S&P 500 has produced annualized returns of 14.7% in that [ten-year] span, and a stock/bond mix has posted 11.4% gains a year—but the average return of 149 colleges and universities analyzed by Cambridge Associates was 8.6%.”
The eleven-year bull market had so much to offer, yet individual investors and institutional investors alike didn't fully participate. Occasionally articles appear talking about public funds being underfunded relative to their future pension obligations. It seems the first place to look is their asset allocation decision and reduced exposure to stocks. As for college endowments, perhaps it is easier to ask alumni for more money than it is to recognize and participate in a bull market.
For both public funds and endowments their use of “alternatives” is puzzling. One feature of alternatives, like some hedge funds, is their attempt to be low in correlation with the stock market. Low correlation is a diversification tool to reduce overall portfolio volatility, but why should public funds and endowments care about volatility? It would seem that they have an investment time horizon of twenty to thirty years. We have argued, in an article coauthored with Tom Howard, that volatility is not the correct definition of risk. We suggested underperforming an investor's retirement goal is risk. With the growth of alternative investments, we have often asked the question, “Who needs an alternative to making 530% in eleven years?”
Anecdotal Examples of Unloved
Investors or reporters would often ask, “Why did the stock market go up today?” Their tone clearly conveyed skepticism and the belief that the stock market should not be going higher. The simple, correct, but flippant answer would have been, “We are in a bull market, stock prices are supposed to go higher!” That answer would not have worked because people do not like being told they are wrong, and they did not realize a bull market was under way.
Even the terminology used to describe the market conveyed the unloved nature. The short-term dips of 5% to 10% were called corrections, which implied that the market was not supposed to be going higher and that it was correcting itself by going down. As we know now, the correct path was upward. The market was supposed to be going higher. In our research department, just to keep our sanity and our long-term view intact, we labeled those dips incorrections.
In previous bull markets, if the market was higher one day, there would be more buying the next day by momentum investors. It is often referred to as “fear of missing the boat” as it is pulling away from the dock. In a bull market it is usually a terrible feeling seeing the market move higher while holding cash. During this bull market, however, if the market was higher on a day the next day saw a sell-off thirty to sixty minutes into the trading day. It felt like investors, not realizing we were in a bull market, felt the advance the day before gave them a chance to get out. So to move higher two days in a row, buyers had to take out the weak jittery money.
One metric used by investors who use technical analysis is comparing the number of issues that advance each day to the number that decline. If over a recent period of, say, ten or thirty days a lot more issues are advancing than declining, there are two interpretations. One is that the advance has breadth and is sustainable. The other is that the market is “overbought” and will soon turn and go lower. Commentary during the bull market typically favored the negative view as the market was labeled “overbought.” It appears that the analyst's predetermined bearish bias influenced the interpretation of the data.
For the eleven-year bull market and especially for the new one that began March 2020, there is a new generation of investor. These new investors are very situational. They don't believe in the broad market, just special situations like the unique stories of Amazon or Tesla. In the early stages of the 2020 bull market, it was the “work from home” theme. How would investors behave if they didn't believe in the bull market but just invested or speculated in a stock they think is unique? They tend to be jittery and set very quick sell thresholds that we believe explains some of the volatility and rapid theme changes that occurred during the eleven-year bull market and the new 2020 bull market.
Confidence
Every week Barron's computes and publishes its Confidence Index. The editors define it as the ratio of the yield on high-grade bonds divided by the yield on intermediate-grade bonds. Think of it as measuring the confidence investors have in the financial system. Naturally investors need a higher yield on the riskier intermediate-grade bonds than they do on the higher rated bonds. If the two yields are very close, say high-grade is 95% of intermediate-grade, investors have confidence in the system and the ability of intermediate-grade companies to honor their payments. But if there is a wide yield gap, say the yield on higher-grade bonds is only 60% of the much higher yield on intermediate-grade bonds, investors would be showing little confidence in the financial system and intermediate-grade companies’ abilities to honor their payments.
Figure 1.4 shows the Confidence Index from December 29, 1978, through February 21, 2020. The straight line represents the average reading for three different time periods. It averaged 93.2 from December 29, 1978, through December 31, 1999. Then it dropped and averaged 83.5 from January 7, 2000, through December 31, 2008. From January 2, 2009, through February 21, 2020, covering the eleven-year bull market and a couple of months before it began, it averaged only 73.5. This recent bull market took place in a setting of low investor confidence in the financial system.
Figure 1.4 Barron's Confidence Index, 12/29/1978–2/21/2020
We contend an investor's confidence affects how he or she receives and processes news. If confidence is high, bad news might get dismissed or softened in its perception. If confidence is low, bad news is on the fast track to negative sensors. During this bull market, investors were viewing the glass as half empty. In this state, they were overly sensitive to mediocre and bad news, with good news or bullish indicators flying under their radar. It is almost as if