In 1952, an economist named Harry Markowitz published research on “Portfolio Selection,” a paper that contained theories which transformed the landscape of portfolio management—a paper that would earn him the 1990 Nobel Prize in Economics. He introduced a mathematical construct called a Mean-Variance Efficient Frontier, which is the set of optimal, diversified portfolios that offer the highest expected return for a defined level of risk. It is a methodology that Beacon Pointe uses in constructing portfolios for our clients.
In an interview that appeared in Money magazine in 1998, Dr. Markowitz was asked how he diversified his personal portfolio when he began investing for his own retirement. He answered, “I visualized my grief if the stock market went way up, and I wasn’t in it – or if it went way down and I was completely in it. My intention was to minimize my future regret. So, I split my contributions 50/50 between bonds and equities.”
Behavioral economists frequently point to this quote as evidence that even the most disciplined investors sometimes make decisions based on emotion. Over the last two years, there have certainly been such temptations. Many investors chose to rush for the doors in the first quarter of 2020, only to miss out on one of the most significant bull markets in history. And there is always a tendency to want to increase allocations to equities during a prolonged bull market. This is often referred to as recency bias and it affects many investors.
Both sentiments are understandable during these unprecedented times.
Strong equity market returns continued in 2021. The S&P 500 returned 11.0% in the fourth quarter and 28.7% for the full year. In fact, since the global financial crisis of 2008, the S&P 500 has posted positive returns in every calendar year except one (2018). Growth stocks outperformed value over the quarter (11.6% versus 7.8%) and for the year (27.6% versus 25.2%).
International equity markets were more mixed. Stocks in developed nations returned 2.7% for the quarter and 11.3% for the year. Emerging markets continue to struggle with reopening. Stocks in those countries were down 1.3% for the quarter and 2.5% over the full year.
Fixed income continues to be a challenge. While yields have risen, they remain low. The yield on the 10-year Treasury rose 61 basis points during the year from 0.93% to 1.52%. The broad fixed income market was flat over the fourth quarter and negative for the year (-1.5%). Municipal bonds were up a modest 0.2% for the quarter and 0.5% for the year.
To be clear, Harry Markowitz’s portfolio did evolve beyond its simple start. In a 2009 interview he stated, “Just to clarify, that is what I did in 1952 … Now I don’t do that … I split my money among asset classes, like efficient portfolios I have seen.”
We have witnessed the high highs and low lows of equity market investing over the past two years. After declining over 30% in early 2020, the market has more than doubled since then. In fact, it has registered three straight years of returns that are significantly higher than long term market averages. With fiscal stimulus ending, monetary policy tightening, higher inflation, and the pandemic surging once again, we are positioning our portfolios a bit more defensively at this time, utilizing a mix of asset classes designed to give you optimal returns for a given level of risk.
It is good though to remember that your portfolios are more than just numbers in a ledger. Your portfolios represent the hard work and discipline it took to accumulate them. They represent current financial security. But, perhaps most importantly, your portfolios represent your hopes and dreams for your families’ future. As an advisor and partner to our clients, we aim to provide peace of mind about our clients finances and strive to build portfolios that align with their life and legacy goals.
Beacon ‘Pointe of View’ – A Market Update January 2021