Tong’s portfolio: Only a fool would call a market top

Earlier this year, we posed the question on whether it would be “a bull or bear market for 2021?” ( The Edge Singapore, Issue 971, Feb 15). Almost immediately after the article was published, the rally in global stocks was met with fresh volatility.

In the US, we saw a selloff in growth and tech stocks, which dampened sentiment around the world. The steep rise in US Treasury yields, from historic lows — on the back of rising inflationary expectations — hit valuations for high-growth stocks particularly hard. Investors rotated into reopening stocks, including financials and industrials as well as beleaguered travel-related airline and hotel stocks. The Nasdaq Composite fell sharply while the Dow Jones Industrial Average (DJIA) and, to a slightly lesser extent, the Standard & Poor’s 500 index held up far better.

Over the past week, we have been seeing yet another shift, back to Big Tech — and quite possibly the broader tech sector. Microsoft Corp, Alphabet (the parent of Google) and Facebook surged to all-time highs while Apple and Amazon.com rebounded smartly from recent lows. All three of the most closely watched bellwether US indices are now either near or at fresh record-high levels — proof that the “everything rally” remains alive and well.

Reasons underpinning the bull market are intact — extremely accommodative monetary policies, massive fiscal stimulus packages and excitement over the reopening of economies with vaccinations. Case in point: The US Federal Reserve reiterated its intention to keep interest rates near zero and, more importantly, that any future change in this policy will be based on actual outcome, not forecasts or projections.

The world is set for an explosive rebound in growth — the International Monetary Fund (IMF) lifted the global GDP growth forecast to 6% this year, the strongest in nearly half a century. According to data provider FactSet, the S&P 500 companies are likely to report earnings growth of at least 28% for 1Q2021, which will be the fastest clip since 2010. As we wrote before, the market as a whole is rarely wrong and only a fool would bet continuously against the market.

Make no mistake, though: The risks are growing. Massive liquidity has resulted in asset price inflation, with signs of irrational exuberance in certain corners of markets. Given the persistently low interest rates, stocks have become the TINA (“there is no alternative”) trade for many, including those investing for the very first time. The average investor too is “forced” to take more risks in the search for yields.

Borrowing is cheap. Margin debt for stocks is rising. According to data from the Financial Industry Regulatory Authority, total margin debt in the US is up 49% year on year in February 2021, the pace of growth harkening back to the periods prior to the global financial crisis and dotcom bust. The high-profile failure of Archegos Capital further underscores the rising risks of excessive leverage and risk-taking using complex (and often opaque) derivatives products, where lax regulations prevail.

In addition, amid the robust earnings rebound, companies may start warning of higher input costs — a lingering fallout from pandemic-driven supply disruptions and bottlenecks, such as the current global shortage in semiconductors — that could lead to pressure on margins over the coming months.

Given all of the above, it is possible that we are headed for a sharper stock market correction than what has been seen so far this year. However, we think attempting to call a market top is a fool’s game. Why?

We analysed the performances of the S&P 500 index and DJIA over long periods of time. And history tells us that buying stocks has never done investors wrong.

We tracked the cumulative returns (before taking into account dividends) for the DJIA and S&P 500 index, assuming we buy and hold for a 20-year period (see Chart 1). What the chart tells us is that, while the actual returns will fluctuate, depending on the starting and ending years, they are all positive for whichever year the initial investment was made — even on the eve of major crashes, before the 1937/38 recession, the 1973 oil crisis or the 2000 dotcom bust.

For sure, there were bad and even worse years during this period, where panic overcame greed. But the key takeaway is this: Stocks have always, inevitably, recouped all lost ground, and much more.

For example, if we bought at end-1999 (before the dotcom bubble burst) and sold at end-2019, the cumulative returns would be almost 1.5 times for the DJIA and 1.2 times for the S&P 500 index. If we were to include dividends, total returns over the same period would be 3 times for the DJIA and 2.24 times for the S&P 500 index!

Put another way, short-term stock price volatility will be smoothened out over time. If we were to buy the DJIA and S&P 500 index in any year since 1930 and hold it through 2020, the compounded annual growth rate (CAGR) would be 8% on average (see Charts 2 and 3). Including dividends, annual total returns (the data on total returns goes back to only 1987) rise to between 11% and 12% on average. Stocks are without doubt one of the best ways to build wealth. And there is no need to take excessive risks. This is a simple “long only” strategy computation. Buy and hold. There are no derivatives and complex structures that no average investor can possibly understand.

What this also means is that investors should stop worrying whether the stock market will fall — it will at some point or, worse, crash. But history has proven that we should still always maintain a fully invested and diversified portfolio. And we must start investing as early as possible in life, to fully capitalise on the powers of compounding. Warren Buffett bought his first stock at the age of 11 — and he has never looked back, steadily accumulating and growing his portfolio each year.

In general, stocks always go up over time. And we do not mean this in the way some Robinhood traders do to justify excessive speculation. Indeed, not all companies will succeed — some will perform poorly and yet others will fail and disappear — and success will not be equal. Thus, stock-picking is key. But stocks as an asset class will continue to rise, as long as the world continues to innovate and technological progress translates into higher productivity and growth over time. And we are certain humanity is created to outperform its past, on a daily basis.

The composition of a fully invested portfolio would change to capture the best opportunities at any point in time. Last week, we disposed of all our shares in Rio Tinto and Vertex Pharmaceuticals as well as part of our holdings in Taiwan Semiconductor Manufacturing Co. These are all companies of good quality, but we think Apple and Alibaba Group Holding have greater upside potential today. Followers of this column would notice that this is not the first time we are buying Apple or Alibaba.

Indeed, Alibaba used to be our single-largest holding in the Global Portfolio because we believe the company still has a lot of room to grow and valuations were comparatively modest. We sold the stock late last year in view of rising regulatory uncertainties, which caused a selloff in its shares.

It is not a reflection of the company’s operations or management. Rather, it is a fact that all innovators seek to capitalise on regulatory arbitrage to gain a comparative advantage over the incumbents. Inevitably, regulations will catch up to level the playing field. This is what is happening in China. Chinese politicians and regulators are not going after Alibaba because of Jack Ma, as most Western-based media suggest. And it will be the same in the US — regulatory scrutiny of Big Tech will grow and these companies will eventually face more stringent regulations. Though we bet few would suggest that US regulators do it because they do not like Mark Zuckerberg’s face (for example).

The Global Portfolio closed 0.8% higher for the week ended April 14, lifting total returns to 60.2% since inception. The portfolio remains nearly fully invested. We continue to outperform the MSCI World Net Return index, which is up 47% over the same period.

Tech stocks including Okta (+16.8%), ServiceNow (+6.7%) and Adobe (+3.5%) were the big gainers last week. At the other end, shares for ViacomCBS (-8.4%), Singapore Airlines (-3.2%), and Johnson & Johnson (-2.3%) ended lower.

Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.