Asset class returns were generally positive in the second quarter of 2024. Insurance-linked securities led all asset classes for the quarter while stocks and bonds produced modest positive returns. Meanwhile, real estate securities turned in their second consecutive quarterly decline. For the year, U.S. stocks have returned a little over 15%, outpacing all other asset classes.
Same as Ever
If you’re looking for a summer book recommendation with a financial theme (who isn’t?), I recommend The Psychology of Money, from one of my favorite authors, Morgan Housel. The book is organized into 20 short chapters that you can read independently, making for an easy, yet insightful read.
Following the success of that book, Housel recently published Same as Ever: A Guide to What Never Changes. I recommend this one too. Amidst the constant changes in our lives, the book focuses on the things that tend not to change. Spoiler alert: a key theme is human behavior. Here’s a sample:
Your happiness depends on your expectations more than anything else. So, in a world that tends to get better for most people most of the time, an important life skill is getting the goalpost to stop moving. It’s also one of the hardest. A common storyline of history goes like this: Things get better, wealth increases, technology brings new efficiencies, and medicine saves lives. The quality of life goes up. But people’s expectations then rise by just as much, if not more, because those improvements also benefit other people around you, whose circumstances you anchor to. Happiness is little changed despite the world improving.
It’s been like this forever. Montesquieu wrote 275 years ago: “If you only wished to be happy, this could be easily accomplished; but we wish to be happier than other people, and this is always difficult, for we believe others to be happier than they are.”
Celebrating 35 Years
At Gibson Capital, we’re preparing to celebrate the 35th anniversary of the founding of the firm. The occasion has me thinking about all that has changed in the investment environment since Roger founded the firm in 1989, and also about the things that haven’t changed. In many ways, the changes have made investing more complicated. For instance, the number of mutual funds and now Exchange-Traded Funds, which didn’t exist in 1989, has more than tripled.1 Want a fund that invests only in pet care companies? No problem, check out ticker symbol PAWZ. Adding to the growth in investment options has been the rise of private market investing, such as private equity, private credit (lending), and private real estate. These markets now measure in the trillions of dollars and can further complicate the investment decision-making process.
But as Housel suggests, some things don’t change, and investor behavior is a classic case in point. Humans are still driven largely by the same motivations, impulses, and fears. Markets therefore reflect those tendencies because markets are made up of humans. Consider the periodic boom and bust periods in financial markets. These bouts of excessive investor optimism and pessimism2 have shaped the investment landscape since the founding of our firm. For some examples, let’s start back at the beginning.
The year 1989 was notable in financial markets as when Japan’s benchmark stock index, the Nikkei 225, hit a peak level it would not revisit for decades. Optimism about Japan’s rise to economic prominence went too far, setting the stage for the long period of negative returns that followed for Japanese stocks. You may remember some of these anecdotes from that period:3
- The Japanese stock index rose every single year in the 1980s, culminating in gains of 40% in 1988 and 29% in 1989.
- At the peak in 1989, Japanese companies accounted for 45% of the value of all global publicly traded companies. Today, Japanese companies make up about 6% of world stock value.
- More than half of the 20 largest companies in the world in 1989 were headquartered in Japan. The four largest were Japanese banks.
- Real estate in Tokyo in 1989 sold for as much as $139,000 per square foot, more than 350 times comparable property at the time in Manhattan.
- The roughly 1.3 square miles occupied by Japan’s Imperial Palace was reportedly worth more than the entire real estate value of the state of California.
It took until earlier this year for the Japanese stock index to again reach 1989 levels.
Only a decade later, in 1999, U.S. stocks were in a bubble of their own. The ‘90s featured nine straight years of positive returns for U.S. stocks, the last five of which all resulted in 20%+ returns. The optimism proved overdone. In the 2000s, U.S. stock investors lost money for an entire decade and suffered through two of the worst bear markets of the last century. Of course, the pessimism brought about by such a difficult decade for U.S. stock investors in the 2000s laid the foundation for the terrific returns for U.S. stocks over the following 15 years, which brings us to the present day.
Ongoing Cycles of Change
So, the arc of our firm’s history has been marked by these long cycles of changing asset class leadership. Non-U.S. stocks led in the ‘80s, aided by Japan’s ascendancy. As non-U.S. stocks cooled off in the ‘90s, U.S. stocks ran with the baton. During the “lost decade” for U.S. stocks in the 2000s, non-U.S. stocks and real estate securities performed comparatively well. More recently, U.S. stocks have been the clear leader.
It might be tempting to think one could have seen the turning points and switched from the prior asset class leader to the next leader. Data on investor returns suggests otherwise. Broadly speaking, investors have underperformed the funds in which they invest. They do so, in part, by becoming too optimistic when others are optimistic (“buying high”) and too pessimistic when others are pessimistic (“selling low”). This fact shouldn’t be all that surprising. Since it is human behavior that largely causes these cycles in the first place, it is likewise human behavior that gets in the way of capitalizing on them.
A better approach to dealing with the ebbs and flows of these investment cycles is to maintain an allocation across multiple broad asset classes. Periodically rebalancing away from the current star performer and toward those asset classes that may be poised for strong future performance helps manage risk and improve results. The benefits are time-tested but the psychological “cost” of this strategy is not trivial. With this approach, you never have all your money invested in the hot corner of the market, and you regularly have a part of your portfolio with temporarily underwhelming results. Not everyone can deal with this cost.
I will share with you one more quote from Same as Ever. Amazon founder Jeff Bezos once said he’s often asked what’s going to change in the next 10 years: “I almost never get asked the question: ‘What’s not going to change in the next 10 years?’” he said. “And I submit to you that that second question is actually the more important of the two.”
In 10 years, investors will still occasionally get carried away. Markets will still have a tendency to overshoot. Decisions you make in market extremes will still have a disproportionate impact on your long-term returns. Investing may continue to get more complicated but it will be the simple things that matter most: an asset allocation well-matched to your goals and risk tolerance and the discipline to stick with your strategy when doing so isn’t comfortable. As Housel would put it — same as ever.
As always, we look forward to our next conversation and want to express our gratitude for the continued opportunity to work together through every cycle of change.
Sources:
1 Investment Company Institute
2 I like this quote from Morgan Housel: “Optimism and pessimism always overshoot because the only way to know the boundaries of either is to go a little bit past them.”
3 Reuters, CNBC, and Vanity Fair
