Your Portfolio Moves in Percentage Terms Not in Point Terms
Greetings!
We had a rocky start to the week, so you know what that means. It’s time for one of Larry’s letters. The following letter is based on my beliefs. I believe the concepts are foundational and are very important.
On Monday August 5th, the talking heads gleefully told us the Dow Jones Industrial Average (DJIA, or “Dow”) was “down over 1200 points.” One financial station had “Crisis” flashing in the background. Geeeez…
In the olden days, I’d probably explain the “Japanese yen carry trade” – the purported culprit. But I’ve learned to focus on the messages I really want to get across.
New Market Highs are Nothing New
When I started in the business in 1984, the Dow Jones Industrial Average was at 1240. Recently the index made a new high just above 41,000.
Client: So, Larry, does this mean there is a lot of “air” between the current level and 1240?
Answer: No! It doesn’t work that way!
The various index numbers are just that – numbers. In fact, they’re referred to as “points,” not dollars. And the number of index points tells you very little. How so?
Client: But Larry, they must mean something.
Answer: Point movements do not tell you how much your portfolio has changed. Read on…
Share Prices Are Affected by Profits
The stock market level is directly related to the underlying share prices of the companies in the market. The share price of a company is directly related to the amount of profits American companies either earn or have the potential to earn.
Client: Larry, Tell me more.
Larry: OK. The bigger the economy the greater the potential to earn profits. It’s all about the size of the economy and its ability to grow over time. These are the keys!
When I started in the business in 1984, the U.S. economy produced ~$4T in goods and services (“stuff”), as measured by gross domestic product (GDP). In 2023, the economy produced ~$27T in goods and services. So, the economy was almost seven times as large at the beginning of this year. (1)
It’s All About Selling Stuff
Generally… We have many more people. People tend to make a lot more money today than they did 40 years ago (wages tend to grow with inflation on average). So, we have more people spending – and the average person spends more.
New companies are born every day, so we have many more companies. Many companies are so much larger than they were 10, 20, 30 and 40 years ago. If a company grows it means it sells more stuff. The more stuff we sell the more money we potentially can make.
This is why the economy is bigger. We have more companies selling more stuff to more people. So, a bigger economy has the potential to produce more profits.
Sales>Profits>Values
Profits support the value of companies. The stock market is, essentially, the sum of the values of all companies.
So…Why Have Stocks Risen in Value Over Time?
Answer: The stock market tends to follow the growth in the economy over many years.
The Ride Has Rarely Been Smooth
Since 1984 we’ve had a number of challenges, including:
- Four economic recessions and ensuing market downturns
- Several market downturns without an accompanying recession (usually short-lived)
- The 1987 one-day market crash
- Hundreds of bank failures (over several different occasions)
- Two real estate speculative bubbles that popped
- The bursting of the internet bubble
- A number of very destructive hurricanes and wildfires
- Several instances of crushingly high energy prices
- The 9/11 terrorist attacks and the ensuing War on Terror
- The Asian currency crisis
- The European debt crisis
- Swine flu, bird flu, Ebola and Covid
- Several different wars in the Middle East and elsewhere
- Russian aggression against the Ukrainian people
- The worst global inflation in more than 40 years
- And seven presidents, each disliked by between 35%-65% of The People.
Although past performance cannot guarantee future results, despite the challenges, the economy has recovered and grown to ever larger levels.
Many of you have heard these words before but people have busy lives and don’t deal with these issues day to day. Our conversations and the points made in my letters tend to fade away over time. But you know I’ll regularly reorient you.
“1000 Points Aren’t What They Used to Be” or “Percentages Tell Us the Truth”
Quiz question:
- If client A’s $1,000,000 portfolio rises by $100,000 and Client B’s $100,000 portfolio rises by $10,000, which did “better?”
Quiz Answer: Each portfolio performed equally – each rose 10%!
Question: If the DJIA rises or falls 1000 points in a day, is this a big day or not?
Answer: It depends on the starting level of the DJIA.
If the DJIA starts at:
- 1,240, a 1,000-point gain or loss is an 80%
- 10,000, a 1,000-point gain or loss is a 10%
- 20,000, a 1,000-point gain or loss is a 5%
- 40,000, a 1,000-point gain or loss is a 5% move.
Your Portfolio Moves in Percentage Terms – Not in Point Terms
Monday’s down market was the 12th largest point decline in history, but only the 422nd largest market decline (in percentage terms)! (2)
So… 1,000 points aren’t what they used to be!
What If…
Over the next 10 years, the DJIA would approximately double if the markets grew 7% annually, for example (which is below the long-term trend). This means, at a 7% annual rate of growth, the DJIA would be somewhere around 80,000. So, if the economy grows similarly to the way it has since WWII, the daily point movements will hopefully continue to get larger over the coming years as they always have.
Why Do Investors “Endure” Recessions?
- Recessions are a drag! So, why subject ourselves?
- Although past performance cannot guarantee future results, stocks* have shown returns well above bonds and inflation over many years.
- Many retirees continue to invest in stocks with a large portion of their financial investments in an attempt to offset the deleterious effects of inflation – to try to grow assets for their later years and for their heirs.
- We’ve found most of our retirees require growth of their money, if they’re to meet their long-term goals!
*Keep in mind, when I refer to “stock” I may be referring to a diversified portfolio of individual stocks, stock-oriented mutual funds, or both.
How Do We Endure a Recession?
- Since stocks can perform poorly for very long periods of time, many investors can potentially reduce the volatility of their portfolio of financial assets by reducing stocks as a percentage of assets and increasing bonds/cash – to a proper target allocation, which we can live with through difficult cycles. This is particularly true as we age. Remember:
- Your stock to bonds/cash allocation is at the top of the discussion list when we have a phone, Zoom, or in-office review.
- My three rules for retirees (see below).
In Retirement
In retirement, people generally live off:
- Interest from bonds,
- Dividends from stocks,
- Any appreciation from stocks that we sell against,
- Social Security benefits,
- Pensions, if any
- Part-time work for those who are able, willing, and inclined.
Why Do We Have Bonds in Our Portfolio?
Larry’s Three Rules for Withdrawing Off the Portfolio in Retirement:
- During normal times: Look to take off stocks and bonds/cash proportionately to maintain the proportion.
- During strong market periods: Try to sell more against our stock to keep our stock allocation from rising above the target.
- During recessions: Try to use bonds and cash to avoid selling stocks “low.”
- This (Rule #3) is the main reason we believe in having bonds in our portfolio!!
In summary:
- Although past performance cannot guarantee future results, historically, stocks have broadly outpaced inflation by a wide margin over many years.
- Broad market averages are much higher than in the past because the economy is much bigger.
- The economy has broadly grown because Corporate America has sold more stuff over time.
- Our portfolio values vary in percentage terms.
- Monday’s decline was the 12% largest DJIA point decline, but only the 422nd largest DJIA decline when measured in percentage terms. The Dow finished the week of August 5th down less than 1%.
- Despite the various challenges we’ve faced, the economy has recovered and grown to ever larger levels.
- Many investors have a portion of their assets invested in stock-oriented investments in an attempt to offset the deleterious effects of inflation on the buying power of our money, and to grow the money for their later years, their children, their grandchildren etc.
- We must endure periodic recessions, which do not come around like clockwork. Stocks can perform very poorly for long periods of time.
- Investors should have that amount in stock – as a percentage of all financial assets – which we can live with through good and bad cycles.
- Bonds can add income to portfolio and help us to endure recessions.
- Setting our stock to bonds/cash ratio should not be done based on a “calendar,” as economic cycles don’t follow a calendar. This is something we discuss during our financial reviews.
I’m already working on another letter. I’ll be making different points.
Enjoy the rest of your summer!
Larry
Important disclosures
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Sources:
(1) The St. Louis Federal Reserve Bank
(2) Raymond James “Up and Adam,” Larry Adam, Chief Investment Officer
Other Sources:
Raymond James Washington Policy Weekly Wrap, Ed Mills, Alex Anderson
Raymond James Weekly Investment Strategy
Raymond James Weekly Institutional Equity Strategy
Raymond James Weekly Economic Release
Raymond James Daily Morning Brew
Raymond James “Up and Adam,” Larry Adam, Chief Investment Officer
The Wall Street Journal
CNBC Professional
Bloomberg News
Financial Advisor Magazine
New York Times
The Boston Globe
Index Definitions
The Dow Jones Industrial Average (DJIA, “The Dow”) is a price-weighted arithmetic index of 30 significant companies traded on the NYSE and NASDAQ maintained and reviewed by editors of the Wall Street Journal. You cannot invest directly into an index.
Important Disclosures
Any opinions are those of Larry Eppolito and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change. This information is not intended as a solicitation or recommendation of any kind. Investments mentioned may not be suitable for all investors. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Diversification and asset allocation do not ensure a profit or protect against a loss.
Mutual Fund Disclosures
Investors should carefully consider the investment objectives, risks, charges and expenses of mutual funds before investing. The prospectus and summary prospectus contain this and other information about mutual funds. The prospectus and summary prospectus are available from your financial advisor and should be read carefully before investing.
Keep in mind that investing involves risk. The value of your investment will fluctuate over time, and you may gain or lose money.
Stocks offer long-term growth potential but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations and the potential loss of principal.
Investing in fixed income securities (bonds) involves certain risks such as market risk, if sold prior to maturity, and credit risk, especially if investing in high yield bonds, which have lower ratings and are subject to greater volatility. All fixed income investments may be worth less than original cost upon redemption or maturity. Bond prices fluctuate inversely to changes in interest rates. In other words, if interest rates rise, after your purchase, you may receive less than your purchase price should you liquidate early. Bonds provide a fixed rate of return if held to maturity.
Past performance is not indicative of future results and there is no assurance that any investment strategy will be successful.
Stock dividends are not guaranteed and are subject to change or elimination at any point without notice.
Other Important disclosures
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