Episode 9 – Smart Phones versus Pizza: Which is the better investment?

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Hello, everybody. Thank you for tuning in to Market Perspectives, a Mercer Advisors podcast where we provide a data driven, common sense perspective on the economy, on markets, and on investing. I’m your host, Don Calcagni, Chief Investment Officer at Mercer Advisors.

Well, I know it’s been a long time since I’ve done a podcast. I think it’s been about three or four weeks. It feels like an eternity to me. I had a pretty severe head cold for the better part of a month, and actually lost my voice for the better part of about three or four weeks. And so obviously, trying to record a podcast when you don’t have a voice is quite challenging. But I’m back in action and looking forward to today’s conversation.

So today, I’m going to focus on this topic around diversification and really what’s happening in the market today. Year-to-date, we have seen an explosive run up in technology stocks, specifically stocks related to artificial intelligence, these AI stocks that seem to be all the rage these days in the market.

And I’ll just highlight one stock specifically, and that’s NVIDIA. NVIDIA is up over 200% year-to-date through Friday’s close of business. So a very significant run up in that particular stock.

And we’re seeing it across technology stocks as a whole. I think technology overall is up somewhere around 35-36% as a sector thus far for the year, year-to-date through Friday’s close. So quite significant.

So when we see stocks like this running up, it’s very common. And I think this is a very human feeling where we have this sense that everybody’s getting rich except us. We call that FOMO, the Fear Of Missing Out. And when you’re seeing these AI stocks dominating the headlines and you see those explosive gains, many of us start thinking to ourselves, well, gee, how come I don’t own that. Or maybe if you already do own that may be thinking, well, why don’t I own more of that.

And if you really think about what those questions are that are ping-ponging around in the back of our minds, those are really questions around diversification. And so I thought it would be helpful to step back and actually look at some real world market data on this idea around just picking one or two or a small handful of stocks to build a portfolio.

And so what we’ve done here is we’re actually looking at data that goes all the way back to 1926. And what we’ve done is we’re looking at that the returns on individual companies compared to the entire stock market. And we’re looking at those returns over a 12-month basis, over a 3-year basis, a 5-year basis, 10 years, and then 20 years.

And we’re asking ourselves a very simple question, and that is, what percentage of individual stocks in the market underperformed the market as a whole? And the whole point here in going through this exercise is to highlight how painfully difficult it is to pick a handful of winners that are going to outperform the market as a whole.

And so when we look at that data and we look at the returns on individual stocks relative to the entire stock market, what we see is that over any 12-month period, going all the way back to 1926, that 54% of stocks actually underperformed the market. I’m going to say that again.

54% of stocks underperformed the market over a 12-month period. Those aren’t very good odds. What that means is that you had a 54% probability of underperforming the market if you just pick any individual stock in the market.

Now, those odds get worse, not better, as time goes on. So much so that by the 5-year mark, 71% of stocks in the market underperformed the market. Meaning that you would have been better off just buying the entire market as a whole in the form of a diversified fund, could be an ETF, could be a mutual fund, doesn’t matter. The numbers get worse. By the time we hit the 20-year mark, almost 90% of individual stocks in the market failed to outperform the market as a whole.

Now, the takeaway from this data is that we should just buy the whole market and not try to find the next Apple, Amazon, Google, whatever the case might be. In this case, perhaps NVIDIA. And I want to give you another example here, just to highlight how difficult it is to pick an outperforming stock.

Let’s go back to late 2009. So this is in the aftermath of the global financial crisis.

This is when the iPhone was starting to become really popular, this whole idea of a smartphone. And if I were to ask you, in late 2009, what you felt the best performing stock would be over the next 10 years, what stock would you pick?

Many people would have picked Apple. Some would have picked Amazon, perhaps Google. Facebook, I don’t think was even public yet.

And those would all be relatively good guesses. I mean, Apple did amazingly well between 2010 and the end of 2019.

The reality is, all of those guesses would have been wrong and they would have been wrong by a mile. The absolute best performing stock in the market for the 10-year period from 2010 until the end of 2019 was Domino’s Pizza.

You heard me right. That’s Domino’s Pizza. A pizza company outperformed Apple.

They sold pizzas.

Apple was selling smartphones. Domino’s is selling pizzas. I doubt that there were many analysts in the market at the end of 2009 that correctly predicted that Domino’s Pizza would outperform Apple over the following 10-year period.

Domino’s Pizza returned 43% annually. It was up over 3,400% during that 10-year period, versus about 25% for Apple and many other technology companies. So 43% average annualized returns. That was a pizza company, not a technology company, not NVIDIA, nothing like that. A pizza company delivered blockbuster returns over that 10-year window.

And so the whole moral of that story is just to highlight how painfully difficult it is to predict accurately tomorrow’s biggest winners. And what I would say is that there’s really no need to try to predict tomorrow’s biggest winners. And that’s because if you have a diversified portfolio, and clients at Mercer advisors do, diversified portfolios already own all of those popular AI stocks.

We already own Microsoft, Google, and yes, Domino’s Pizza. I actually took the liberty of looking at our underlying holdings in our average global equity portfolios. We run a range of different global equity portfolios. So I looked across them on average. And I just wanted to see what was our allocation to NVIDIA across our global equity portfolios.

And on average, NVIDIA is actually our fourth largest holding by individual companies. Microsoft was our largest holding, followed by Apple, followed by Meta, NVIDIA, Broadcom, Alphabet, Amazon. So we already have exposure to these companies, by definition, when we invest in a broadly diversified portfolio.

And so there’s no need to try to predict what’s going to happen to individual companies, or individual sectors, or whatever the case might be, over the next 30 days, 12 months, 1, 3, 5 years. You don’t have to play that game. And in fact, you’d be better off by just buying a well-diversified portfolio rather than trying to pick tomorrow’s biggest winner.

Let me give you one more example. If we go back to late 2021, something a bit more recent. You may be thinking, Don, 2009, 2019, that’s ancient history by now. And I was thinking to myself when I was putting together my notes, I’m like, OK, maybe that’s fair. So let’s look at something perhaps a bit more recent.

If we go back to late 2021, what we see is that technology stocks continued to be on a tear, coming out of the whole COVID shutdown. We saw great companies like Amazon continue to do quite well. And so in late 2021, there were many investors who were overweight technology, who felt that technology was going to continue to do well going forward.

If anything, energy stocks were boring. We were still dealing with global shutdowns. Price of energy had come down. But then we entered 2022.

And what happened? The market began to correct. The valuations came down. The Federal Reserve began raising interest rates.

Oh, and by the way, Russia invaded Ukraine and sent the world’s energy markets into a bit of a tizzy and the price of oil had skyrocketed. And so in 2022, well, what happened? Well, technology was actually down almost 30% in 2022. And energy stocks, these boring energy stocks, actually returned almost 58% in 2022.

And as things came to an end, at the end of 2022, many investors began to think, gee, maybe I should have more energy in my portfolio. Energy is doing so well. This war in Ukraine doesn’t look like it’s going to end. We’re entering into what could be a really cold winter.

And oh, by the way, there was a sabotage of the Nord Stream gas pipelines in Europe. And so logically, I think a very well-meaning, very well thought out investment thesis was, hey, let’s overweight energy heading into 2023. And by the way, maybe we should lighten up on those technology companies heading into 2023, since they’re not doing so well and didn’t do so well throughout 2022.

Well, of course, these things rotated yet again and energy is flat this year. I think it’s positive about 0.14%

through Friday’s close of business. And technology is up 36% for the year. So my point here is that if you’re thinking, well, OK, Don, I’m not going to try to pick individual stocks, but maybe I can time sectors.

Maybe sector rotation is a viable strategy for predicting or outperforming where the market is going to go in the next, let’s just say 12 months.

I would argue that’s exceptionally difficult to do. And again, you don’t need to do that. Market returns over time, reward investors with good returns. You don’t need to try to look for the next Domino’s Pizza. You don’t need to look for the next Amazon.

So what are the takeaways here? And I think the most important takeaway from this discussion is that the biggest risk in our portfolios isn’t anything that we own or don’t own, it’s ourselves. The biggest risk in any investment portfolio is not the investments, it’s the investor.

It’s our behavior. It’s how we go about making decisions. It’s how we respond to external stimulus. The financial press could be the business channel on television, could be the headlines. It’s how we keep our own behaviors, our own biases, our own impulses.

How do we keep that in check? How do we keep FOMO, that fear of missing out in check? And how do we resist this drive that we have to keep up with the Joneses, which in this case would be to try to outperform the benchmarks. How do we resist all of that?

Well, I think there’s three time-tested, well-proven strategies to do that. Number one is broad diversification, both across global asset classes, both public and private markets, and then diversifying within those asset classes, not just owning one or two, or five, or 10, or 20 stocks, but owning hundreds or thousands of companies.

So that’s number one. And the nice thing about diversification, by the way, is that you can say to yourself with confidence that no matter whatever it is at the moment, that’s doing a great job in outperforming the market, you can say to yourself legitimately that you likely own some of that. So you still have bragging rights when it comes to thinking about your portfolio. Yes, we own NVIDIA and we own Microsoft in our portfolios. So that’s number one, is broad global asset class diversification, both across and within asset classes.

Number two is having a well-designed, often reviewed and updated financial plan. Investing is not meant to be some sort of gladiatorial spectator sport. It is a means to an end. It is how we help our families achieve the goals and objectives that we have for ourselves and for our loved ones.

It is a very serious exercise that requires prudence. It requires foresight. It also requires patience. Patience, arguably one of the most lacking ingredients in most investment portfolios.

So that’s number two, is having a plan. We need to understand what are we investing for. What’s the why behind the portfolio.

Finally, number three, is having a trusted advisor. Now, I know that sounds a little self-serving for a moment. So here me out.

All of us, I hope, have a family doctor. All of us, I hope, are going in for our annual physical.

And if you think about the parallels between financial health and our physical health, there are many. And we go to our family physician to get their advice.

All of us these days can jump on our smartphones and research our different health challenges. And the internet is full of all kinds of health advice on everything from nutrition, to exercise, even how to perhaps cure cancer.

But I think it’s critically important that we go to our family physician once a year to get the truth, to understand, at least for us, given our unique health, given our unique chemistry, what is the best way to ensure that we maximize our health span. Not just our lifespan, but our health. How do we maximize our health so that we’re living not just longer, but healthier lives.

So the whole idea here behind working with a trusted advisor is to have somebody that you trust who can hold us accountable. My family physician will never tell me that it’s OK to stop exercising. They will never tell me that it’s OK to eat garbage food. As much as I love snacks and things like that, there’s just no way they’re ever going to tell me that. And that’s their way of holding me accountable.

It’s the same thing in working with our advisor.

A trusted advisor can run interference difference between stimulus and response. The stimulus being, of course, the financial press, maybe it’s the business channel.

And the response is we go into our account and we start putting all of our money into one or two stocks. So having that trusted advisor to hold us accountable, to make sure that we are making the best decisions possible for ourselves and for our loved ones, that is a great way to keep our own behaviors in check.

Well, that’s all for today. I hope our listeners found that helpful. And as always, if you should have any questions, please feel free to reach out to your advisor here at Mercer Advisors, and we will do our absolute best to get back to you as soon as possible. I’m Don Calcagni. And we look forward to seeing you next time. Thank you.

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