Large US Companies’ Cautionary Tale

State College, PA – Large growth companies have been the top performing asset class for the last several years starting back in 2014. They have been better than small and value companies by comparison in six of the last seven years. 

This environment does create pause for the academic minded investor knowing the historic reality of small and value companies’ outperformance of large growth companies. It is always a mental challenge when we see one asset class shine for several years, especially when the majority of the 20+ other asset classes are waning. It is not uncommon in a well-diversified, global-based, portfolio to see some asset classes down while others are up, (dissimilar price movement, umbrellas vs suntan lotion) that’s diversification being applied. We know this is nothing new and has happened many times in the past historically where one asset class outpaces the other for a period of time. We do have to remind ourselves that we are getting all the returns of that asset class but often rolling the profits into asset classes that are down in order to take advantage and rebalance. This would be 1 of 3 of the primary tenants of investing: own equities (stock), diversify (umbrellas, suntan lotion), and rebalance (asset classes back to a target % of ownership). 

As humans we have a very short-term mindset and memory, especially when it comes to investing. Times like these require discipline to take the profits from the one strong asset class and spread it out over the other areas. The visual effect looks like a portfolio may not be gaining ground based on the current account balance, but, in fact, you’re gaining shares of ownership in the majority of the other 20+ asset classes. 

I was recently discussing this concept of rebalancing with a client whose vocation is farming. He made this comment, “So I had 100 pigs before the market went down, now I still have 100 pigs, but they’re just leaner right now.” Yes, you still have the 100 pigs they are just skinnier in the current environment. But….because a few of the pigs are fat we are going to send a couple of them to the market and trade for several skinny pigs to add to the fold. You see, we are looking at it from a long-term perspective, recognizing that different seasons bring different conditions for the pigs. 

Currently the only pigs that are really fat are the large growth companies. Many other areas of the market, especially US small/value companies along with emerging and developed international markets, are the skinny pigs right now (COVID crunch). However, this is also a cautionary tale. When one area of the market is predominantly up, the tendency is to grab more fat pigs rather than looking to the skinny pigs and the long-term value breakdown. This is why discipline is so important with continued rebalancing, otherwise we get too heavily weighted in one area.

A great example is looking at the Standard & Poors 500 index which is made up of 500 US large companies. Currently five US large tech companies: Google, Facebook, Apple, Microsoft, and Amazon make up 23%. Majority of the portfolios we analyze are already weighted heavy to the large growth side. A compounding factor is how heavily the large index is weighted to just a few companies. It’s a reminder, this is how many people lost huge amounts of wealth in the tech bubble of the early 2000s. We are seeing that set up all over again, in the same area ironically. A well-diversified portfolio is rarely sexy so to speak, but is sustainably producing, long-term financial security, historically. 

Academically we must do what is counterintuitive to our human nature, currently run toward the pain (buying small and value currently) and run away from the pleasure (selling US large growth companies).

Harnessing the value achieved through rigid academic rebalancing, buying stuff when it’s down, selling stuff when it is up, takes time and discipline. You see it might be a two-year window, it might be a five-year window, one never knows. What we do know is equities, diversification, and rebalancing are three solid, indisputable, academic truths of investing. One of the things as a financial coach that’s always been difficult, is getting people to realize the underlying value that they have in a global based portfolio even when the balance is down. Times like these will test your investment philosophy and sleep factor. It is part of the human wiring where we are constantly trying to find patterns in our lives, along with the emotion of fight versus flight. To run toward pleasure (buy what is up) and run away from pain (sell what is down) is natural and hard wired into our DNA. Academically we must do what is counterintuitive to our human nature, currently run toward the pain (buying small and value currently) and run away from the pleasure (selling US large growth companies). What we do know is that from 1927 to 2019 that US value companies returned 11.8%, compared to 9.9% annually for US growth companies. When we look at small it was 11.4% compared to 10.2% annually for US large companies. Hindsight is always 20/20. Prudence and discipline have always reigned supreme in the world of investing. 

About Paul Nichols

Paul is the founder of Financial Abundance, a Registered Investor Advisory firm and EDI, an Estate Planning Firm with offices in State College and Lewisburg. He has been working with individuals, families and businesses for over twenty years, including many Fortune 500 companies. He has educated tens of thousands of people through seminars, workshops and various international speaking engagements where he shared the stage with many notable individuals such as Ronald Reagan, Robert Kiyosaki (author of Rich Dad, Poor Dad), Mike Ditka, General Schwarzkopf, and Newt Gingrich to name a few.

In 2000, after many years of traveling to consult companies and individuals, Paul decided to relocate from Colorado to State College, PA (his wife’s hometown) to develop a local advisory firm.

Paul operates under the core belief that education plus understanding leads to clarity and confidence; resulting in peace of mind. He is a proud father of three and devoted husband of 20 plus years.

Some of Paul’s accomplishments:
Regular contributor to the Centre Daily Times, via the “It’s Your Money” blog
Featured in the movie Navigating the Fog of Investing
Regular contributor to Town & Gown as the publications Investor Coach
Host of the weekly iTunes Podcast, It’s Your Money
Member of the Western PA Better Business Bureau
Member of the Centre County Chamber of Business and Industry