Or how I learned to hate globalization and embrace my inner nationalist
2016 was a year of surprises, to say the least, but these surprises do not seem random. There appears to be a pattern here — people feeling forgotten and shaking their fists and shouting, “we’re not going to take it anymore,” while the incumbent parties react with dismay and even resentment. And then the polls turn out to be wrong and the “unthinkable” becomes the new reality.
We are observing the election results and political movements in various countries and following capital markets and currencies. None of this is about a political point of view; it is just observing what is happening. One obvious lesson is that things are unpredictable, even when they seem to be clear and “everyone” agrees on something. That’s why we do not make market bets, thinking we know what is coming next.
In the U.K., the tipping point apparently came when the European Union (EU) authorities in Brussels threatened to take away their tea kettles and toasters! Believe it or not:
The U.K. had already declined to join the now deeply troubled euro currency deal (see PIIGS1). Now, they are exiting the EU and keeping their tea kettles, thank you very much.
Meanwhile, we don’t need to remind you of the tumultuous U.S. election. The difference turned out to be working-class people in places like Pennsylvania, Michigan and Wisconsin feeling ignored, and switching their votes to elect someone who did speak to them.
In many other parts of the developed world, particularly in Europe, populist parties and candidates are threatening to upset the apple cart and turn away from the leadership of elites, who seem to some to have more in common with each other (globally) than with many of the people experiencing the results of their policies.
Stay tuned — this may just be the beginning. As Italian banks teeter on the brink of insolvency, the entire EU may be in serious jeopardy.
So what does this have to do with my portfolio?
Well, in the six months since Brexit, the U.K. economy has been the strongest among the major European economies and stronger than the U.S. After predictions of doom, things proceeded to improve. Funny how that works sometimes.
In similar fashion, U.S. equities suffered a brief, overnight decline in futures markets on election night, immediately followed by what is now being called the “Trump rally.” Conventional wisdom called for disaster, but was wrong. Again.
We do not know what is coming next; we stay invested. We know good and bad things will happen, often rapidly and unexpectedly. This is long-term investing; the events of the day will cause us to feel fear and greed, but our discipline keeps us on track regardless.
Anything of special note happening on the investment side?
Well, yes, as a matter of fact. You may recall that a year ago, we were discussing “FANG” stocks: Facebook, Apple, Netflix and Google. Large-cap growth stocks had once again2, through 2015, put on a multiyear run so that small cap and value appeared to be underperforming, despite the fact that those two factors, small cap and value, have clearly outperformed in the long run and are expected to add long-term return to the portfolio. We even had Rafia Hasan, our Director of Investments, record a short video discussing the subject.
2016 was a big year for small cap and value. As Rafia explained in the last video and will continue explaining in a new video (coming soon!), these factors do not outperform the broad markets each and every year. You have to hang in there sometimes, and this year was a perfect example of what we were waiting for.
Side Note: Dimensional Fund Advisors (DFA) Funds
As you know, we make extensive use of DFA funds in our portfolios. These funds are often called “smart passive,” because while they are passive like index funds — holding large numbers of stocks at low cost and not seeking to pick stocks to beat the market — they are designed to add extra weight to small stocks and value stocks to add long-term return. And they do not have to do costly trading to match a particular benchmark. In a very smart and low-cost way, they deliver the return of parts of the equity market we want to have more of.
Two examples from domestic-equity DFA funds make the point for 2016. While the S&P 500, the broad large-cap benchmark, earned about 12%, these two DFA funds — designed to deliver more value and/or small-cap exposure — earned a lot more:
S&P 500 11.96%
DFA Large Cap Value 18.89%
DFA Small Cap Value 28.26%
Source: Dimensional Fund Advisors
Sometimes, the extra return comes in big chunks, unexpectedly and rapidly. So we stay invested and wait for it. It works.