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Quarterly Commentary

April 2021

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January 7, 2021

To the friends and clients of the Harvey Investment Company:

The stock market notched another strong result in Q1 2021. Building upon the 18.4% advance last year, the S&P 500 advanced 6.2%.  More stunning is the five-year annualized growth rate of 16.3%.

The rally broadened as companies that depend on healthy overall economic growth kicked in while the hot tech stocks of last year languished.   Evidence of this transition was provided by the divergence in the performance of the popular market indexes.  The S&P, as mentioned, was up 6.2% for the quarter, the Dow Jones Industrials were up 8.3%, while the tech heavy Nasdaq gained 2.9%.

Anticipating a sharp recovery in the economy, intermediate term interest rates jumped sharply.  The yield on the 10-year US Treasury bond leaped, nearly doubling to 1.7%. This rise caused investors a temporary bout of anxiety and volatile equity prices, but equanimity was quickly reestablished.  It appears investors welcome a short-term pop in the economy, but expect powerful longer-term influences to assert themselves and keep inflation subdued.  Inflation and inflationary expectations are the primary determinants of interest rates which directly affect stock valuations over time.   

We have been accused of occasionally building our quarterly letters around quotes that we find especially clever. Under oath, we would confess to this being the case.   In July of 2019, we quoted Albert Einstein as saying, “If I had an hour to solve a problem and my life depended on the solution, I would spend the first 55 minutes determining the proper question to ask….for once I know the proper question, I could solve the problem in less than five minutes.”

The problem at hand is one only you can answer.  What do you want from your stock portfolio?  Though your life doesn’t depend on solving this problem, it is an important question.   You could answer by naming the annualized return you expect.   Or, to get at it, you might attack the problem by asking a question requiring a more concrete answer.  For example, assume you don’t take any income from your stock portfolio, and there are no additions or withdrawals, how many years do you expect it to double in value?  Or, perhaps more revealing, what length of doubling time would be a disappoint to you?

Here are some considerations:

- The long-term return on stocks, using the S&P 500 index as a proxy, yields varying returns.   From 1957 to 2018, fifty years, the return was 7.96% annually. For the last 30 years, the return was 9.11%.  From the end of 2010 to the end of 2020, the return was 13.88%.  Clearly, the start and end points really make a big difference, as does the length of the measuring period. 

- A portfolio growing at 5% a year doubles in 14 years.  A portfolio growing at 10% a year doubles every 7 years.  A portfolio growing at 15% a year double every 5 years.

- Over any meaningful time period a portfolio’s growth will produce a return that closely approximates the underlying growth of the earning power of the companies in the portfolio.  Over the ten-year period mentioned above, the S&P 500 grew at 13.88% while its underlying companies grew earnings at 5.62%.   The wide difference is a stark reminder of how much the start and end points of the measurement period determine the result.    

- The record of investors beating the return available from owning a large, well-diversified basket of stocks is poor, though many strategies are employed to do just that.  Each strategy, and the diversified approach as well, carries its own risks.   Understanding these risks, and assigning the proper weight to them, is a key element in hatching a plan for the future that will produce a result that is satisfactory to you.  

Perhaps you concluded long ago that this problem is so full of nuanced variables that attempting to answer it is a pointless exercise.  (Of course, we all want the 15% return but without risks.)  In any case, a big part of our job is to help our clients develop plans that fit with the risk levels they are willing and able to take.  It is particularly timely in today’s frenzied market climate to review and reaffirm that your portfolio is structured in a way that will likely meet your aspirations.  We welcome a visit to help you in this endeavor be it over the phone, via a Zoom call, or in person.

Regarding risk and reward, we wrote in our inaugural investment letter, “We believe there is an investment discipline which, if practiced diligently, leaves wide open the tremendous benefits common stocks offer and, also, meaningfully reduces the risk of substantial, permanent loss of capital.  The Holy Grail for investors is more reward and less risk.  The approach that offers this is easy to describe and understand.”   Twenty-one years of practicing this discipline has left our faith in it undiminished.

One favorite quote that we haven’t yet been able to work into a letter is, “There is not much traffic on the extra mile.” We drive the extra mile to expunge superficial judgements and generalizations---the killers of sustained superior performance.  Avoiding these twin demons is, perhaps, the key to the discipline we practice.

 We sincerely thank you for your patronage and loyalty.        


 Samuel C. Harvey