Welcome to a special edition of Murdison Minutes. As much of the financial community is intent on providing their outlook (predictions) for the year ahead, we thought it was more fitting of our investment strategy to offer up the lessons we learned in 2023. We believe that year ahead outlook pieces do more to placate investor's behavioural biases than they help produce beneficial investment outcomes. More on that in our first lesson:

A year ago, the resounding consensus was for a recession by mid-year, which would lead to interest rate cuts. This "obvious" future outcome tempted many investors into government bonds that would benefit handsomely from rate cuts. The regional banking crisis in March motivated many to double down on their recession and rate cut prediction and portfolio positioning. This all made sense to a "rational" human brain, but unfortunately, market's consistently disregard what smart people think makes sense.

Our research was focused on a more knowable set of information; inflation remained 2-3 times above target, and long-term government bonds traded well below their long-term average yield once you factored in inflation (real return). Short term bonds paid higher yields and had less risk than long-term bonds if inflation stayed high and rates continued to climb.

As we all know, a recession never materialized and rates continued to climb until November, causing another 10-months of pain for many bond investors. This was just one clear example that reinforced our long-held belief that betting big on predictions is not a reliable investment strategy.

The financial media birthed another piece of hopefully soon-forgotten jargon in 2023: "The Magnificent Seven", refers to the seven largest companies that make up the S&P500 – Apple, Microsoft, Amazon, NVIDIA, Alphabet, Meta and Tesla. These seven companies make up nearly 30% of the entire S&P500, so their stock performance has a profound impact on the movement of the total index and they were collectively up over 100% in 2023. The S&P500 returned 26.29% in 2023, but if you exclude the Magnificent 7, it returned less than half that (approximately 12%). The conclusion, if you are a stock picker, it was critical you owned at least some of those 7 stocks. To make a stock-picker's job even trickier, it wasn't only important you owned them, you had to have a large allocation to them (again, the index has nearly 30% allocated). For example, if you purchased the same 500 stocks as the S&P500, but you allocated equally to each of them (instead of by each company's market capitalization), your return was 14%, or only a little better than if you didn't own the Magnificent 7 at all!

Our lesson, beating stock market indices by picking stocks is very, very difficult and perhaps becoming increasingly so. Most investors like owning quality stocks and/or ones with names they recognize and business models they can understand. Not surprisingly, these are often also the biggest companies. Thus, they tend to make up most of stock market indices. Over time, the returns from high-quality, large, "blue-chip" stocks are fairly similar. The challenge to stock pickers is buying high valuation, relative newcomers like Tesla or Amazon. By the time they become name-brands, they are often trading at high valuations and have already had fantastic price appreciation, typically not factors that "quality" investors are keen on. This is one of the reasons 92% of Large-Cap equity mutual funds underperform the S&P500 (source, "S&P Indices Versus Active Scorecard", Mid-Year 2023).

Buying an index for core equity allocation not only provides majority exposure to those "blue-chips", but also the potential to participate in the next growth story like Tesla or Amazon. Only a select few see these growth stories coming and/or have the conviction to hold their position in even after exponential returns. Couple that with the significant tax and portfolio management efficiencies and the case for indexed core equity exposure is compelling.

2022 was a rough year for investors. In fact, it was perhaps one of the worst years most investors had experienced because almost all asset classes lost considerable value for the calendar year, that doesn't happen often. Typically, a few asset classes go down and a few go up and typically whatever trend is in place, doesn’t persist for the entire year. Unfortunately, that was the case in 2022. Stocks fell, bonds fell, plenty of real estate fell. Amongst the worst hit were stocks that were classified as technology or growth stocks. The Nasdaq 100 index that is heavily comprised of large technology companies, fell 33%.

Turn the page to 2023. The worst hit sectors and stocks of 2022 produced huge gains, with the Nasdaq 100 up 54%, its best annual return since 1999. Even bonds managed to eke out gains thanks to falling yields in the final two months of the year.

Nearly 60% of the returns from the S&P500 in 2023 came in only two months (January and November). If you missed January, you made 20% instead of 26%. If you sold at the end of October, after three months of declines you only earned half the return.

Computerized, high frequency trading is partially responsible for markets moving faster than ever. The odds are increasingly against trying to time the market. Yes, asset prices swing wildly and at times can become over or under-valued but typically it is only obvious with the benefit of hindsight. Identifying those environments in real time, then executing a profitable strategy is an incredibly low-odds proposition. This doesn't mean "do nothing", but we think too many investors try to do too much, to their own detriment. The "fat pitch", where there are obvious deals in the market are incredibly rare.

I read an interesting study from Morningstar that argued that if most large-cap equity fund managers went on vacation for ten years, their returns would have IMPROVED! The reason is that the companies they initial owned ten years ago were excellent long-term investments, but unfortunately, the manager's inclination to "tinker" meant that they sold off companies that ended up producing better returns than what they replaced them with. This makes sense when you think of what most people are inclined to do when they have big gains…sell/take gains. When in fact, the data suggests investors should hold on to their best performing positions most of the time.