Don’t Chase Performance • Market Efficiency and Predictions • California Municipal Bond Update
Monthly AIRE Perspectives – February 2025
Dear Friends and Valued Clients,
Please see below for The MAP – Monthly AIRE Perspectives for this month.
Stock Markets: Don’t Chase Performance
Much of what we discuss with clients with regards to investing in the stock market relates to the Efficient Markets Hypothesis (EMH), which states that all news, expectations and information instantly get priced into the stock market, making stock picking and market timing very difficult, if not impossible. However, this does not mean we bury our heads in the sand and don’t consider factors that need to be considered, particularly as they related to the principles of successful long-term investing. Behaviorally, investors often have the urge to chase the best performers of the recent past, even if the long-term patterns of those investments have not matched their recent performance.
One case in point is the performance of large-cap growth stocks, which have had the best performance of all size and style asset classes (large cap growth, large cap value, mid cap growth, mid cap value, small cap growth, small cap value.) This has largely been due to the performance of the “Magnificent Seven” – all great companies that are among the most successful in history. However, we do not recommend chasing these winners – even if they continue to outperform – as the performance of this category has been a historical anomaly. We invest in all six of the aforementioned asset classes (including large cap growth), with a balance between both growth and value stocks. In fact, historically, the best-performing of these six categories of stocks has been small cap value, followed by mid cap value, large cap value, mid cap growth, and then large and small growth. By remaining balanced between these six categories and not trying to make predictions on which is going to be the best performer going forward, we stay diversified and reduce the risk of underperformance of any one category. We remind clients not to fall victim to chasing the best performance of the recent past. You can view the chart below on performance, followed by an article from Dimensional on the recent outperformance of large cap growth.
Above the Fray. How Extreme Was Recent Large Growth Outperformance?
Wes Crill, PhD, Senior Client Solutions Director and Vice President
US small value stocks underperformed large growth stocks by about 4.5% per year over the past five years. Some investors have asked what went wrong with small value to garner such underperformance. Looking at returns over this period compared to the long term, we see the story is more about what went anomalously right for large growth.
Small value’s five-year number was squarely in the middle of its historical range of outcomes for rolling five-year returns, which span from -1.1% at the 10th percentile to 28.8% at the 90th percentile. Small growth and large value were both similarly far from their extremes over the past five years. Large growth, on the other hand, bumped up against its 90th percentile outcome of 19.6%.
It’s not clear that recent performance for value versus growth is helpful in predicting the future. An historically good run for growth doesn’t imply these stocks will come back to earth. But investors concerned
More on Market Efficiency and Predictions
The reason we often share articles from Dimensional is because their market views, led by some of the smartest minds in the industry – including Nobel prize winners and professors at some of the top business schools in the nation – are very similar to ours, and we value their thought leadership. Here are two more articles from Dimensional on predictions. The first “Prediction Season,” reviews the predictions of some of the largest firms in the industry, and shows that not a single one came close in predicting of the S&P 500 for the full 2024 year – a trend that has been similar almost every year. You can read the article by clicking here.
The second article addresses a question we often receive during election time; “Can You Predict Postelection Winners?” In this article, the performance of top stocks during an election month are compared to the performance of those same stocks over the course of the full presidential term, finding that the initial top performers often performed worse than the market as a whole. You can read that article here.
The answer to us remains that we should not invest primarily using predictions or “gut feelings,” but by adhering to long-term principles of successful investing and asset allocation, customized to each client’s risk tolerance and time horizon. Be careful of having strong feelings about the performance of any particular investment! To cite a quote from Stephen Hawking: “The greatest enemy of knowledge is not ignorance, but the illusion of knowledge.”
California Municipal Bond Update
Municipal bonds make up one of the few asset classes we buy individually, rather than through ETFs. The reasons for this are because: (1) we save on the annual expenses of ETFs (although they are low), (2) it allows us to manage the duration of each client’s portfolio in a customized manner, (3) it gives us more stable and predictable cash flows, and (4) the historical default rate of investment grade munis has been extremely low.
The recent wildfires in Southern California have given reason to review the credit worthiness of various entities in the state and in Los Angeles. While we continue to monitor the situation, we continue to hold these bonds and do not feel there is a danger of default on our high quality bonds.
Once again, we would like to thank you for your trust and loyalty, and look forward to speaking with you in the upcoming month.
The commentary and opinions expressed in our articles on this page reflects the personal opinions, viewpoints and analyses of the AIRE Advisors, LLC employees writing the article. The articles on our website should not be regarded as a description of advisory services provided by our firm or performance returns of any AIRE Advisors, LLC’s clients. Any past performance discussed in these articles is no guarantee of future results. The views reflected in the articles are general in nature and made to provide education about the financial industry. These views and opinions are subject to change without notice. Any mention of a particular security, sector, and related performance data is not a recommendation to buy or sell that security or in that sector. Our firm manages client accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the articles. To determine what kind of investments may be appropriate for you, please consult your financial advisor prior to investing. Also, please note that all investing involves risk and the possible loss of principal capital.
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