2021 came and went in the blink of an eye. Our perception of time seems warped since we entered the Pandemic in the beginning of 2020. We are now almost 2-years into a new normal that seems to continually be evolving – new covid variants, supply chain challenges, inflation surprises. As we all try to figure out what is next, living in the present becomes increasingly more challenging. Some of us have been able to return to enjoying activities that we were not able to participate in last year while others have taken a more cautious approach or continue to confront challenges or concerns; nonetheless we all face a different world than we did in 2019. Going out for dinner is different, travel requires more preparation and checkpoints, educating our children involves the uncertainty of remote vs. in person classes, our employers and employees have faced a new hybrid work environment. It seems we have been chasing a moving target of returning to our old definition of normalcy. While frustrating, we have all been forced to learn to cope with this new reality. We most likely will continue life in a predictably unpredictable manner.

What is perhaps most impressive is the resilience of people and their innate ability to adapt. In 2020 our economy, our local business, and travel came grinding to a halt closing off much of the world. Today, world economies have largely reopened, our local neighborhood restaurants and coffee shops are coming back to life, supply chain logjams have started to clear allowing for goods to flow more normally. The United States is a bright spot as we had one of the swiftest economic recoveries in history: The National Bureau of Economic Research stated the Covid recession was the shortest in US history, lasting just two months, from February to April 2020. This recovery was reflected in the stock market rally – the S&P500 returned nearly 119% from the market bottom of March 2020 (3/23/2020 – 12/31/2021).

In DC, lawmakers passed six major bills since the onset of the pandemic, totaling a whopping $5.3 Trillion. These bills included support for small businesses, economic stimulus payments, expanded unemployment compensation, increased public health support, tax incentives, direct aid to state and local governments, educational support, and a variety of other stimulative programs to combat the impacts of the pandemic. In November, a $1 Trillion Infrastructure Bill was signed, directed to improve roads, bridges, public transit, power grids, drinking water and broadband internet. All these bills were passed without significant fundraising mechanisms. However, the $1.75T Build Back Better Plan failed to pass. This bill which included a variety of potential fundraising tax increases was pushed into 2022.  We will keep our clients apprised of new developments that will potentially have an impact on their personal financial situation.

The stimulative effects of the COVID Relief bills combined with another year of historically low interest rates, a neutral tax environment and rebounding corporate earnings ushered in another banner year for equity risk. 2021 was another great year to own risk assets as investors and clients were generally rewarded with another year of double-digit portfolio returns.   A year that was the third consecutive year of positive equity market returns and was also notable for the lack of volatility. To illustrate, the S&P 500’s largest 2021 peak-to-trough decline was -5.2%, compared with historical average of about -15%. Our Co-Chief Investment Officer Andrew Murphy pens an internal morning note for our team each day. Below are some of the points by which we will remember 2021:

• New Highs: The S&P 500 closed at a record high 70 times this year, the most since 1995.

• Meme Stocks: Speculators flooded to buy shares of struggling companies, including, GameStop and AMC.

• IPO Record: According to Dealogic, over 1,000 companies have gone public, raising over $300 billion. This is the most since Dealogic began tracking data in 1995.

• Cryptocurrencies: According to Statista, there are now over 6,000 different cryptos in existence with Bitcoin holding a 40% market share.

• Non-Fungible Tokens (NFTs): NFTs had a massive surge in popularity. According to OpenSea, one of the largest NFT marketplaces, sales were $2.6 billion in October 2021, up from $4.8 million in October 2020.

What does all this mean? Well, that is a great question. From a valuation standpoint things feel a bit frothy. Navigating from here will be more challenging as we, as investors, face an investment environment that contains more unknown factors. As Howard Marks, one of the great investors of our time articulated in his latest memo, “there is little to no history that’s relevant to today. That means we don’t have past patterns to fall back on or to extrapolate from.”

SETTING EXPECTATIONS

Our Investment Committee meets formally at least once per month to assess current economic and market conditions to determine how to best position our client portfolios from a risk-relative standpoint. Since the bottom of the market in March of 2020 we have experienced a near straight run up in the equity markets. The has made the job of investing client money both easy and increasingly more challenging. Easy because newly invested cash generated returns for clients (generally in a short period of time). Challenging because investor expectations seem to have adjusted to a new reality of consistently inflated returns. There is a big psychological and emotional component to investing that makes current conditions even more precarious. Specifically, recency bias and confirmation bias play a role in a “new normal” for the investor mindset. No one has a crystal ball, and we are not attempting to predict how the market will fare in the short-term.  We are simply bringing to light some of the observations we have gathered over the last year.

Recency Bias:

Recency bias is the tendency to place too much emphasis on experiences that are the most “recent” in one’s memory. It is a cognitive bias that describes the inclination to overemphasize the relevancy or importance of recent events. This is important because it can cause or tempt clients deviate from their strategic financial plan, potentially compromising their long-term success.

Annual double-digit market returns with historically low volatility have created a new baseline for investors return expectations. Big returns with low risk now seem realistic. Over the last year we noticed an interesting theme from our client conversations. Clients were generally more tempted and eager to put money to work, to run lower cash reserves, and to consider increasing portfolio risk. We could summarize by saying that even our more conservative clients were pondering how increased equity exposure might benefit them. Well, this certainly makes logical sense as there was almost no additional risk associated to increasing equity exposure during the year. The standard deviation (a measure of volatility) of the S&P500 index for the year was 12% while the Bloomberg Barclays US Aggregate Bond Index was 3%.

This is the recency bias at its best, looking in the rear-view mirror and extrapolating that the same decisions in the future will provide similar results; perhaps most importantly, a similar psychological reward.  There is a reason the best-known financial industry disclosure is “past performance is not a guarantee of future performance”

Confirmation bias:

Confirmation bias is the tendency to seek and align with information that supports or reinforces what we believe to be true and to ignore or downplay information that contradicts these beliefs. In 2021 it was easy for investors to develop a confirmation bias that the equity market always goes up.

Investors’ appetite for risk taking and speculation has increased as it has been difficult to lose money since the market bottom in 2020. To put this in context, an investor would have made money each time they “bought the dip” through the end of 2021. Investors that decided to put money to work during this period were rewarded with psychological confirmation of making the “right” decision. Even though there was plenty of negative headline news such as rapidly increasing inflation, a surge in new COVID variants, supply chain issues, accelerated tapering of Federal reserve bond buying program and future rate increases, decelerating GPD, ignoring this information worked in 2021. Investors that decided to bet against the broad market during this time period would generally have lost – The lack of volatility generally makes it much more difficult to generate positive returns from short positions.

These biases were certainly on full display in 2021 and our concern is that they may have laid the groundwork for unrealistic decision making going forward.

Moving Forward & Sticking to The Financial plan:

So, if investors could do no wrong by being more aggressive by ramping up portfolio risk and investing new cash in 2021, then why shouldn’t we expect the same going forward? It is a fair question, but what we do know is that at some point the risk dynamic will rebalance. No one knows when the scales will tip. It may happen quickly, or it may take some time. The hard work comes when we, as investors, start to experience volatility again. As with most market events, it will most likely hit unexpectedly, and it will be important not be caught off guard.  As Warren Buffet famously states “only when the tide goes out do you discover who’s been swimming naked”. We would like to note, that this does not mean that the market can’t continue to run from here.

What we can control is how we allocate our client portfolios and regulate our exposures. We can position our client portfolios to align with their unique level of tolerable financial risk. As a firm we do not believe that the current environment of low volatility and high returns is sustainable. As such we have revised down our longer term expected future returns to compensate for banner returns achieved over the last few years. In our client conversations we are emphasizing what we believe are more realistic return assumptions. These more conservative return assumptions are what drive our client financial plans.

At Winthrop Wealth our Financial Planning process drives our portfolio risk strategy (i.e., we do not believe that portfolios can be properly invested without understanding a client’s larger financial picture). As such, projecting more conservative returns from the same risk models allows us to operate with a margin of safety. We believe that utilizing these more conservative assumptions allows us to position client portfolios in a way where clients can better endure market volatility when it does emerge. As fiduciaries we have an obligation to our clients to act in their best interest; this includes providing realistic guidance.

Benjamin Franklin famously says that “if you fail to plan, you are planning to fail”.  We believe proper planning, preparation, and a robust process for consistent execution provides the highest probability for success in achieving any goal.  We approach our client relationships in the same manner.  We also realize that life isn’t linear, it changes along the way – everyone has a unique path.  We are here for every step of that journey.

Developments on the Winthrop front:

We continued to invest in our team and infrastructure in 2021 in pursuit of consistently enriching the client experience. In November we brought on a new advisor (Jonathan Hunter) who brings over a decade of experience – we have known Jon personally for over two decades. Since we are in a relationship business, built on trust, we make every effort to bring on new team members that have the integrity that our clients expect.  Our mission of creating continuity for our clients involves making sure that we have the right team in place. This means hiring in advance of growth and making sure that our clients are aware that we will always have members of the team that are familiar with the client relationship.

We renewed our commitment to the Boston market by signing a long-term lease on a brand-new office space in Boston’s Back Bay. While our team has still been working in a hybrid capacity, we believe it is important to eventually return to a collaborative in-person environment. One of our key objectives with the design of the new office was to create space where both our team members and clients feel safe. We have designed an efficient new space with more dedicated offices, meeting rooms and state of the art air handling systems. Our expectation is that the new office will be ready at some point in Q2 of 2022. We look forward to welcoming you.

We are geared up and excited to roll out our new website in the first half of 2022. We have invested in updating our brand over the last few years and the website will be a lynchpin that ties everything together – making it easier for our clients to access our in-house content and their accounts. We also plan to ramp up our frequency of client webinars in 2022 – the webinars we put on in 2021 were a hit and we recognized the value of doing more of these educational events.

We are honored to have made the INC5000 list as one of the fastest growing companies in the United States in 2021 for the first time ever. We also won, for the second year in a row, both the National and Regional Best and Brightest Award for employee satisfaction. These awards are a testament to the key investments we have made in our team and infrastructure. As we mentioned in last year’s client letter, we pledge to continue our robust reinvestment program to get better every day.

We enhanced our charitable support across organizations that make significant positive impacts on food security, covid relief efforts, social change, cancer, rare disease, mental health, animal welfare, among others. We are intimately familiar with the organizations which we support and their impact in our communities near and far are incredible.

As a firm we go into 2022 more prepared and focused than we have ever been. We are excited to serve you and your families and vow to continue managing the business with a guiding principle of continuous improvement.

A Quick Reflection on our Gratitude Practice:

As we reflect on 2021, I re-read our 2020 Client Letter and came across a paragraph that really resonated:

2020 forced us to take a pause in our otherwise busy, structured lives and examine the good, the bad and the ugly in the world and in ourselves. It forced us to redefine “normal.”  It forced us to take account of what we were taking for granted. And it forced us to realize what is actually meaningful. As we went through the trials and tribulations of 2020, we started to see things in a new light. That light was one of gratitude.

As I read this, I realized that while 2020 was unprecedented in terms of the whirlwind of change that it brought about, so was 2021. Many of us thought that life would normalize, but what many of us found is that we still face a predictably unpredictable environment. Our practice of gratitude has been a guiding light in 2021. We appreciate the small things more – like being able to congregate in the office or go out to lunch with clients and friends. Personally, I came to the realization that gratitude is most powerful when associated with a feeling. It is not the “being” in the office that matters, it is the feeling of camaraderie. It is the feeling of joy when having dinner with an old friend, it is the feeling of excitement when we get to reconnect with a family member across the globe, it is the feeling of freedom when we get to play our favorite game. Being grateful, not for the experience, but for the feelings associated with these experiences creates fullness. It creates a richness to life – living life to its fullest extent.

While we are still living with Pandemic overhangs, we are optimistic about the future. We remain committed to being here for our clients and partners, regardless of what life throws our way. We are grateful for all the wonderful relationships that we have and look forward to working with you and your families in the year ahead. Most importantly, we wish everyone good health for 2022.

With Gratitude,

The Winthrop Wealth Team