Dear Clients and Friends,
There is nothing about this market that appears safe. The sharp drop in October has been followed by a half-hearted rally in November that gave way to a downright pessimistic market in December. The commentary that was firmly bullish earlier this year has given way to a bitterly bearish tone, where mentioning the words “Bear Market” gives one a reason to be listened to. This is the cycle, in all it’s emotion and hand-wringing, that investors should come to expect out of a market that has had a long period of solid returns.
Today, information moves faster and is more pervasive than ever before. Everything from markets to cars are responding with lightning speed to every small input, and the sensitivity of our markets hasn’t been this high since the Credit Crises of ’08. However, the market remains a market of stocks, and it will continue to reflect the underlying fundamentals of US business well into the future. No one knows the future outcome for the risks currently being worked out by the market, but there are some predictable patterns that emerge when the markets are in turmoil. And it is upon these patterns that I will base my best argument for staying put and riding out the current wave of volatility.
The Fed has a pattern of raising rates to cool down the economy, and this is Economics 101. What is not predictable is the glide-path that the Fed must take to adequately cool the economy without risking a recession in economic growth. The labor market has a pattern of tightening and wages going higher as companies compete for labor. What is not predictable is when this ‘wage inflation’ will occur, and at what point this might cause uncontrollable inflation. Trade disputes have a predictable pattern of being worked out with compromises that take shape under the watchful eye of the market. What is not certain about these compromises is who will benefit and who will be hurt by the compromises made on trade.
What the market is facing is not a crisis, but rather a reckoning. Maybe things aren’t as rosy as they seemed 12 months ago. Maybe we have some issues that are going to take some time to work out. The recognition that these risks exist, is something that can be counted as a positive, but the market never reacts to recognizing risk with positive emotion, because humans are not built that way. The human brain hates losing, it experiences over twice the amount of pain upon loss than it does pleasure upon gain. This leads to an over-simplification of risk in the human brain, which tells you, “Risk is bad, get rid of what it losing and the pain will go away”. But what if I told you the pain of safety has been worse?
Over the last decade an investor in a safe investment such as CDs, Money Market, or Treasuries has probably averaged around 1%. A person in a well-diversified portfolio of stocks and bonds has averaged closer to 5-6%. If that investor in the ‘safe investment’ wanted to take an average of 5% a year for income, they would be effectively going broke slowly, but with absolute certainty they would be going broke. The investor taking the risk and achieving market-like returns would have simply made a little money or just stood still, but the achievement of standing still has never been more appealing. In a low rate world, the retiree looking for income has never had a more appealing risk/reward than taking risk and living with the results.
After WW2, the US had a massive debt to sustain and rates were kept exceptionally low for almost a decade. As the economy expanded into the 60s and 70s, the expansion began to express large inflationary pressures, and it wasn’t until the early 80s that the crescendo in inflation was finally put to an end. If you could go back to 1981 and buy a 30-year treasury yielding 15%, would you? The answer is probably not, because as yields go up prices go down, so many investors had been burned in the preceding decades by rising rates. In other words, the 30-year treasury had too much risk. So goes the story of our markets, it is almost always the unloved assets that have the greatest potential for gain, and by default appear to have the greatest level of risk.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All investing involves risks including loss of principal. No strategy assures success or protects against losses.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.