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Change Of Seasons- Industry Portfolio Advice is Not Natural

I live in Steamboat Springs, CO. and we got a ton of snow in mid October.  The ski area was covered and like many mountain folks, I decided to “hike” (walk up in skis using skins) up to make a few early turns on Saturday before the area opens to the public.  Clearly, despite looking good from afar, it’s still too early for this nonsense – no snow at the base.  As I skied through the grass, I was reminded that there are seasons to everything when we would naturally change our behaviors.  Investing is no different, despite what our industry would have you think.

“Set it and Forget it” is Not Natural

                “Set it and forget it” is one of those instructive industry phrases.  It is meant to convince investors that they should just set a static portfolio of stocks (60%) and bonds (40%) and then forget it.  You won’t ever have to make changes or adapt to conditions, just leave it alone and everything will be fine over the long term.  True, there are periods of time, when a 60/40 static portfolio does well and requires little if any changes to underlying positions.   We’ve actually been in one of those periods since 2016.  But people forget the long periods of time when it doesn’t work, like the 70’s and early 80’s, when stocks gave up 40-50% (1974) and bonds ALSO lost 15-20% as inflation ripped into the system.  

 I believe in bio-mimicry.  Here’s the definition.

Bio-mimicry is an approach to innovation that seeks sustainable solutions to human challenges by emulating nature’s time-tested patterns and strategies.

Let’s unpack that in the context of investing.  What is one of Nature’s time-tested patterns?  Well, how about the seasons and all the adaptation that happens surrounding it.  Animals behave differently in different seasons, right?  They shed their fur, they migrate to a different climate or move into hibernation. Farmers would not plant seeds in the winter because they have no expectations that anything will germinate in cold temperatures.  Humans put on clothes to keep us warm or head to the lake to cool off depending on the time of year. Now why would we expect that a fixed group of investments, held in the same mix of securities, would yield a favorable result in all “seasons” that the markets experience over time.  It’s unnatural.

The Deficient Frontier – by Greg Morris

                Bear with me on this thematic journey for one more moment as I would like to empirically show you that there are indeed different “seasons” to the markets lasting decades.  Greg Morris is a long-time friend and hilarious market guru, analyst and asset manager.  He posted this study in Stockcharts back in 2016 and I would encourage any serious investor to read it thoroughly.  


Students of markets know that there is something called the efficient frontier which is generically a scatter plot (averaged as a line curve) of return and risk data for many different asset classes over a specific time period. A portfolio will generate optimal risk adjust returns with a proper mix of stocks and bonds as determined by the efficient frontier. However, Greg’s work shows clearly that the very shape and slope of this curve changes dramatically each decade.  In simple terms, he shows that a 60/40 portfolio will go through very tough decades in terms of a total return.  In Greg’s words, “Did you want to be 40% invested in bonds during the 1970s when interest rates soared?  Did you want to only be invested 60% in equities in the period from 1982 – 2000 which was the greatest bull market in history?  Of course not!  Markets are dynamic and so should investment strategies.”

In the chart below, the vertical axis is return, and the horizontal axis is risk (or volatility).   The various lines represent the return and risk characteristics of different asset types during each of the decades.

A close up of a map

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As Greg says in his work, the big brokerage shops, banks and now robo advisor platforms,  spend a truck load of marketing dollars trying to convince to you that there is a magic, static mix of stocks and bonds (60/40!) that will yield the results you want in all market conditions.  There is no substance to that suggestion.   Dynamically changing your holdings over time on a rules-based approach is the only thing that works overtime!

Ok, enough, let’s bring it home to the changing season of today’s market and explore where we might adapt.  

Dynamically Shifting Back Toward Stocks

                Bonds have been a great place for investors to maintain an overweight position for the better part of the last two years.   Two years ago, in January of 2018, we suggested that stocks were overbought and prone to losses and encouraged rebuilding a healthy bond position.  These were the days when we called out Bitcoin as “Pirate Ninjas” and mocked the high-flyers like Netflix and the rest of the FANG gang.  They all got smashed.  Many are still in trouble.  Bonds were unloved at the same time and the thinking was that the Fed was going to raise rates into the distant future to reload the gun.  Well bonds took off and have enjoyed a great 22 months of performance.

Now, it is time to shift back toward stocks and reduce our bond exposure as we follow our dynamic rules-based approach to asset allocation.

Last week marked another trigger point to cut bond exposure and prepare to add back some stock exposure if you haven’t already done so.  Regular readers will cycle back to last week’s “Big 3” discussion to discover where we should focus our new purchases.  I use the words, prepare to add back, because the stock market is extremely overbought in the short term and we expect some profit taking almost immediately.  Gamers might consider waiting for stocks to pullback from here.  We have no idea how long the relative strength of stocks will last and yes, we see the pile of evidence suggesting a recession is still on the horizon.   But the season is changing in terms of asset class performance and we are just not smart enough to argue with it.   These changes can and should be made incrementally as evidence unfolds and confirms.  For instance, in September, we carried almost 50% in bonds, 25% alternatives and 25% in World stock index ETFs.  Today after weeks of dynamic adjustments, we have 25% bonds, 15% alternatives and roughly 60% in World stock ETFs (in Small caps, Value and Internationals!)

Other adaptations to consider might surround your exposure and expectations for real estate.  If bonds are going down in price and long-term interest rates are beginning to rise again, we would have to check our expectations for real estate, home-builders, and all related industries.   It would seem fairly obvious to all that real estate prices are very high; cost of building is high and now the cost of borrowing money is rising.  Remember, that affordability of the cost of a mortgage is not an absolute thing, it is only relative to where it was recently.  Any rise or fall in interest rates has an immediate effect on the number of available buyers.  Buyer beware!

I’ll leave you with an important consideration looking into the very distant future.  It would be worth your time to listen to this podcast.   https://think.kera.org/2019/11/04/dallas-fed-president-robert-kaplan-on-recent-rate-cuts/

You will hear Krys Boyd interview Robert Kaplan, President and CEO of the Federal Reserve Bank of Dallas.   It is insightful and a little shocking to hear the very frank and revealing comments of one of the most important members of the Federal Reserve.  In short, the Federal Reserve is acutely aware of four structural issues that are challenging everything from the US Dollar as the world’s reserve currency, to massive under-funding of entitlements (social security and medicare) and the future of labor in our country.  These are not small issues not to mention the political risks over the next 12 months.  Listen to Kaplan’s comments and ask yourself if this is time to “set it and forget it” considering the potential for disruption looking forward.  There are rapidly changing opportunities AND accelerating risks in the financial markets today.  

Despite the incessant drum beat of passive indexing styles, there may be no greater time in history to be dynamic, nimble and highly selective with your hard-earned investment capital.

Sam Jones

President and CEO, All Season Financial Advisors, Inc.