October 23, 2023
These are the days that test all of our patience as investors. These are the days when we feel compelled to act to stop the pain and avoid the long list of unknown negative things that can happen to our wealth. Bear markets chip away at our confidence through magnitude and duration of losses, sometimes both. Needless to say, historically, these are also the moments when real opportunity develops for the next multi year bull market higher. I find it very helpful during these phases of the market cycle to simply read our emotional state, acknowledge it and work to get ourselves in the right frame of mind. Let’s do that.
These are some of the emotions and questions you might be asking yourself now.
Why Do I have Anything Invested in the Financial Markets?
Indeed, when cash, money markets and CDs are paying 5% thanks to the Fed’s most aggressive rate hike cycle in history, there is a higher comparative bar of demands for your investments at risk. As of the close last Friday, the S&P 500 is still down -11.5% from its highs at the end of 2021. How about bonds? The Lehman Aggregate bond index is down over -17% from its highs, not in 2021, but August of 2020. That’s more than three consecutive years of losses in what has been the safest side of the financial markets for decades! The list of sectors and asset classes that are negative by 4-5% YTD is long. Meanwhile opportunities to make money in 2023 have been highly concentrated in just a few names that are now giving up ground as well. Why invest at all?
Several very good reasons:
- The Fed is ending their rate hike cycle now and the bond market should become a more productive asset class from here. By more productive, I mean far outperform cash and money markets for the foreseeable future. Current yield is the best predictor of bond returns and today a 10-year Treasury bond is paying nearly the same rate as the highest cash rate. However, as recessionary pressures grow, we will also see Treasury bonds rise in price to add to the total return. Bonds will outperform cash from here. We added to our 10-year Treasury Bond position today across several strategies this morning.
- Stocks have historically outperformed cash and bonds. This is a simple fact. Over time, especially any time period longer than 5 years, stocks have moved up and to the right earning 7-8% on average with positive returns at least 93% of all years (see chart below). These are naturally incredible odds of success. Note that even over any 6-month period, stocks have gone up 70% of the time I don’t know of any opportunity out there that offers such a high natural probability of “winning”.
And now dear investors, now prices and valuations have reset significantly since 2021 and the probabilities are quickly increasing that we will see an end to this multi-year bear market and the beginning of a new multi-year bull market in the next 6 months. If bonds find a lasting bottom right here, right now, then stocks may be doing the same. You must remember that stock prices reflect the future. How much of a recession is priced into stocks, select sectors and asset classes? Quite a bit! As I mentioned in last week’s Red Sky Report “40% off”, we already have some generational buys developing now. Historically, gains off of any bear lows will be far higher than “average” historical returns. Also remember, if you find yourself wanting to sell all to cash now, you might be locking in losses and have the equally difficult decision of when to get back in. From our seat, this is an incredible time to rebuild (rebalance) a fully diversified portfolio of stocks, bonds, commodities and alternatives as we discussed last week.
- Interest on cash and money markets are peaking.
Just when you thought it was safe to go to cash and earn an easy 5%! With the Fed effectively ending their rate hike cycle having successfully contained runaway inflation, we should see the yields and interest on cash and money market rates begin to taper and eventually fall in 2024. The same goes for lending rates, bank loans and private credit funds. These are the days when these types of safe instruments look and sound great but make no mistake, these are the peak days for yields on cash. Certificates of Deposit (CDs) could make sense for money that wants to live permanently in cash because you can effectively lock in these peak yields for years. However, please re-read above. Bonds and stocks outperform cash over nearly all time periods. CD’s also have penalties for early withdrawals. For those who missed our annual meeting presentation, this is what inflation has done over the last 12 months.
Again, if history repeats, we should all expect to see the interest on cash and money markets, follow the same path lower, well into 2025.
I’m Tired of Losing Money (or not making money)
We are all tired of losing money. This is a bear market, and it is what it is. We are tired of risk; we are tired of politics and wars and the Federal Reserve and the media. You are in good company believe me. Losing money with your long-term investment capital is part of the game as markets simply do not go up in a straight line. I struggle to find anything that is trading above the 2021 highs with the exception of a few stocks and maybe commodities. It is no wonder we all feel this way and I am truly empathetic to all. Our active, risk managed strategies, like All Season, Gain Keeper and Income strategies are doing an admirable job of controlling portfolio volatility to less than ½ of their benchmarks. Controlling volatility helps you sleep at night but does not mean you won’t still experience some losses of course. The goal is to get to the end of this bear market cycle with the following:
- Your emotional capital intact, ready to buy or deploy cash when the time is right.
- Your financial capital intact or in a “recoverable” position
Age is also an important consideration with risk and investing of course. We are encouraging our retired clients or those living off their investment accounts in some form, to adopt the two-bucket approach we described in previous updates. The two-bucket approach allows for a cash bucket to carry two years or more of living expenses beyond other sources of income like social security, rents, etc. Meanwhile, your growth and income bucket can be left alone to weather bear markets, grow and generate income to replenish you cash bucket when needed. The two-bucket approach effectively allows you to emotionally separate your needs for cash today from the anxiety of watching your investment balance go up and down.
Younger clients have it easy and can simply look for discounted opportunities like we have developing now, to allocate excess savings from earned income to investment accounts. Buy low, accumulate shares at discounts, pay attention to taxes, avoid selling much of anything and keep your 20-year goggles firmly in place. Easy!
That’s it for this week. Just a little much needed pep talk. 😊
This time will pass, and returns will come again. Patience is critical now.
Thank you for your continued trust and confidence,
Sam Jones
