The Odd Couple
A common theme in movies are the relationships between key characters. Sometimes these relationships can be challenging as was illustrated numerous times on-screen between Jack Lemmon and Walter Mathau, who happened to be very good friends off-screen. The two actors are perhaps best known for their clashing roles in “The Odd Couple” and of course local favorite “Grumpy Old Men.” (The latter of which was meant to be a comedy but may be viewed as a satirical documentary in this part of the country.) In these movies, there are differences between their characters which were not always complimentary and would at times be adversarial. The relationships between asset classes can be similar – they may be in contradiction to each other, which is good for diversification, but this does not always happen and we should be aware they can, and do, change over time.
Conventional wisdom over the past three or four decades has been to hold a mixture of stocks and bonds in your portfolio with the thought being that if stock prices fall, bond prices will rise to cushion the impact. A quick reminder that the relationship between bond prices and yields is an inverse one; meaning if yields fall, prices go up and vice versa. Prior to the beginning of this year, bond yields have, for the most part, fallen over the past three or four decades, giving rise to bond prices. Now that we are faced with the highest levels of inflation in 40 years, we are experiencing a fast rise in bond yields, which we expect to continue for at least the next year. So far in 2022, we have seen the fallacy of having a portfolio consisting only of stocks and bonds – both have dropped in value. If you are a retiree drawing upon your investment portfolio, this means you have had to withdraw money when the market is lower, which comes at the expense of future growth, made worse when the loss of compounding is included.
Historical data indicates that bonds tend not to fluctuate as much as stock prices because interest rates generally do not move very quickly. This year seems to be an exception as there has been a fast rise in interest rates with the Federal Reserve taking action to fight growing inflation. Most bond portfolios have lost money year-to-date with the widely followed Bloomberg Barclays Aggregate Bond Index being lower by about 7%. Benchmarks tracking longer duration bonds are down double digits. So much for bonds being a “safe haven,” especially when you figure in the effects of inflation.
Despite positive returns last week for the major stock market indices, marking the first time this year they have had consecutive weeks of positive returns, they remain lower year-to-date. Energy has performed strongly, but that is an exception as many industries have performed quite poorly. Had you invested only in energy stocks at the beginning of the year, or sometime during the last half of 2021, you would be doing very well but that lack of diversification is not prudent investment management. When the pandemic hit in 2020 and oil prices dropped to literally zero, most energy stocks lost at least two-thirds of their value. We’ve recently seen many high-growth technology stocks retreat some 50% or more, and in some cases 75%, from their highs. Many of these stocks have rebounded slightly over the past two weeks but if you lose 50% of your value, you need to make 100% to get back to break-even so even these rebounds are not nearly enough with many stocks remaining well below their all-time highs. Further evidence of the importance of diversification between asset classes and sectors. For the first time in a long time another asset class, commodities, are having their day in the sun, but this may be nearing a tipping point. Demand may drop if prices rise much further, putting pressure on prices; we most likely have reached an equilibrium point and will see most commodities, such as oil, trade in a range for the time being.
The stock market seems to be creeping upwards after hitting a bottom, at least in the short-term, on March 14th. With inflation now “raging” (a term used by one of the Federal Reserve Governors), interest rates rocketing higher, and the possibility of us being on the precipice of World War III it is rather surprising the most market indices are only down 5%. Perhaps this is telling us something. The stock market is considered to be a leading indicator and recent moves suggest that things are not that bad and despite world events the economy remains strong.
More than one Federal Reserve Governor, including Chairman Jerome Powell, have publicly acknowledged the Fed is behind the curve fighting inflation and a half-point rate increase is certainly on the table during the next Fed meeting in May. According to FactSet, bond market futures are giving a half-point rate increase at the next Fed meeting an 85% probability but this should be taken with a small grain of salt since it is known the futures markets can move quickly and are very dependent upon data and events.
This coming week marks the end of the quarter, one which many investors would like to forget since it has been a rather rough start to the year. As mentioned above, the market is starting to show some resilience and many times in history the stock markets hit their low points in March and then quickly rebounded eventually ending with positive gains for the year. 2003, 2009, and 2020 come to mind as examples. Please give us a call if you would like to review your portfolio to make sure you are best positioned for the changing relationships between asset classes. There are multiple options for keeping your hard-earned money safe while keeping pace with inflation. We would be glad to discuss how these might work for your individual situation.
Have a great week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
Please contact us if you would like to review your individual financial plan or learn how the TaxSmart™ Retirement Program can help you.
Office phone # 952-460-3260