Walking the Tightrope: The Fed, the Market, and Your Bonds
Interest rates don’t always make headlines, but when they do, they tend to shake everything else. That’s because rates sit at the heart of the economy: they influence borrowing costs, savings yields, and business investment.
By Senior Advisor, Director of Institutional Investment Management Kirk Ludwig, AIF®.
Interest rates don’t always make headlines, but when they do, they tend to shake everything else. That’s because rates sit at the heart of the economy: they influence borrowing costs, savings yields, and business investment. When rates rise, borrowing slows down and saving money becomes more attractive. When rates fall, money moves more freely, boosting spending and growth. The Federal Reserve adjusts short-term interest rates to keep this balance in check - more like walking a tightrope than pulling a lever. One wrong step, and they risk leaning too far in either direction.
Lately, that balancing act has gotten tougher. One day, markets are reacting to sticky inflation. The next, it’s fears of slowing growth (i.e., recession). Economic data keeps shifting, headlines flip week to week, and forecasts feel outdated the moment they’re made. With so much in flux, the Fed held interest rates steady at its last meeting, opting to wait for more clarity. Tariffs could end up raising prices and slowing growth at the same time - a combination economists refer to as stagflation. It’s not a word we throw around lightly, but it explains why the Fed isn’t rushing into a decision.[1] Sometimes, staying put is the most thoughtful move.
It’s a challenging environment for policymakers, but it’s just as noisy for investors. And in times like these, clarity isn’t the most realistic goal. Preparation is.
That’s why, at SJS, we don’t try to guess the next move. We focus on building portfolios that can withstand evolving markets. Our fixed income strategy (bonds) is designed for a wide range of outcomes:
Short-duration bonds to help in an environment where prices stay elevated and yields potentially rise.
Inflation-protected bonds to assist in times of unexpected or prolonged inflation.
Longer maturity holdings that benefit if growth slows and yields fall.
A diversified mix of credit bonds, including investment-grade corporate bonds, as well as selectively-chosen high yield bonds and private credit to capture higher yields.
We don’t build portfolios to match the news. We build them to withstand it.
We’ve seen many economic cycles. Each one brings its own uncertainty, but this one feels especially dynamic. With so many moving parts, the outcome may look very different from what anyone expects. That’s why we don’t build portfolios around predictions; rather we build them to adapt. Time and again – we believe thoughtful diversification, discipline, and a clear process prove more effective than chasing headlines.
So yes, the Fed may be walking a tightrope. And yes, markets may stay moody.
But your bond portfolio? That should stay steady.
Important Disclosure Information & Sources:
[1] “Federal Open Market Committee”. Board of Governors of the Federal Reserve System, federalreserve.gov.
There is no guarantee investment strategies will be successful. Past performance is no guarantee of future results. Diversification neither assures a profit nor guarantees against a loss in a declining market.
MarketPlus® Investing models consist of institutional quality registered investment companies. Investment values will fluctuate, and shares, when redeemed, may be worth more or less than original cost.
Statements contained in this report that are not statements of historical fact are intended to be and are forward looking statements. Forward looking statements include expressed expectations of future events and the assumptions on which the expressed expectations are based. All forward looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties which could cause actual events or results to differ materially from those projected.
The Tale Of Two Curves: What The Yield Curve Means For You
The yield curve isn’t just an academic concept; it impacts real-life decisions.
By Senior Advisor Kirk Ludwig, AIF®.
In September 2024, the Federal Reserve started lowering interest rates after a long stretch of raising them to combat inflation. This marked a notable shift, as the Fed appears to have achieved a soft landing - taming inflation without derailing the economy. But here’s the catch: not all rates have followed suit. In fact, some rates are higher today than they were at the start of the year. Below is a graph of the Treasury yields along the maturity spectrum at the beginning of the year and the end of the year, known as the yield curve, and reflecting the changing market sentiment.
Source: “Daily Treasury Par Yield Curve Rates”. U.S. Department of the Treasury, 02-Jan-2024 through 31-Dec-2024, treasury.gov. See Important Disclosure Information.
At the start of the year, short-term interest rates were elevated due to aggressive Federal Reserve action to manage inflation. Over the year, inflation levels eased, and the Fed shifted to lowering rates, and short-term yields followed. But the longer-term rates have risen, incorporating expectations for growth, inflation, borrowing needs, and many other factors. This divergence tells us something important: while the Fed controls the Fed Funds rate, the market determines all other rates. The front end of the yield curve reflects what the market thinks the Fed will do next, while the back end reflects everything else into the future.
The yield curve isn’t just an academic concept; it impacts real-life decisions. If you’re watching your money market yields, you’ve likely noticed they’ve been dropping. On the other hand, if you’re shopping for a 30-year mortgage, rates have drifted higher. For investors, money market and short-term bonds are experiencing lower yields, while longer-term bonds are paying more income. That’s not to say that you should be shifting everything to longer maturities; it just simply means that the market is pricing future risk differently. Paying attention to maturity terms is critical, and that’s why we focus on the shift in all interest rates - not just the Fed Funds rate.
The yield curve has often been labeled the market’s crystal ball, supposedly predicting recessions and expansions. But a crystal ball might be giving it too much credit. A Magic 8-Ball is probably more fitting - you shake it and get a random answer like “Ask again later” or “Outlook not so good.” What the yield curve does exceptionally well is capture the collective thoughts of the market today. It’s a snapshot, not a prophecy, and tomorrow’s new information could change the picture entirely.
Important Disclosure Information:
There is no guarantee investment strategies will be successful. Past performance is no guarantee of future results. Diversification neither assures a profit nor guarantees against a loss in a declining market.
Statements contained in this article that are not statements of historical fact are intended to be and are forward looking statements. Forward looking statements include expressed expectations of future events and the assumptions on which the expressed expectations are based. All forward looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties which could cause actual events or results to differ materially from those projected.
Advisory services are provided by SJS Investment Services, a registered investment advisor (RIA) with the SEC. Registration does not imply a certain level of skill or training. SJS Investment Services does not provide legal or tax advice. Please consult your legal or tax professionals for specific advice.
SJS Outlook: Q4 2024
This Outlook includes a letter from Scott J. Savage on gratitude and excitement, what the yield curve means for you, planning financially for the new year, SJS puppy, and looking forward to Q1 2025.
Courageous Community Services: Promoting Healthy Lifestyles
The mission of Courageous Community Services is to provide meaningful, inclusive opportunities for individuals with disabilities and their families through advocacy, education, and engaging recreational experiences.
An interview with Kirk Ludwig, who is a Senior Advisor at SJS Investment Services as well as the Treasurer of the Board of Directors of Courageous Community Services (CCS). This interview is part of our Stories of Giving & Achievement Series, highlighting community involvement efforts. If you are interested in learning more about Courageous Community Services, please visit the CCS website or contact Kirk Ludwig.
Kirk, can you tell us about Courageous Community Services (CCS) and their mission?
Most people might know CCS by the former names of Camp Courageous or The Arc of Northwest Ohio. Through a merger between agencies, today the agency is known as Courageous Community Services (CCS). The mission of CCS is to promote healthy lifestyles and better quality of life for persons with developmental disabilities and their families by providing support, education, advocacy, socialization, and outdoor recreational experiences which foster inclusiveness and independence. Our campers have limited social and outdoor recreational activities as part of their normal routines. Camp is designed to deliver these experiences while providing life skills, advocacy, and respite for family members and caretakers!
Source: “A Day in the Life of a Camper“. Courageous Community Services, ccsohio.org.
What is your involvement with Courageous Community Services? How did you originally get involved / what do you do within the organization?
Currently, I serve on the Executive Board as Treasurer as well as chair of the Finance Committee. Additionally, I’m on the Strategic Planning and Facilities Committees. 2023 is my 12th consecutive year participating on the board and second round as an active board member.
Many years ago, I coached Special Olympics, through which I met several families who were members of the Arc of Northwest Ohio Board. At the time, I couldn’t fully comprehend the challenges that the athletes and their families dealt with on a daily basis. It didn’t take long to understand the struggles and needs that these families faced. It was very easy for me to want to get involved in a way that advocated for a better way of life. One that provided respite for the caregivers as well as fun social interactions and outdoor activities for our campers.
When the Arc and Camp Courageous merged, I was very excited about the opportunities that the camp experience would have for the community that we serve. Camp delivers experiences that so many people take for granted. Spending time outside in a wooded park-like setting, playing games and laughing with other campers and counselors, swimming or wading in the zero-depth entry pool, participating in arts and crafts, gardening, and so many other camp activities.
Source: “Peer Buddies“. Courageous Community Services, ccsohio.org.
What is your proudest moment or biggest accomplishment since you’ve been involved?
One of the major challenges for CCS is consistent annual funding. For many years, the agency received funding support from the Lucas County Board of Developmental Disabilities, but the funding ended several years ago. Approximately 95% of the campers use Medicaid waivers to pay for camp, which only covers a fraction of the total cost that it takes to operate the agency and maintain the pool and campus. The shortfall is typically covered by grant writing, fundraisers, and private donations.
Recognizing the challenging budget and the desperate need to repair and upgrade the 50-year-old camp facilities, the agency was in need of raising capital. CCS owned about 84 acres of wooded property adjacent to the Oak Openings Preserve Metropark, which is well known in the park district community because of the diverse number of species that occupy the land.[1] With this in mind, we received the assistance of Metroparks Toledo to explore the unused property of CCS. They discovered populations of at least 15 plant species listed as endangered, threatened, or potentially threatened in Ohio.[2] This qualified the property for conservation purposes, and allowed Metroparks Toledo to be eligible for a grant to purchase about 64 acres of the CCS property.[2]
The timing was (accidentally) perfect! The property sale closed near the beginning of the pandemic. Camp was closed for 2020, a limited hybrid version occurred in 2021, and there was a slower “back-to-normal” opening for 2022. During the down time, CCS was able to use some of the proceeds from the sale to do the necessary upgrades to the dining hall as well as the boys and girls cabins. Additionally, we were able to build a new administration building, add a new walk-out viewing terrace, repair major cracks in the pool, and add a sensory-friendly walkway.
More importantly, the proceeds provided the necessary support to keep camp operating with all the new and improved grounds. My involvement in assisting with the transaction has been my biggest accomplishment to this point, but I hope my proudest moment is yet to come. There are endless joyful stories from our campers and their wonderful experiences, which makes all the time and energy worthwhile!
Source: “Agreement Will Preserve Natural Area While Enhancing Services for People With Disabilities“. Metroparks Toledo, 18-Aug-2020, metroparkstoledo.com.
How can the community get involved with CCS?
According to the CDC, approximately 1 in 6 individuals between the ages of 3 and 17 lives with one or more developmental disabilities.[3] Though this is a staggering percentage of the population, it doesn’t include the family members and caregivers also impacted by the individual with the disability. There is a tremendous need in our area for respite services as well as opportunities for socialization and outdoor activities for many of the members of our community.
People can help CCS by volunteering their time by participating in social walks, joining in camp clean-up days, or sharing their knowledge and skills serving in a board position. Making introductions to other agencies with similar missions is also helpful. And of course, all financial support is greatly needed and appreciated.
CCS is providing so many exciting opportunities for hundreds of campers and their families, but there is so much more to do. We’ve been very fortunate and grateful to maintain and improve camp during these extremely difficult times, but now it’s time to thrive and take camp to the next level!
Source: “Advocacy“. Courageous Community Services, ccsohio.org.
Important Disclosure Information & Sources:
[1] “Oak Openings“. Metroparks Toledo, metroparkstoledo.com.
[2] “Agreement Will Preserve Natural Area While Enhancing Services for People With Disabilities“. Metroparks Toledo, 18-Aug-2020, metroparkstoledo.com.
[3] “Health Needs and Use of Services Among Children with Developmental Disabilities“. Centers for Disease Control and Prevention, cdc.gov.
Hyperlinks to third-party information are provided as a convenience.
Suggested Reading
SJS Outlook: Q4 2022
The SJS Q4 2022 Outlook includes our insights on the U.S. bond market over the past year, steps to help you plan financially for the new year, a thank you to Bev Langley, and looking forward to Q1 2023.
Please click on the image below.
Suggested Reading
What A Difference A Year Makes: Bonds
For 2022, the bond asset class started the year with extremely low yields and less desirable return expectations. Going into 2023, the higher yields provide bond investors with a brighter outlook!
By Senior Advisor Kirk Ludwig, CFIP, AIF®.
The past year presented the financial markets with high volatility and change. Many of the imbalances caused by the pandemic continued to disrupt segments of the global economy and markets. From inflation soaring to a multi-decade high of 9% in June 2022, to lumber prices plummeting by nearly 65%, to global stocks trading in bear market territory for much of the year, volatility was widespread throughout financial markets.[1][2][3]
Given the complexity of the economic landscape, and the higher uncertainty that came with it, the volatility was not unusual from a historical perspective. However, one market that DID surprise many investors was the U.S. bond market. As one of the largest and most heavily traded financial markets in the world, the U.S. bond market was caught off guard as the Federal Reserve ramped up its campaign to battle inflation by aggressively raising short-term interest rates.[4]
The following chart puts perspective on the changes in Treasury rates across the yield curve. The one-year U.S. Treasury note started the year yielding 0.39% and ended with a yield of 4.73%. As illustrated, it wasn’t just short-term rates that were impacted - rates for all other maturities across the yield curve rose as well.
Source: “Daily Treasury Par Yield Curve Rates“. U.S. Department of the Treasury, treasury.gov.
It's not uncommon for the Federal Reserve to raise or lower interest rates to control economic growth and inflation. However, in this case, the surprise was the speed and magnitude of the rate hikes. With the starting point of short-term interest rates near 0%, bonds didn’t stand much of a chance to generate enough income to offset the change in prices associated with the rapid increase in yields. As a result, the general U.S. bond market suffered one of its worst years in recorded history.[5]
There is a silver lining to higher yields! Over the past decade, conservative investors holding short-term bonds, CDs, money market vehicles, or cash in checking & savings accounts have suffered historically low returns.[6] Now, the spike in interest rates is providing yields on conservative ultra-short-term investments such as one-month Treasury bills at 4% or better. Those willing to extend Treasury maturities to a year can expect to see yields north of 4.5%.
As the Federal Reserve continues its mission of driving inflationary pressures lower, while attempting to avoid a recession, the Fed may continue to raise interest rates further in the near future. We believe further interest rate increases are less concerning compared to a year ago because the risk and return tradeoffs are more favorable for bond investors today.
At SJS, we are consistently monitoring all segments of the markets and assessing the risk and return characteristics of each asset class. For 2022, the bond asset class started the year with extremely low yields and less desirable return expectations. Going into 2023, the higher yields provide bond investors with a brighter outlook!
Important Disclosure Information & Sources:
[1] “Consumer Price Index for All Urban Consumers: All Items in U.S. City Average“. Federal Reserve Bank of St. Louis, fred.stlouisfed.org.
[2] “Lumber (LBS)". Nasdaq, nasdaq.com.
[3] “SJS Weekly Market Update“. SJS Investment Services, 2022, sjsinvest.com.
[4] “Money, Banking, & Finance“. Federal Reserve Bank of St. Louis, fred.stlouisfed.org.
[5] The general U.S. bond market is represented by the Bloomberg U.S. Aggregate Bond Index, which measures the performance of investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. Data source: Morningstar, 1976-2022.
[6] “Interest Rates“. Federal Reserve Bank of St. Louis, fred.stlouisfed.org.
There is no guarantee investment strategies will be successful. Past performance is no guarantee of future results. Diversification neither assures a profit nor guarantees against a loss in a declining market.
Statements contained in this article that are not statements of historical fact are intended to be and are forward looking statements. All forward looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties which could cause actual events or results to differ materially from those projected.
Indices are not available for direct investment. Index performance does not reflect the expenses associated with management of an actual portfolio. Index performance is measured in US dollars. The index performance figures assume the reinvestment of all income, including dividends and capital gains.
Advisory services are provided by SJS Investment Services, a registered investment advisor (RIA) with the SEC. Registration does not imply a certain level of skill or training. SJS Investment Services does not provide legal or tax advice. Please consult your legal or tax professionals for specific advice.
Hyperlinks to third-party information are provided as a convenience.
MarketPlus Investing
Video on our MarketPlus Investing philosophy.
Important Disclosure Information:
There is no guarantee investment strategies will be successful. Past performance is no guarantee of future results. Diversification neither assures a profit nor guarantees against a loss in a declining market.
MarketPlus Investing® portfolios consist of institutional quality registered investment companies. Investment values will fluctuate, and shares, when redeemed, may be worth more or less than original cost.
Statements contained in this video that are not statements of historical fact are intended to be and are forward looking statements. All forward looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties which could cause actual events or results to differ materially from those projected.
Advisory services are provided by SJS Investment Services, a registered investment advisor (RIA) with the SEC. Registration does not imply a certain level of skill or training. SJS Investment Services does not provide legal or tax advice. Please consult your legal or tax professionals for specific advice. This material has been prepared for informational purposes only.
Suggested Reading
The Fed Poked The Bear
Rising interest rates are not always a bad thing. As interest rates move higher, the drop in value can be concerning, but in the longer-term, higher rates mean higher expected returns for investors, as bonds begin to produce more income.
By Senior Advisor Kirk Ludwig, CFIP, AIF®.
March 20th was the celebration of the Vernal Equinox and the Earth’s axis has once again shifted us into a new season. From the green pop of tulips sprouting to the warmth of the sunshine spilling through the windows, the United States began celebrating one of their most beloved seasons: The NCAA March Madness Basketball Tournament, or as many of us like to call it… Spring! Along with spring comes the chirping of migrating birds and the waking of hungry bears. This spring the Fed gave the “bond bear” a bit of a poke to get the season rolling.
After a two-year hibernation of zero percent interest rates, the Fed has embarked on the challenging mission of hiking interest rates to combat elevated inflation levels while not inducing a recession at the same time.[1] By increasing short-term interest rates and reducing the size of their balance sheet, the Fed will attempt to orchestrate a soft economic landing.[1] So how many times will they need to raise interest rates to accomplish their goal?
Now for the bad news “bear”… The Fed indicated their intent to continue raising rates into the near future.[1] As of the end of March, the market is expecting the Fed to raise rates eight to nine more times in 2022.[2] This number has changed multiple times in the past few weeks and will likely continue to adjust in the coming months.[2] As new information is presented to the market, bond yields will quickly reflect the possible changes which may occur as a result.
Why are rising rates viewed negatively by the market? Let’s revisit how bond values can change based on the change of market interest rates. Like a teeter-totter, when rates rise, bond values fall and vice versa. Additionally, the sensitivity of the price change is primarily impacted by the term length (maturity) of the bond. The longer the maturity, the more sensitive the price of the bond will likely be. With this recent move higher in yields, the S&P U.S. Aggregate Bond Market Index dropped 5.57% in the first three months of 2022.[3] One of the worst starts of the year on record.[3]
However, rising rates are not always a bad thing. As interest rates move higher, the drop in value can be concerning, but in the longer-term, higher rates mean higher expected returns for investors, as bonds begin to produce more income. The chart below shows the change in yields for three different time periods; 1.) 09/30/21 - before the Fed indicated their plan on raising rates, 2.) 12/31/21 – early stage of the Fed’s plan, and 3.) 03/31/22 – the market’s interpretation of future rates as of the end of the quarter:[2]
Source: “Daily Treasury Par Yield Curve Rates“. U.S. Department of the Treasury, treasury.gov.
As illustrated in the graph, current interest rates have moved markedly higher since the start of the year. Short-term rates - inside three years - have had the most dramatic move as the market prepares for future rate hikes. The longer maturities, which often provide more information about future growth and inflation expectations, have experienced a parallel shift higher. The shape of the yield curve prices in the future expected events, i.e. rate hikes, inflation, economic growth to name a few.
With all the uncertainties surrounding today’s markets, the day-to-day news can be distracting to investors. If you’re worried about how many more times the Fed is going raise rates, know that the market has already priced in that risk. Future inflation? Same answer. Possibility of future recessions… same! Therefore, trying to make long-term decisions on short-term news can often lead investors down the wrong path.
‘Ok, so what should we do now?’ SJS does not react to the short-term noise, but we do evaluate the longer-term expected risk and return characteristics of each segment of the portfolio and manage to those risks. Some of the adjustments that we have made on behalf of our clients:
Maintaining a shorter duration than the total bond market: We believe this reduces interest rate risk relative to the total broader US bond market, while still maintaining broad diversification.
Investing in shorter-term inflation-protected securities: We believe this hedges the portfolio against sharp increases in inflation, while still maintaining a relatively short duration.
Adding diversified alternative investments: We believe investing in diversified alternatives with low correlation to US stocks and bonds can help to redistribute expected risk, broaden diversification, and increase expected returns compared to US fixed income over the long-term.
While you are enjoying the shift into this new season, be comforted in knowing that SJS is continuously monitoring the market and keeping your best interests top of mind. As markets experience higher levels of uncertainty, the best course of action is to maintain a strong discipline with broad diversification. Yes, the hungry bear may seem scary, and you will likely want to run, but the market will eventually find its balance so we can all get back to monitoring our college basketball brackets.
Important Disclosure Information & Sources:
[1] “Fed Raises Interest Rates for First Time Since 2018“. Nick Timiraos, 17-Mar-2022, wsj.com.
[2] “Daily Treasury Par Yield Curve Rates“. U.S. Department of the Treasury, treasury.gov.
[3] “S&P U.S. Aggregate Bond Index“. S&P Dow Jones Indices, spglobal.com/spdji/en. The S&P U.S. Aggregate Bond Index is designed to measure the performance of publicly issued U.S. dollar denominated investment-grade debt.
There is no guarantee investment strategies will be successful. Past performance is no guarantee of future results. Diversification neither assures a profit nor guarantees against a loss in a declining market.
MarketPlus Investing® portfolios consist of institutional quality registered investment companies. Investment values will fluctuate, and shares, when redeemed, may be worth more or less than original cost.
Advisory services are provided by SJS Investment Services, a registered investment advisor (RIA) with the SEC. Registration does not imply a certain level of skill or training. SJS Investment Services does not provide legal or tax advice. Please consult your legal or tax professionals for specific advice. This material has been prepared for informational purposes only.
Statements contained in this article that are not statements of historical fact are intended to be and are forward looking statements. All forward looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties which could cause actual events or results to differ materially from those projected.
Indices are not available for direct investment. Index performance does not reflect the expenses associated with management of an actual portfolio. Index performance is measured in US dollars. The index performance figures assume the reinvestment of all income, including dividends and capital gains. The performance of the indices was obtained from published sources believed to be reliable but which are not warranted as to accuracy or completeness.
Hyperlinks to third-party information are provided as a convenience and we disclaim any responsibility for information, services or products found on websites or other information linked hereto.
There's Always Something To Worry About
There will always be something to worry about, but with the right portfolio design and disciplined approach, you can whether almost any storm.
By SJS Investment Services Senior Advisor Kirk Ludwig CFIP, AIF®.
When it comes to the financial markets, there’s always something to worry about. In today’s “uncertain” market, people are worried about the COVID resurgence, stock market valuations, long-term trend of inflation, the Fed’s plans on monetary and fiscal policy, potential tax law changes, and debt ceiling negotiations. Many investors become so worried about risks and uncertainty that they sell out of the market.
Yet risk is the nature of markets, and that’s a good thing! Can you imagine a stock market with nothing to worry about? It would essentially mean there would be no perceived risk for investors. What’s the expected return for investments with little or no risk?
The One-Month Treasury Bill is considered one of the lowest risk investments available in the public markets and carries an annual yield of 0.03% as of October 12, 2021.[1] In this case, the expected return for little or no perceived risk is near 0%. There’s a simple rule in investing – risk and return are related! If you want return, there must be a level of risk you’re willing to accept.
Source: Avantis Investors, Bloomberg, as of 30-Sep-2021. The US Treasury yield curve compares the yields of maturities from short-term Treasury bills (<1 year) to long-term Treasury notes and bonds (>10 years).
People dislike risk because they are worried about the uncertainty of the future. Yet from a broadly-diversified investing perspective, the greater the uncertainty, the higher the risk. Investors expect to be appropriately compensated for accepting risk. An investor who owns a One-Month Treasury Bill understands there’s very little to worry about when it comes to volatility, and agrees to give up expected return for the comfort of safety. We want stock market investors to understand that while the value of their investments can drop rapidly at times, investors tend to benefit significantly from this risk in stocks over the long-run.
For example, when COVID-19 first started spreading in the US, the S&P 500 fell roughly 34% from February 19, 2020 through March 23, 2020.[2] Even before the US reached its highest spike in COVID cases, the market started rebounding, and this year has continued to set new record highs.[2][3] As of October 12, 2021, the S&P 500 is up roughly 95% since the lows set on March 23, 2020.
Even with their knowledge of financial history, some investors are currently worried that the US stock market is overvalued. The Price / Earnings (P/E) ratio of the S&P 500 is around 25, which places this time period in the top 5 percentile of historical market valuations since 1930.[4] However, not all sectors of the US economy have equally high valuations. For example, the mega-cap growth space, driven by the FAAMG stocks, has a P/E around 39.[5] Conversely, the small value space, which is heavily weighted with financials and energy companies, has a P/E around 14.[6] As this accompanying graph demonstrates, the valuation spreads between growth and value stocks are near record highs around the world.[7]
Source: “Are Value Stocks Cheap for a Fundamental Reason?”. AQR Capital Management, 30-Aug-2021, aqr.com. Spreads are constructed using the Hypothetical AQR U.S. Large Cap, International, and Emerging Valuation Theme Models, and are adjusted to be dollar-neutral, but not necessarily beta-neutral through time. For illustrative purposes only and not representative of an actual portfolio AQR currently manages.
General market commentary doesn’t always capture the full picture of the markets. When you dig further into the details, you’ll often find a different story.
Given all of this information, we do not anticipate a major stock market correction in the short-term. But markets are unpredictable, and it’s possible a stock market correction may occur. If so, we don’t think that you should be alarmed, because stock market corrections are relatively common.[8] Since 1946, the S&P 500 has experienced a 5% drawdown every 7 months on average.[8] Similarly, 10% corrections have occurred every 22 months, and 20% corrections every 76 months (6.33 years) on average.[8] Despite all of these corrections, the S&P 500 has continued to march onward, returning 11% annually since 1946.[4]
In summary, there’s always something to worry about, but it’s rare that a well-known issue causes a major stock market correction. Most issues are well-known and analyzed by markets participants at every moment. Typically, it’s a surprise event that serves as the catalyst for a market selloff. Despite all of the surprise events of the past, global stock markets have remained resilient and have rewarded investors over the long-run.[9]
We believe that the best course of action for managing unexpected events is through controlling what you can, such as broad diversification with the appropriate balance of growth and stability in your portfolio. You can use market volatility as an opportunity to rebalance to your target asset allocation. As certain asset classes increase in value, you can look to reduce exposure, and as asset classes decline in value, you can look to add; the simple notion of selling high and buying low. There might also be an opportunity for tax loss harvesting.
By focusing on the long-term goals of your portfolio, you can reduce the temptation of making major changes based on short-term news events. There will always be something to worry about, but with the right portfolio design and disciplined approach, you can whether almost any storm.
Important Disclosure Information & Sources:
[1] “Daily Treasury Yield Curve Rates“. U.S. Department of the Treasury, 12-Oct-2021, treasury.gov.
[2] “S&P 500 (^GSPC)“. Yahoo Finance, 12-Oct-2021, finance.yahoo.com.
[3] “COVID-19 Projections”. Institute for Health Metrics and Evaluation, healthdata.org.
[4] “S&P 500”. Morningstar Direct, January 1930 - September 2021.
[5] “CRSP US Mega Cap Growth Index“. Morningstar Direct, 30-Sep-2021. The CRSP US Mega Cap Growth Index includes the largest U.S. companies, with a target of including the top 70% of investable market capitalization, ranked by various metrics to consider valuations.
[6] “CRSP US Small Cap Value Index“. Morningstar Direct, 30-Sep-2021. The CRSP US Small Cap Value Index focuses on the bottom 2% - 15% of US stocks by market capitalization, ranked by various metrics to consider valuations.
[7] “Are Value Stocks Cheap for a Fundamental Reason?“. AQR Capital Management, 30-Aug-2021, aqr.com.
[8] “Putting Pullbacks in Perspective“. Guggenheim Investments, August 2021, guggenheiminvestments.com.
[9] “Stocks for the Long Run”. Jeremy Siegel, 2014, Wharton School Press.
There is no guarantee investment strategies will be successful. Past performance is no guarantee of future results. Diversification neither assures a profit nor guarantees against a loss in a declining market.
Statements contained in this article that are not statements of historical fact are intended to be and are forward looking statements. All forward looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties which could cause actual events or results to differ materially from those projected.
Indices are not available for direct investment. Index performance does not reflect the expenses associated with management of an actual portfolio. Index performance is measured in US dollars. The index performance figures assume the reinvestment of all income, including dividends and capital gains. The performance of the indices was obtained from published sources believed to be reliable but which are not warranted as to accuracy or completeness.
Hyperlinks to third-party information are provided as a convenience and we disclaim any responsibility for information, services or products found on websites or other information linked hereto.
Suggested Reading
The Sum Of Its Parts
Like for a bicycle or car, you need all of the pieces in all of the right places for your investment portfolio to work properly.
By SJS Senior Advisor & Director of Institutional Investment Management Kirk Ludwig.
What do bicycles and portfolios have in common? More than you might think. My son likes to tinker—to take things apart and put them back together, to see how they work. When he was younger, we bought him a new bike, and the first thing he did was take it apart. But, after he was done taking it apart and putting it back together, there were three pieces lying on the garage floor. The bike looked the same as it did before, but when he tried to ride it, something wasn’t right. It still looked like the original bike, but it didn’t work like it was supposed to. You need all of the pieces, in all of the right places, for the bike to function properly.
So, what about all of the components of your investment portfolio? Have they been mindfully assembled? Or do you have some extra pieces like yield, term or liquidity lying on the proverbial floor? All of these pieces are necessary to have a complete, well-designed portfolio.
For example, we find that many fixed-income investors will look only for the highest yielding bond without considering what it may do to the bigger picture. Buying a bond isn’t just about the yield; there are more components to evaluate. We also need to consider maturity, the creditworthiness of the issuer, the structure of the bond (e.g., callable versus non-callable), how the yield compares to similar bonds, and most importantly, how the bond may impact the degree of risk of the entire portfolio.
When we build an investment portfolio, whether it’s a bond portfolio or a diversified portfolio that includes stock and bond exposure, the focus is on how all of the pieces come together, not on just any one component. The value of the design lies in the way all the components integrate and work together.
You could also compare a balanced portfolio to the inner-workings of your car. Sure, all cars need an engine to go. That’s what powers the car. But, a good braking system is just as important—you need to have quality tires and stable brakes to be able to balance the power and strength of your engine. If your engine needed work, you wouldn’t take your car in to have the brakes fixed, or get new tires to correct the problem.
It’s the same with your investments. Instead of an engine, brakes and tires, you have safety, liquidity and return to consider. All have their places in both longer-term and shorter-term investments and serve different purposes. But, all are also useful in designing a balanced portfolio.
At SJS, the MarketPlus® Investing approach is to help you understand risk, first and foremost. Then, we utilize all the parts to construct a portfolio designed to meet your objectives and goals using our MarketPlus models as the cornerstone. We know that investing is different for everyone, just as there are different car options for everyone. We base investment recommendations on what you’re trying to accomplish and knowing what you need to get there. And, finally, by putting all of the pieces in all of the right places to build and maintain a portfolio that can help you get to your destination.
Important Disclosure Information:
There is no guarantee investment strategies will be successful. Past performance is no guarantee of future results. Diversification neither assures a profit nor guarantees against a loss in a declining market.
MarketPlus Investing® models consist of institutional quality registered investment companies. Investment values will fluctuate, and shares, when redeemed, may be worth more or less than original cost.
Advisory services are provided by SJS Investment Services, a registered investment advisor with the SEC. Registration does not imply a certain level of skill or training. This material has been prepared for informational purposes only.
Hyperlinks to third-party information are provided as a convenience and we disclaim any responsibility for information, services or products found on websites or other information linked hereto.
Suggested Reading
I Know You Can’t Predict The Future, But….
The stock market, like the bookmaker, handicaps all known information. You are betting on if your expectation is different than what the market expects.
By SJS Senior Advisor & Director of Institutional Investment Management Kirk Ludwig.
It’s human nature to ponder what the future holds and what it means to your investments. As the market grapples to understand the long-term implications of the COVID-19 pandemic, global trade, elections or (fill in the blank), the market continually factors known information into today’s prices, whether we understand all of the underlying factors, or not.[1] With so many variables influencing future market movements, it is a challenge to predict how the markets will respond…yet, investors still try to speculate on what happens next…we can’t help it, it’s our nature!
During periods of great uncertainty, markets can change course quickly, creating high volatility while the markets reprice risk. These periods, like we are experiencing in 2020, can be very perplexing to understand. How can stocks move higher when the future seems so uncertain? Are historically low interest rates signaling slow growth and low inflation for many years to come? What does the rise in the price of gold signal to the markets? These types of questions are endless.
Think of the market like a sports gambling bookmaker. If you were to place a bet on the outcome of a professional sporting event, you’d likely research who has home team advantage, injury lists, top player stats, and all the other factors which may give one team an advantage over the other. The bookmaker, and all the other gamblers, are aware of these same advantages. In order to even the playing field, the bookmaker will create a “spread”, giving the underdog extra points to compensate for these differences. At this point, you’re no longer betting on who wins, but you’re betting on if the spread is correct or not. This is much more difficult to predict!
The stock market, like the bookmaker, is always handicapping all known information. If you’re increasing or decreasing your risk exposure to stocks based on how you believe the current news will impact your investments, know that the market has already priced in these factors. What you’re really betting on is if your expectation is different than what the entire market, on average, is expecting. Again, a much more difficult prediction.
We don’t think that an investment strategy should be built on speculating if the market is accurately reflecting future expectations. More importantly, we think investors should reflect on how their investment strategy is positioned to meet their long-term desired outcomes based on long-term patterns.
At SJS, we focus our attention on the process and design. We develop portfolios to match the risk and return expectations of our clients through broad global diversification with the proper balance of growth and stability to match their long-term goals. We believe design matters most. Having the appropriate exposures to multiple asset classes and market factors improves the likelihood of a successful investment plan and removes the temptation to speculate on current events.[2][3]
If you would like to learn more about how to design your investment portfolio, feel free to reach out to us. We are always here to listen and assist!
Important Disclosure Information and Sources:
[1] “Eugene F. Fama, efficient markets, and the Nobel Prize.” John Cochrane, 20-May-2014, Chicago Booth Review.
[2] Unconventional Success: A Fundamental Approach to Personal Investment. David Swensen, 2005, Free Press.
[3] MarketPlus Investing® models consist of institutional quality mutual funds. Mutual fund investment values will fluctuate, and shares, when redeemed, may be worth more or less than original cost.
Advisory services are provided by SJS Investment Services, a registered investment advisor (RIA) with the SEC. Registration does not imply a certain level of skill or training. This material has been prepared for informational purposes only.
There is no guarantee investment strategies will be successful. Past performance is no guarantee of future results. Diversification neither assures a profit nor guarantees against a loss in a declining market.
Hyperlinks to third-party information are provided as a convenience and we disclaim any responsibility for information, services or products found on websites or other information linked hereto.
Suggested Reading
Hope Is Not Our Strategy
We all hope for things. But there are many situations where hope isn’t enough. With MarketPlus Investing, we use science and decades of research to guide us.
By SJS Director of Institutional Investment Management Kirk Ludwig.
We all hope for things, every day. We hope for good weather, we hope traffic flows smoothly, we hope our favorite contestant will be named the winner on the latest TV talent competition. Hope is a part of human nature – a feeling, an emotion we all experience.
But there are plenty of situations where hope just isn’t enough. Hope may be a lot of things, but it is not an investment strategy. Sure, we hope that our investments allow us to save for our children’s college education, or purchase that vacation home, or retire comfortably. In this case “hope” means that we want our investments and planning to pay off so that we can do all the things that we invest for.
Hope – and fear – can affect the way investors evaluate alternatives. When markets are up, and everything seems to be going our way, feeling hopeful is easy. Hope can lead investors to think optimistically about the future, to ask the question: How good can it get? According to Hersh Shefrin in his book Beyond Greed and Fear, an investor who says, “I’m hoping for…” may be willing to accept more risk to reach that goal.
On the opposite side of hope is fear. These two feelings have a way of affecting our ability to make rational investment decisions. So, that same investor who had been feeling hopeful may now feel fearful, saying, “I’m afraid of …,” and may be less likely to take on more risk. (Hersh Shefrin, Beyond Greed and Fear, 2002.)
How emotions influence decision-making forms the basis of behavioral finance, which seeks to explain why investors may make irrational financial decisions. One concept that can affect investors is “hindsight bias,” which often occurs in situations where a person believes, after the fact, that some past event was predictable and completely obvious. Of course, in reality, the event could not have been anticipated. But the way we feel today is likely the result of what we’ve experienced in the past, and this will influence how we feel about the future. In financial markets, as in many other areas of life, a number of events seem obvious in hindsight. We’ve all heard the old saying, “Hindsight is 20/20.” Psychologists believe that hindsight bias allows us to believe that events are predictable to find order in our world. (Albert Phung, Behavioral Finance: Key Concepts, Investopedia.com.)
Advisors provide value by understanding these behavioral tendencies and helping clients guard against them. The advisor advises, adjusting portfolio risk to meet investor needs, not based on their level of hope or fear.
With MarketPlus Investing, we’re not “hoping” that a single stock will do better than the market, or “hoping” that an active fund manager will continue to outperform.
Instead, we’re using science and decades of research to guide us. (Dimensional Fund Advisors, Putting Financial Science to Work, February 2015.) MarketPlus investing is all about science and structure. We share the Nobel-prize winning investment philosophy of Eugene Fama of the University of Chicago, and other time-tested theories developed with his colleague, Kenneth French, of Dartmouth College.
MarketPlus Investing is based on four core fundamentals.
Markets are efficient and priced fairly.
Speculating is futile.
Global stocks and bonds have rewarded investors over the long term. History has proven this, especially for those who have a strategy and stick with it.
Portfolio design matters most.
Interestingly, not one of those fundamentals mentions “hope.” The financial industry has a way of selling hope, and playing on emotions. By relying on science and “controlling the controllables” to an extent, we can help put your mind at ease. A MarketPlus Investing portfolio is designed to best manage asset allocation, risk and tax implications for you – all while optimizing your expected return for the risk assumed. There are always factors we can’t control. But when we rely on what we know through science, we can reduce the anxiety felt when facing challenging markets, providing peace of mind without leaving things to “hope” or chance.
Suggested Reading
Bond Returns – Could The ‘Drought’ Be Ending?
In the bond market, we have been experiencing our own version of a “drought” over the past decade – a shortage of income (or, yield) from our bonds.
By SJS Director of Institutional Investment Management Kirk Ludwig
Whether you’re an SJS client living in Ohio or Arizona – or somewhere in between – chances are good that you have experienced an environmental drought at some point during your lifetime.
In the bond market, we have been experiencing our own version of a “drought” over the past decade – a shortage of income (or, yield) from our bonds, with respect to the fixed income allocations in our MarketPlus® portfolios. A drought begins and intensifies when there is a continued shortage of rainfall. Over time, the ground dries up. The “green” goes away as plants, shrubs, and trees die or fall dormant. The ground remains fertile but, in the absence of precipitation to generate new growth, crops fail to produce their yield.
Typically, we think of bonds, or fixed income, as the “safer” part of our portfolios, since they generate income while providing portfolio stability. However, since the Great Recession in 2007, short-term bond rates have hovered near zero percent, evaporating any income from this part of the portfolio.[1] Now that the U.S. economy is feeling more stable, the Federal Reserve has increased their target rate to 2.25%, which in turn has showered the bond market with a much needed income boost.[2]
Similar to how a gentle rainfall would not immediately end a weather drought, a gradual increase in interest rates doesn’t automatically lead to higher income. When interest rates go up, the principal value of a bond will actually adjust lower to make up for the higher market rate. This adjustment period often dampens fixed income returns in the short-term, but leads to a higher income stream in the future. As a result, the returns in fixed income investments year-to-date in your portfolio have been fairly flat.
We are eager to start capturing greater yields, but we have to be patient. In the current interest rate environment, the bond portion of our MarketPlus portfolios will gradually start capturing the increase in rates as shorter-term bonds mature and proceeds are reinvested at today’s higher yields. The Federal Reserve will likely continue to raise short-term rates in the near future, which means bond returns may continue to be flat for a while. However, we believe that we will soon start to see evidence of higher yields as they sprout within the portfolios.
A recovery following a drought is gradual. It doesn’t happen like a flood – instantly inundating. The recovery occurs by having a steady, soaking rain for a few days or more. Before you know it, your resources are recovering and the drought has ended.
Our hope is that our client portfolios start to benefit from these drought-ending rate increases, and that their future “harvest” will be more bountiful.
Sources:
[1] Daily Treasury Yield Curve Rates, U.S. Department of the Treasury.
[2] U.S. Rates and Bonds, Bloomberg.com.