This unease can largely be attributed to the perceived challenges posed by elevated interest rates, geopolitical conflicts, and an unhappy consumer. When you factor in the tumultuous nature of the investment landscape over the past three years, it's not surprising that even the most confident investors may find themselves hesitating. Cognitive bias is indeed a thing and shapes people’s viewpoint.
As doom and gloom as some of these opinions feel… We aren’t as pessimistic as most... Let’s take a deeper dive into how we got here.
"Interest rates are to asset prices like gravity is to the apple. They power everything in the economic universe."
-Warren Buffett
Over the last three years, our discussions have consistently highlighted the pivotal role played by interest rates and inflation as dominant forces in the markets. During periods of near-zero interest rates, all assets experienced a positive impact, propelling the economy into a phase of heightened activity. Since 1981, the cost of money, reflected in interest rates, has consistently decreased, leading to a continuous uptrend in asset valuations. The COVID-19 pandemic and subsequent lockdowns further intensified this trend as an unprecedented amount of money was injected into the system. However, the landscape shifted when inflation emerged as a significant factor in the equation.
In mid-2022, inflation reached a peak, surpassing 9%, prompting the Federal Reserve to adhere to its mandate by implementing measures such as tightening short-term interest rates and reducing the money supply. This shift in monetary policy resulted in a challenging calendar year for all asset classes. Equity markets experienced a decline ranging from 20% to 30%, bonds were down 15-25%, and even the housing market saw a slowdown, with mortgage rates hitting 6-7%. The adverse impact extended beyond conventional assets, affecting even the diversified portfolios.
The more speculative you were, the more pain you felt. There has already been a number of high-profile bankruptcies (WeWork, Smiledirect, Bed Bath & Beyond, SVB, FTX, and Yellow Freight), and numerous other entities find themselves on the brink, struggling as the cost of capital to sustain unprofitable or economically unviable plans dwindles. This outcome, while unpleasant, aligns with expectations in this phase of the economic cycle, emphasizing the importance of diversification to mitigate risks and avoid overcommitting to a single investment strategy.
New Year, New Markets
Despite the initially modest outlook, 2023 commenced with a resurgence, notably witnessed in major equity indices such as the S&P 500 and the Nasdaq 100, which managed to reclaim the majority of their losses from 2022 within the first seven months.
Conversely, the fixed income landscape presented a more difficult scenario. The continued rise in interest rates presented a major challenge for bonds. While the potential for higher yields on cash and bond investments in the future exists, the path to this point has been burdened with considerable difficulties.
It has been hard for all interest-rate sensitive asset classes.
Drawdowns from All-time Highs Through Q3 2023
· Intermediate-Term Bonds- 17%
· Long-term Bonds (20+ years)- 47.66%
· Small Cap Stocks (IWM Index)- 30%
In straightforward terms, long-duration bonds and small-cap stocks bore the brunt of the impact. Unless your portfolio was heavily weighted toward the largest-cap companies and short-duration bonds in the last two years, you likely faced returns reminiscent of a bear market.
The Outlook Ahead- (our opinion only….)
Since the beginning of November, there has been a modest decline in interest rates, accompanied by a partial reflation across all asset classes. This movement appears to be a short-sighted reaction as markets attempt to anticipate the potential outcomes when interest rates level off, assuming the Federal Reserve successfully brings inflation under control and rates stabilize. We firmly believe that this is an eventual inevitability. There will come a day when the upward movement is not merely a head fake but signals the commencement of a new cyclical bull market.
In terms of positioning, we are gradually increasing duration within the fixed income segment of our portfolios. Simultaneously, we're adopting a slight overweight position in small-cap stocks and municipal bonds. We hold the view that the increase in interest rates was a necessary corrective measure for the financial system, contributing to its overall health. Presently, we are incorporating short-term treasuries as a complement to cash in many portfolios. Diversification remains our guiding principle, and adapting to market dynamics is typically a beneficial means of rounding out a portfolio.
Next week, I will build upon this discussion by delving deeper into the long-term performance of equity and fixed income markets following extended drawdowns.
As always, please don’t hesitate to reach out if you or anyone you know has any questions.
Thanks
Frank Vance
Retirement Capital Advisors
800 Battery Ave SE
The Battery, Suite 100
Atlanta, GA 30339
Office- 412-722-3795
frank@retire-me.com
Securities and Advisory Services offered through Commonwealth Financial Network®, member FINRA/ SIPC, a Registered Investment Adviser. Fixed insurance products and services are separate from and not offered through Commonwealth Financial Network
Disclaimer: The term markets, market, S&P 500, or any other reference to financial markets are notional concepts and not specific investment advice or suggestion. This article does not constitute specific investment advice, and none is implied or inferred. This article is for clients of Retirement Capital Advisors only. Investing entails risk of loss of principal and no guarantee of returns are inferred or implied. Please consult your personal financial advisor if you have any questions.