Normal
As asset prices fall, all things equal, implied future returns rise.
Watching stock and bond markets through this year to date, it may seem that things are abnormal. U.S. stocks are down approximately 16% and U.S. bonds down approximately 9%, with international stocks and bonds performing approximately similarly. In the meantime, global commodity prices are up approximately 28%. But the world is emerging from a long period of extraordinarily low inflation and interest rates. During that period, Americans especially have enjoyed very low prices and easy supply of materials, products, labor, and financial capital (interest rates). In the first quarter of 2022 we are experiencing a return to what I would consider to be “normalcy”, where prices for materials, products, labor, and financial capital are now more dear, especially after the disruptions wrought by COVID-19. And one of the main places changing effects are being felt is in portfolios, where falling asset prices are behaving inversely to price rises in materials, products, labor, and financial capital. This makes total sense, and is a reversal of a multi-decade dynamic in which asset prices (stocks, bonds, and real estate) have risen as material, labor, and capital prices fell.
I cannot tell you where and when new equilibriums will be set, I can only tell you that as asset prices fall, all things equal, implied future returns rise. That is not a bad thing, because as clients who have attended our conferences and webinars can attest, for several years I have warned that asset prices had reached levels where future returns could not be expected to match historical returns. For example, since the 1920’s the S&P 500 collection of large American companies has returned 10% on average, each year. But as recently as early this year, implied future returns for that index were for only perhaps 5-6% returns (and even lower for the “growth” segment of that index), a sobering 50% to 60% of the very long term historical return. And so I have warned clients that either their expectations for future returns would have to adjust downwards, or prices would have to adjust downwards, or some of both. Many prices have indeed adjusted downwards this year, and I would argue that 30-year mortgage bonds on offer at a 5% yield make much more sense for us as investors than the 3% and under that prevailed recently.
It can be dismaying and unnerving to see the value of your portfolio decrease. But I want you to know that I am pleased at how our portfolios have held up during this year’s downturn, and their strong performance relative to market benchmarks. I have invested you in more attractively priced stock portfolios, and was not tempted to chase the high-flying technology stocks, cryptocurrencies, and other “sexy investments” that have now come crashing back to earth here in 2022. I have invested your portfolio in investment-grade government, corporate, municipal, and asset-backed bonds and avoided low credit quality bonds that promise higher yields but often deliver lower returns during times of market stress. I have also avoided owning long-term bonds that have lost relatively more value as interest rates have risen, and many, many months ago I added shorter term Treasury inflation protected bonds which have proven themselves to be good ballast during the recent and current period of high inflation. You own a highly diversified, low-cost, high-quality portfolio that is proving its mettle during this time of stress in financial markets.
At the same time, if you feel that your personal circumstances have or are changing, and you feel that these changes may recommend changes in your portfolio, I welcome a discussion with you to discuss it together. Our suite of financial planning, risk tolerance testing, and trading tools stands ready to assist us in our analysis. In the meantime, Jaycee and I are spending large amounts of time together in our “war room” looking at all client portfolios. We have been executing trades to, where advisable, recognize tax losses and gains, and to re-organize portfolios to make them even more efficient to manage on an account-by-account basis. That work will continue this year. If you see trades take place in your accounts in upcoming days, please know that we are hard at work taking opportunistic actions that are in your best interests as we see them in the current market environment.
While financial markets are behaving normally, other things in the world, however, are not. The mental illness of racism continues to afflict many, even our youth, in the United States of America and holds our country back from achieving its true potential greatness. Tragedies like that which took place yesterday in Buffalo, New York, where a young man shot and killed many good people at a grocery store simply because the color of their skin was different from his, should never happen. Financial markets will generally react rationally to changes in supply chains, interest rates, and inflation. It is up to each of us, however, to take appropriate views and actions with regard to other abnormalities. I hope that each of us will. New Capital Management stands against hatred and prejudice of any kind, and I know that we stand together with many, many others, first and foremost, with our clients.
