Portfolio Strategy Review Q3 2023

by | Oct 15, 2023 | Portfolio Strategy


As we try to remain calm through the recent turbulence, it’s worth remembering that markets have seen it all before, though every economic cycle presents unique challenges and opportunities. Capitalism, we the buyers and sellers and makers of goods and services, adapts and moves forward.

The Road Back to Normal?

In the wake of the Great Financial Crisis of 2008-09, cheap money and credit helped kick start and maintain economic activity. Interest rates remained well below long term normal averages from 2009-2022. Stock and bond prices rose. Technology and globalization helped keep inflation low. In 2022, a painful adjustment in stocks and bonds grew out of supply chain disruptions, heavy government stimulus, and a strong economy.

Cheap money and cheap stuff are no longer cheap.

Mortgage rates are near 8% up from 3% in late 2021. In 1982, I bought my first house on an assumed mortgage at 12.5%; market rates were 17% at the time! On the bright side, today we get paid over 5% on short-term bonds and cash. Inflation has moderated but remains stubborn. And the overall bond market has moved toward more normal rates.

Markets have a tendency toward mean reversion, meaning they may experience highs and lows, but they tend to move toward an average. The chart below helps us see the recent interest rate trend toward long-term averages.

In normal economic environments, short-term rates are lower than long-term rates. Will short-term rates decline from here? Or long-term rates increase from here? That will depend on the economy, inflation, and government deficits.

Every economic cycle is different because of the complex interplay of global geopolitical and economic forces. Geopolitical tensions and the dysfunction in congress add to the uncertainty. The future is never clear as we would like.

Five years ago, many high profile economists were predicting secular stagnation. This view held that interest rates and inflation would remain subdued because of aging societies and low birth rates. More recently, the consensus forecast of bond analysts for the past year has been that long-term rates will go lower, and a recession was imminent. Both views to date have proven wrong.

The Economy is not the Market

The economy is not the stock or bond market, but they are connected. Economic data can give us insight into future market moves. Other times it provides false signals that excite media pundits, short-term traders, and keeps investors teetering between fear and greed!

The Markets Speak: Noise or Logic

What’s bad is good; what’s good is bad….on 2nd thought its good but it eventually could be bad. So goes the emotional roller coaster.

Bad news is good news: the most recent ADP jobs report was weaker than forecast. The market rose because weakness means inflation is being defeated and interest rates won’t go higher.

Two days later……

Good news is bad news: the government jobs report was much stronger than expected. The market declined on fears that a strong economy means inflation is still a problem and rates could increase more. Yet a couple hours later markets rallied and ended the day up. Good news is good news!

A horrific massacre in the Middle East incites potential for a broader regional war and markets rose…..?

Markets are complex systems that often defy logical, rational thinking. The levers that drive economics and markets are not always readily apparent.

COVID showed us how sensitive supply chains are to disruption. Corporations’ zeal for lower costs and higher profits left us overdependent on foreign countries. As onshoring takes place we should expect that prices will remain higher. US workers can’t afford to work for the same wages as people in Latin America, China or Southeast Asia. Corporations will try to pass the higher wage costs on to consumers or they will take a hit to profit margins. Onshoring is a price we will need to pay to secure supplies and the production of goods.

The forces below are not a comprehensive list, but they highlight key issues at work and the tensions that they create.

Inflationary Forces
· Reshoring/onshoring (aka deglobalization or re-globalization)
· Labor shortages
· Labor wage gains
· Natural resource shortages stemming from Russia/Ukraine war
· Corporate profit margins stay at record highs?

Deflationary Forces
· China’s deflation (they rely heavily on globalization)
· Aging populations in Europe, China, and the United States
· Technology (ChatGPT, AI)
· Competition
· Corporate profit margins could trend lower?

The Return of the “Bond Vigilantes”

The government is funded by income taxes and by government debt (aka US Treasury bonds).

The term “bond vigilante” was coined back in the 1980’s. Basically it means that institutional bond investors demand higher interest rates to buy US Treasury bonds for the perceived risk of owning them. This looks like what is happening with long dated bonds this year.

The US faces record levels of debt at a time when our income tax rates are at historic lows. Democrats insist on social spending increases; Republican’s insist on tax breaks. The real solution will require a compromise. At this date, Republicans can’t even agree that they are on the same team. Stay tuned.

The Most Important Point

Asset mix is the most important thing to get right when saving and investing for your goals. As noted above, the market has seen it all before. Trying to time the different market moves is a risky business.

A long time horizon helps minimize the risks that occur along the way as capitalistic forces adapt to changing environments.

Having more allocated to stocks helps grow long term wealth.

As you near retirement preservation becomes more important. As the chart below shows, markets very seldom move in the same direction. The S&P 500 was down 9% over a ten year period, yet holding several different assets helped offset the decline. A diversified portfolio can help to offset risks.

A diversified portfolio and more allocated to bonds helps preserve and protect your wealth.

Jerry Matecun – Founder, President
Expert guidance to plan your future, preserve your lifestyle, and retire with confidence. For a confidential consult, contact me at jerry@compoundvalue.com.

PLEASE NOTE: You can’t invest directly in an index. Past performance does not guarantee future performance. All investments are subject to risk, including possible loss of the money you invest. Diversification does not guarantee profit or protect against a loss. Nothing herein or elsewhere on this site constitutes investment, legal, or tax advice. For details please see Disclosure.

Advice that Matters for business & personal financial insights