By: Jeff Anderson, CFA
|Close||Weekly return||YTD return|
|US Treasury 10yr Yield||2.82%||-19.8%||141.8%|
Source: Wall St. Journal
If it weren’t for Friday’s rally, the major US stock market indices would have been down over 5% for the week. Why did stocks rally Friday? In a radio interview Thursday evening, Fed Governor Jay Powell said they will not simply raise rates without concern for its effects on the economy. They are making decisions based on data that is changing quickly. To me, this is a breath of fresh air. Previous Fed Governors were purely “model-driven.” Powell seems to be more flexible and, frankly, more up to the task than previous governors. We have had academics at the helm for decades. Powell is not an academic. He’s pragmatic, not dogmatic. In the same interview, Mr. Powell admitted that they should have raised rates sooner. This admission is a breath of fresh air. No one has all the answers. We view economics as a hard science, but it is not. It is part science and part psychology. When investors get increasingly confident in their views on the future, markets tend to tilt that way. Warren Buffet is credited with saying, back in 1973, that, in the short term, the stock market is a voting machine. In the long run, it’s a weighing machine. What does that mean? Basically, in the short term, stocks (& bonds, real estate, etc.) are driven by investor sentiment, but in the long run they are driven by value. Today’s economic climate is uncertain and investor sentiment is in the gutter. This happens repeatedly. When times are good, we tend to extrapolate those good times well into the future and asset prices get expensive. When times are bad (or uncertain), the opposite happens. We tend not to question things when times are great, but we get extremely focused on what “isn’t working” during bear markets. Making emotional decisions during times like this can be harmful to retirement goals.
We know that having a diversified portfolio is necessary to building wealth over time. The reason diversification works is that certain asset classes work better at different times. They all have some expected return profile. For example, Small Cap stocks tend to outperform Large Cap stocks over the long-term, but they tend to be more volatile and move a little differently than Large Cap stocks depending on the economic cycle. Small Cap stocks tend to underperform heading into a recession but do much better than Large Caps coming out of a recession. Predicting recessions is just plain hard. We can see the direction the economy is taking but guessing how or when the economy will tip into a recession is difficult. Over the long-term, it’s meaningless anyway.
One last note on diversification. The Walton family is the wealthiest family in the US. Their net worth is about $240 Billion. Most of that is their ownership stake in Walmart. They also have a family office that invests their other money. Their largest holding is an international equity ETF.