By: Jeff Anderson
|Close||Weekly return||YTD return|
|US Treasury 10yr Yield||4.008%|
Source: Wall St. Journal
To say it was another volatile week for equity markets must seem like a bout of déjà vu. Stocks fell to start the week, fell even harder Thursday morning when disappointing CPI data was released, only to completely reverse course and finish higher. In fact, the Dow Jones Industrial average fell 500 points in the morning and rose a whopping 800 points later in the day to mark the largest single day swing (in points, not %) on record. The week finished with the broader markets finishing lower Friday. Given the stickiness of inflation and the increased probability of a more aggressive rate hike in December, it wasn’t a surprise. The Fed is 100% committed to getting inflation under control and that means getting as aggressive as possible with rate hikes. With CPI coming at 8.2% for September, it was in line with the previous month but higher than the markets wanted. The good news was that supply chain issues have eased, sending core inflation across the goods sector down to 6.2% or so. Unfortunately, inflation in the services sector more than made up for that decline. You can chalk it up to wages. Service sector jobs have seen steady wage growth. The Fed is aimed at increasing unemployment. The neutral rate of unemployment is about 4%, meaning that is what the Fed sees as “normal”. Anything lower means the economy is running a little too hot. Chairman Powell and his team take out their blunt instrument called “interest rate policy” and try to bludgeon it. Raising rates should slow economic activity. Slower economic growth should slow job growth. Slow job growth and you hope you can dampen the upward pressure on wages. Which, in turn, should slow inflation. That’s the playbook. The Fed is willing to accept higher unemployment and even a recession.
Over the next 30 days, we’ll have a pretty good handle on corporate earnings for the third quarter as well as guidance for the fourth quarter in addition to the mid-term elections. Earnings are still expected to grow, albeit at a much slower rate that projected three months ago. The Republicans are expected to take the House and possibly the Senate. That would likely spell gridlock the remainder of President Biden’s term. Gridlock is actually good for markets.
The San Diego Padres Roster – an Analogy for Your Investment Portfolio:
The Padres’ pitching staff is stellar. No doubt. Their closer, Josh Hader has, in my mind, the most stressful job on the team. He sits around all game until, if they’re winning, gets the call in the 9th inning to preserve the victory. Eight innings of baseball determines whether he’ll be needed or not. In total, He only pitched 50 innings during the regular season. The entire regular season has 1,458 innings, not including any extra innings. So, Hader is used less than 4% of the time yet his role is as important, if not more, than most of his teammates. And what did it cost the organization to have a pitcher take the mound for 4% of the time? $11 million this year. Seems like a lot, but it’s only 4.6% of the entire payroll. I guess you could say his playing time vs his salary is somewhat in-line. Interesting you might say, but what does it have to do with an investment portfolio? Plenty.
Baseball, like investing, is dependent on statistical analysis. Building a team is like building a portfolio. You can’t play without a pitcher, or a catcher, or first basemen. You need 9 players on the field. From there, you need the best player for that position that offers the best risk/reward in addition to how well he fits into the team’s game by game strategy. The manager is playing a live game of chess. He starts with a gameplan but has a set of alternate moves he can make when conditions change. For example, if the game is close and the opponent’s best hitter is up next, it might require a pitching change. That kind of thing.
It’s not dissimilar to investing. To do it correctly, you need a starting lineup. Stocks, Bonds, Real Estate etc. The next task is to figure out how much of each? Too much of one asset class causes a hole in your lineup. If your investment opponent is inflation, the kind of stocks and bonds you need are slightly different than when your opponent is an economic recovery. You need a long-term game plan as well as the ability to make changes when conditions necessitate it.
Like the importance of Josh Hader’s 4% contribution to the team is, so might your 4% withdrawal rate be as equally important. Some changes required might seem small, but they can have a meaningful impact. It’s all a balance.
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