Battling Seesawing Rates and Volatility
Parents, at least in years past, have often pointed out how tough it was growing up in their day. The proverbial story of walking 5 miles to school in the snow provoked eyerolls in many children. That oft-repeated story became a target of derision with ever-increasing obstacles added to each re-telling. An argument could be made that it was tougher back in the “old days”. Certainly, grandparents or parents who lived through the Great Depression would have little disagreement from most.
As we have advanced into the age of the internet, social media, and smart phones, I would posit that children today may indeed have it tougher. They are over-stressed, over-stimulated and over-monitored. Parents are now capable of tracking every movement of their child if desired. The amount of surveillance is mind-boggling and only growing. They must feel like they are constantly watched.
There are hardly any lazy days of summer today. Scheduled from morning to night, children are constantly under pressure to perform all within a carefully constructed safety net. Everything is done to ensure maximum safety. Compare a playground from thirty years ago to a modern one. From a concrete foundation in the past to wood chips or rubber, every component has been sanitized for safety.
Risk reduction has become risk elimination. This creates a fake bubble where children almost never face adversity. For them to grow into mature adults, some failure is necessary. Let them fail and don’t step in to solve it. Let them take on a challenge without a parent coming to the rescue. Let them go to a playground on their own. Let them interact with other children with no supervision. They need to get on a seesaw with an adversary trying to bounce them off. Okay, rant off.
Speaking of seesaws. We are seeing continued volatility and not just in the equity markets. Similar to the two sides of a seesaw, bond prices and interest rates are inversely related. In other words, when one moves up or down the other moves in the opposite direction. If the price of the bond goes up, the rate goes down. And vice versa.
Typically, longer-term bonds will have a higher rate because a buyer is willing to “lock” their money up for a longer period. One way we see a longer-term bond’s rate decreasing is when demand increases. If you have taken an economics class, one of the first lessons taught is that increased demand (barring other factors) will increase the price of that product. So, in the example of the 10 Year Treasury, demand has increased to such an extent that it has driven the yield below the 3 Month Treasury yield. (See chart below)
Why is this important? This is the dreaded inverted yield curve. Long-term bond yields are now below short-term bond yields. Most experts consider this an indicator of a looming recession.
Should we panic and sell everything? Of course not. We are long term investors, not speculators. The inversion highlighted above is only a week old. It bears watching. An inversion of a month or longer is certainly a strong indicator of choppy waters in the markets if not a full-blown recession.
What should investors do? It depends on two main factors. Your time horizon and your risk profile. If you have a time horizon of two to three years, your portfolio allocation should be dramatically different than a person with a 5-year time horizon. Longer term investors can withstand volatility. Someone close to retirement may want to consider their equity exposure.
Risk tolerance can be measured with about 12 profiling questions. One key question is:
- When you hear “risk” related to your finances, what is the first thought that comes to mind?
- I worry I could be left with nothing
- I understand that it’s an inherent part of the investing process
- I see opportunity for great returns
- I think of the thrill of investing
Risk is then measured on a spectrum. If you selected the first answer in the question above, your equity exposure should be less than if you selected the other 3. Combine that with a short time horizon and you probably should not be in the equity markets at all.
The challenge is balancing that with increasing life spans where growth in a portfolio is required. If you would like to discuss portfolio strategy or financial planning, please contact me. Feel free to share with others and make suggestions for future articles: firstname.lastname@example.org