What’s on Your Mind?
What’s on Your Mind?
Can you remember a time in your school years when a teacher or professor suggested that if you have a question about a topic, you should ask because surely others have the same question? Based on this, we assume many of you might have the same questions that have come up from time to time in recent months. With no further ado, we would like to address some of those common questions.
With all the uncertainty these days, should we change anything?
Recent talk of trade wars and the on again off again denuclearization of North Korea certainly lend their fair share of economic and geopolitical uncertainty. While these events may be unique to present times, a constant throughout history has been the presence of uncertainty about the future in light of present events. Another constant is that long-term investors have been rewarded with rising stock prices and dividends in the face of one uncertainty-causing event after another. To change an investment strategy or philosophy in response to a new concern runs counter to the near impossibility of predicting events much less, how markets may respond to them. A sound long-term investment strategy recognizes near term events as noise, however unsettling they may be, and the uncertainty as what causes stocks to achieve their returns.
What do rising interest rates mean for my portfolio?
Let’s take a step back first and understand why interest rates go up. Interest rates tend to go up in response to strengthening economic conditions and outlooks. This sounds like a good thing, right? Well, leave it to financial “journalism” to try to convince us otherwise. A stronger economy means more jobs, more business investment and higher earnings, which all tend to translate to higher stock prices – we have seen this the last couple years since rates began their nascent climb. Higher rates also help keep inflation contained. It is true; however, that bond prices decline when rates rise, but higher rates on bonds are a welcome change after many years of paltry bond yields.
Will they (interest rates) keep rising?
If we were to take the Federal Reserve on its word, we can expect another two or three rate increases in the second half of this year. Attempting to discern where interest rates may go from there entails speculating on how rapidly the economy continues to grow and, possibly even more difficult, how the Federal Reserve may interpret economic results. As with stocks, such speculations about future economic growth and interest rates prove to be similarly inaccurate and altering investment strategies in response can be perilous to a portfolio’s success.
It has been a while since the last bear market, should we be preparing for the next one?
We have the utmost confidence that a diversified global stock portfolio will continue to provide the long-term investor with above inflation returns in the future. We are equally as confident that we will experience temporary setbacks from time to time in the form of market corrections and bear markets as we have in the past. These temporary events are the cost of higher returns expected from stocks. The trouble is that it is nearly impossible to predict when they may happen. Because of that, we are always planning for their occurrence by balancing stocks and bonds based on what your portfolio needs to do for you with this in mind.
Stocks are at or near all-time highs – should we be trimming our stock allocation?
The answer to this question comes back to the perils of near term forecasts, but it often does become difficult to envision share prices that advance to the next new high as we tend to anchor our expectations to the recent past. New high water marks for stock prices do not mean trouble is around the corner, though. In fact, with stocks having increased in three out of four years, we should expect new highs in more years than not. After significant increases in stock prices, disciplined portfolio management through rebalancing back to your target asset allocation acts as a mechanism to ensure that some stocks are sold at high, or expensive, levels. The opposite is also true – when stocks experience a decline, rebalancing back to a target asset allocation entails selling bonds to purchase cheaper stocks. Rebalancing provides discipline to a portfolio and risk management to help us avoid “calling a top” in markets or awaiting a downturn.
The central tendency in these questions is our desire as investors to understand an unknowable future through predictions and forecasts and an inclination to “do something” in response to them. However, study after study has proven the difficulty of making consistently accurate predictions or forecasts about events and how markets may respond to them. In light of this, our investment outlook never wavers due to current market conditions or the latest forecasts – investors will be compensated with above-inflation returns in exchange for their long-term ownership of US and global companies, but there will also be periodic setbacks that require broad diversification and an appropriate allocation to bonds.
Investment predictions are no better than sports predictions
For any soccer fans out there, recent World Cup forecasts by the large global investment banks, UBS and Goldman Sachs, highlight the fallibility of “expert” and “quantitative” forecasts. After 10,000 World Cup simulations, UBS predicted a victory for the defending champion, Germany. Germany failed to advance beyond the first round. Maybe UBS’s algorithm was subject to recency bias. Goldman Sachs, using one million simulations, predicted victory for the all-time winningest team, Brazil. Perhaps Goldman’s algorithm fell victim to the “Gambler’s Fallacy” indicating that after failing to advance to the finals in the last three tournaments, it had to be Brazil’s turn to win. Like in sports, market and economic predictions are best used for entertainment purposes only.
Thank you again for allowing us to serve you and please let us know if you have any questions or comments. We always look forward to hearing from you.
The Partners of PrairieView
Source: YCharts. Indices: S&P 500, Russell 1000 Value, CRSP US Small Cap, CRSP US Small Cap Value, MSCI World Ex USA, MSCI ACWI Value, MSCI ACWI Small Cap Value, MSCI Small Cap World Ex USA, MSCI Emerging Markets, Barclays US Government/Credit 1-5 Year, Barclays Global Agg Ex-US Hedged, Barclays Municipal Bond 1-5 Year, TIAA Real Estate Account. All index returns presented as total return inclusive of dividends.
Matt Weier, Senior Wealth Manager
Director of Investments
Chartered Financial Analyst
Certified Financial Planner®