Keep This In Mind...Submitted by Latitudes Financial Strategies on March 17th, 2021
Readers of this space know that I have been talking about the eventuality of interest rates going higher and the resulting changes we’ll need to make to our portfolios for about 10 years. This month, it finally began to happen, interest rates have increased as the 10 year government bond increased its yield to about 1.5%, about triple where it was a year ago (Like a stopped clock: I was eventually right!)
Why? Even though the Federal Reserve has stated that it is currently planning no rate hikes, the bond market itself began to anticipate a future need for more normalized rates and drove bond prices lower, that’s what markets do, they look ahead. Let me give a quick recap of what this initial move in rates has done:
*Stock prices have begun to correct, meaning that stock buyers may soon have an alternative in bonds. We think loading up on bonds in currently premature, as rates will still go higher over the coming years but in figuring out market valuations, higher rates mean that we don’t have to pay up as much for stocks as we do in a low rate environment.
* People who are managing their own retirement accounts (or are having someone like me do it for you) may soon have reasonable rates in fixed income type vehicles, allowing us to take some risk off the table as we go froward.
*The U.S. Dollar will go up in value compared to other currencies.
* Industries like banks and financials will become more attractive as lenders can now charge higher rates on loans and increase their profits.
We’ve had an unusual couple of years in investing as markets simply went straight up, no matter what the news or financial conditions: pandemic, trade sanctions, a collapsing economy: the markets only see good news and our statements showed a higher balance every month. This set of circumstances is pretty unusual, and it allowed us to make quite a bit of money over the last few years, it was the time to ride some winners and stay mostly invested. I’m afraid, thanks to interest rates, that we are eventually headed to a more normal set of circumstances. Stocks, it turns out, go up and down!
To be sure, we invest in companies with a 3-to-5-year time horizon, but lately we’ve been hitting some of our long-term targets in months, not years, and that’s a good thing, as long as we remember that it’s not a normal thing. Investing involves risk: company risk, political risk, economic risk, interest rate risk and systemic risks, that’s largely my job: to manage all of them.
Last weekend I got to read Warren Buffet’s annual shareholder letter, release Saturday morning. It is always a lesson in investing and I highly recommend that you read this annual gem . (Click Here To Read).
Warren, the 7th richest person in the world, is arguably our greatest investor, he has amassed his wealth (for himself and his shareholders) by being a long-term investor who treats his portfolio like a business, like a company. I try to do the same with your portfolio, we aren’t traders (although once in a while the right market conditions demand that we trade). We try to take positions in companies and industries that will provide profits over time in order that their share value increases. That’s why we don’t worry about the day-to-day fluctuations in the markets but, tactically, we do stay alert to seminal changes in the markets. Rising interest rates are one of the important changes that we are always on alert for. We’ve already positioned ourselves for a rise in rates, and I expect higher rates are coming, although we might pause for a while at these new current levels.
In any market there are places to invest, as we mentioned, markets go up and down. We are in a transitional phase now where bonds are still precariously hovering near higher rates and some stocks are valued near their all-time highs. I’ve got this, it’s a normal investment scenario, with a long-term perspective we will do well. So, why don’t we just sell everything and reinvest everything because the market went down for a few days. That’s how amateurs invest, professionals understand that markets are not predictable on a daily (or hourly) basis and that investors should keep a long-term perspective. The following chart shows what happens if you miss some of the better days that come along in the market:
SO, staying invested is about the only game in town, at least for the portion of your assets allocated to stocks. With higher rates however, some of us may be able to begin to invest in some types of fixed income investments to take some risk off the table, that’s a good thing, I look forward to the day when we can return to a more “normal” asset allocation, one where we can have some assets in safer investments with higher rates: but we aren’t quite there yet! Rates are going to drift higher and, since they are going higher because of a potentially booming global economy, stocks are still considered a good value at current levels.
There’s been a lot of speculation in the market lately, another sign, I’m afraid, of market exuberance and the need for a correction. We have tried to avoid some of the frothier scenarios, sticking with our long-term approach to value investing, we don’t like to buy stocks because they are going higher through speculation, we buy stocks that go higher because they represent great companies with great earnings. That’s the difference between a professionally managed portfolio and a do it yourselfers.
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