Archive for Economy and Investing

Falling Flat: The Not-So-Predictive Yield Curve

Economy and Investingon January 10th, 2019Comments Off on Falling Flat: The Not-So-Predictive Yield Curve

Written By: Zach Bennedsen, CFP®

If you’ve been following recent market news, you’ve undoubtedly heard about the recent turmoil in the stock market. As we noted last week, 2018 was the first year in a decade that US markets finished lower than they started. This fact doesn’t mean a lot on its own, but it certainly doesn’t stop the talking heads from…well, talking. Pundits love to grab statistics and buzzwords that can generate a story, often plucking only the economic measures that support their case.  One of the phrases you may have seen put forth, often as a harbinger of recession, is the dreaded “inverted yield curve.” The story goes that once the yield curve flattens or inverts, the stock market is certain to take a downturn. Today, we’ll take a closer look at what exactly the yield curve measures and what (if any) predictive value it has.

Before we proceed, let’s take a moment to define a yield curve—for our purposes, we’ll specifically define the Treasury Yield Curve. The US Treasury issues notes, bonds, and bills of various lengths (maturities) to investors. These financial instruments all offer a rate of return (yield) that is based on a variety of factors, but typically is most heavily influenced by the amount of time the investor must wait to receive the return. The Treasury Yield Curve measures the return of these instruments versus maturity of each. Typically, the yield curve resembles the orange line on the following chart. The curve increases over time because an investor requires a higher return if they part with their dollar for a longer amount of time.

Sometimes, however, the Treasury Yield Curve looks more like the blue line. In fact, that’s what the yield curve looks like right now. The question is, why? There are many things that can affect the shape of the yield curve (Federal Reserve Policy, investors flocking to long-term bonds, etc.). While some say that an inverted yield curve is the best signal of an impending recession, its predictive nature of stock market performance is questionable. One of the most commonly cited statistics in favor of the relationship between the yield curve and stock market performance is that the last seven (or another number, depending on your source) recessions were preceded by an inverted yield curve. Upon closer examination, however, we can see that the length of time between an inverted yield curve and a recession is far from constant. Logically, we could also say that the last seven recessions were preceded by a presidential election, or by an AFC team winning the Super Bowl.

As we well know, markets go up, down, and sideways with time. Recessions happen. They have happened in the past and will happen in the future. That doesn’t mean that an investor should run for the hills every time the markets get a little jittery. The reasons are twofold. First, it is impossible to accurately predict exactly when markets will go down. For example, if an investor had moved to cash at the sign on an inverted yield curve in February 2006, they might feel smug about the ensuing 2008 market crash, until they realized they missed out on almost two years of positive market performance in the interim! The second reason is that even if an investor correctly timed their exit from the market (doubtful), they still won’t know when to get back in.

To wrap up, let’s take a look at some statistics that the researchers at Dimensional Fund Advisors, one of our strategic partners, have collected. Dimensional looked for yield curve inversions in various countries since 1985, and found that “In 10 out of 14 cases of inversion, local investors would have had positive returns investing in their home markets after 36 months. This is not much less than the historical experience of these markets over the same time frame, regardless of the shape of the yield curve. These results show that it is difficult to predict the timing and direction of equity market moves following a yield curve inversion.”

So, if the yield curve has no predictive value, what are we doing here at Yeske Buie? As always, we’re staying tuned into the goings on of the global economy, while staying grounded in our evidence-based investment philosophy. To start, we invest in a globally neutral portfolio, meaning that about half of Client portfolios are allocated to overseas markets. Furthermore, we address the cyclical nature of the stock market by incorporating short-term high quality bonds into our Clients’ portfolios. In the event of a prolonged economic downturn, this stable reserve can serve as a bridge to support spending for spending Clients. In the same situation, accumulating Clients can rely on their stable bond allocation to act as a source of funds to rebalance into stocks while the stocks are temporarily cheap.

If you’re still curious to learn more, tune in on Wednesday, January 23rd to our 2019 Financial Review & Outlook. You can reserve your virtual seat here.

Quick Take: Market Perspective in Two Charts

Economy and Investingon January 7th, 2019No Comments

The stock market has become much more volatile in recent weeks and months and we thought we’d offer a brief perspective.

First, we know you’ve seen the headlines that market performance last year was the worst in a decade, based on the S&P 500.

That is true.

However, considering the fact that 2018 was the first year with a negative return since 2008, that statement doesn’t necessarily have much meaning. The S&P 500 fell 37% in 2008 and 4% in 2018, after having risen by more than 200% during that same decade.  So, yes, last year was the worst in a decade, but not exactly a catastrophe.

In contrast to the S&P 500’s 4% fall in 2018, the average Yeske Buie portfolio lost about 9%. This is largely due to the fact that we construct global portfolios with a significant allocation to Overseas markets, which did worse than US stocks last year.

As you can see from the chart below, however, US and Overseas markets regularly (though not predictably) trade leadership.

This chart shows the relative performance of US and International Markets, with bars on the top indicating periods when the US performed better and bars on the bottom showing those periods when Overseas markets did best. As you can see, neither dominates forever and a truly diversified portfolio must include both.

We’ll be covering these and other matters in greater depth in our upcoming webinar on January 23; we hope you’ll join us. You can reserve your virtual seat here.

In Case You Missed It: What the Stock and Bond Markets are Telling Us

Economy and Investingon October 18th, 2018No Comments

OK, let’s be honest, we never really know what the stock and bond markets are telling us in real time. It is only after the fact, with the benefit of hindsight, that we know what the signal meant. The economy and the financial markets are complex, chaotic systems that defy short-term prediction or analysis. For an example of how short-term noise can obscure the real story, see “Weekend Chart Challenge.”

Having said that, we can still harness economic theory to tell us what “might” be going on. We can tell a story that is not inconsistent with the facts.

First, let’s start with interest rates, inflation, and the bond market. Much in the news lately has been talk of the impending arrival of the dreaded “inverted” yield curve which would portend a coming recession. Normally, long term interest rates are higher than short term rates because long term bond investors need to hedge against the risk of future inflation. Historically, when short rates are higher than long rates, a recession follows within a year or two. Recently, however, both short and long term interest rates have been rising, and for all the right reasons writes Neil Irwin in the New York Times (Interest Rates are Rising for All the Right Reasons). Irwin makes the case that the rise in longer term rates is actually a signal that bond investors believe strong economic growth will continue.

Which brings us to the stock market, which, while up at the moment, has been down 3% – 4% in recent days. The first time in years that we’ve seen that kind of downside volatility. Interest rates have been a major culprit if you believe the headlines. The economic case for blaming interest rates is two-fold: first, when the yield on the 10 year Treasury bond is higher than the dividend yield on stocks, investors might be seduced into leaving the stock market in favor of bonds. The second rationale has to do with theories for how stocks should be priced. One popular approach to determining the “intrinsic” value of a stock is to take a projection of all future dividends and “discount” them back to present value. When interest rates go up, the discount rate goes up, causing the present “intrinsic” value to go down.

But these economic relationships are not set in stone, there are still all those confounding variables. Many times in the past, for example, interest rates have gone up and stocks have also gone up. If interest rates are signaling future economic growth, stock investors may still determine that there’s more upside to be had by staying in the market. Again, anything we observe in a given day, week, or month is more noise than information (again, see Weekend Chart Challenge for a good example of that).

So, by all means enjoy all the theories for recent volatility, but take some time to enjoy a long walk as well.

In Case You Missed It: Is it Smart Money or Dumb?

Economy and Investingon October 3rd, 2018No Comments

In Jason Zweig’s latest Wall Street Journal offering “The ‘Dumb’ Money Is Bailing on U.S. Stocks. That’s Smart.” he makes the case that “now more than ever, investors need to consider investing in overseas stock markets.”

His argument is based on the observation that no country’s markets dominate forever and when it starts to feel that way, it’s usually time to head for the exits.

Markets tend to lose their dominance right around the time it seems most irresistible. The Japanese stock market rose 22-fold over the 20 years through the end of 1989, making it the world’s best major performer.

If you were Japanese, that pinnacle of local outperformance marked the perfect time to diversify outside the country. The Nikkei 225 index, which hit its all-time high of 38915.87 on the last trading day of 1989, remains below 24000 as of this week.

The chart below shows how the U.S. and overseas markets have traded leadership since 1980.

Of course, it’s not time for us/you to head for the exits as we’ve always had a significant, geographically-neutral allocation to international stocks that results in half of each portfolio being allocated outside the U.S.

As always, if you have any questions about any of the funds in your portfolio, we’re always here to talk. And in the meantime, be well!

In Case You Missed It: Short Take – Emerging Market Blues

Economy and Investingon September 20th, 2018No Comments

Emerging markets (EM) have been in the news lately, in part because stock markets in those countries have been falling in recent months (for reasons we’ll discuss further) but also because of crises and disruptions occurring in a handful of specific countries. The New York Times recently published an article which specifically profiled the troubles in Argentina, Turkey, South Africa, and Russia, prompting us to share our thoughts on the topic.

Our preferred vehicle for gaining Emerging Market exposure is the DFA Emerging Markets Core Equity portfolio (DFCEX), which, while down 1.4% for the 12 months just ended, has done well for long-term investors and has had a particularly nice run over the past two and a half years (see chart below).

Relative to the bad news detailed in the New York Times article, nearly 70% of the DFA Emerging Markets Core Equity fund is invested in China, Korea, Taiwan, and India (see below) and none of it in Venezuela or Russia (two of the troubled countries profiled in the article).

One of the things that has depressed emerging market returns lately, along with those of other non-US markets, has been the recent rise in the dollar. However, and notwithstanding the fact that rising US interest rates, all other things being equal, tend to strengthen the dollar, it’s path is ultimately unpredictable. As you can see in the chart below (2016 to present), the dollar rises and falls relative to other currencies, having boosted EM returns in 2016 and 2017 and taken some of it back this year. In the long run, we believe the dollar-driven fluctuations tend to cancel out, leaving the underlying economic fundamentals as the main drivers of performance.

We’re currently maintaining an average allocation to emerging markets of about 7%, which we believe an appropriate exposure to this important component of the global stock market.

As always, please don’t hesitate to give us a call or drop us a note if you have questions about any aspect of your portfolio (or anything else, for that matter!).

Defining the “Perfect” Investment

Economy and Investing, Yusuf Abugideirion September 6th, 2018No Comments

Written By: Yusuf Abugideiri, CFP®

If you asked a room of 100 people to define the “perfect” investment, you may not get 100 answers, but you’d certainly get more than one. And more than one answer may be correct! The criteria for judging the merits of an investment include the investor’s risk profile, time horizon, and goals. This sheds some light on the fault of the original prompt for this post, an article about “stomaching” the perfect investment – while there is almost certainly no one “perfect” investment, it is possible to develop an approach to investing that can build a portfolio that fits an individual’s needs perfectly. For the purposes of this piece, we’ll limit the possible ingredients of said portfolio to stocks, bonds and cash.

Risk Profile

Before an individual begins to invest, it is critical that they develop an understanding of their unique risk profile. Let’s start unpacking the term “risk profile” by looking at the three parts that comprise an individual’s risk profile:

  • Risk Tolerance: Refers to the trade-offs that an individual is willing to make when faced with uncertain outcomes. This tends to be a stable characteristic that shifts only slightly over long periods of time.
  • Risk Perception: Represents an individual’s perception of what the trade-offs actually look like in the current environment. This characteristic is very unstable and can vary widely as a consequence of changing external circumstances. Risk perception can stabilized through the accumulation of experience and/or education.
  • Risk Capacity: Refers to the availability of resources that can mitigate financial risks. For example, an individual can increase their risk capacity by receiving multiple stable sources of income or by building significant cash reserves. This is something that can be improved through financial planning.

While an investor may think they know their risk profile, using outside resources can help ensure this is true. For example, one can learn more about their risk tolerance by taking an assessment and reviewing their scores. From there, engaging a financial planner can help them manage their risk perception, develop a strategy to increase their risk capacity, and build a plan that will help them meet their goals.

Time Horizon and Goals

When developing that plan, the individual’s time horizon for meeting each of their goals will also need to be defined. The time horizon of the goal, within the context of an individual’s risk profile, is the key driver in determining the investment plan for achieving it. Some goals, like funding retirement or education expenses, take years or even decades to achieve. Others, like saving for a down payment on a car or building an emergency fund, can be accomplished more quickly.

For big goals with long time horizons, investing in a mix of stocks and bonds makes sense because doing so enables the investor to capitalize on the magic of compound interest over time. The longer the time horizon, the greater the capacity for risk; as such, a greater proportion should be allocated to stocks to capitalize on their higher upside potential (especially for big goals that can only be achieved via a combination of savings and investment returns). As the investor gets closer to the end of a given goal’s time horizon, the mix should shift more towards bonds and cash to secure the value of the portfolio while still maintaining the ability to grow. In contrast, if a goal is small enough that it can be achieved by setting aside cash for a few months, investing in stocks or bonds may be inappropriate – the potential for significant positive investment returns is mitigated by the short time horizon, as fewer compounding periods lessens the potential upside.

For more on Yeske Buie’s investment philosophy and approach to developing the “perfect” portfolio, check out the links below.

The Correct Way to Think About “Corrections”

Economy and Investingon April 4th, 2018No Comments

We’ve had a bit of a bumpy ride over the past two months as market volatility, strangely absent last year, has come roaring back. We think it’s all going to be fine (you knew we were going to say that) but it doesn’t mean we won’t have a bit of a bumpy ride along the way. Here are a few thoughts on what’s happening and how to think about it.

Your morning paper is going to tell you that the market experienced a “correction” today, as U.S. stocks closed more than 10% lower than the highs of January 26. While the concept of a “correction” has no formal definition in economics, it is commonly used when a stock or market falls by 10%. There have been 37 corrections since 1980, which is to say that they’re pretty common.

What is special about this 10% threshold? Nothing. It’s an arbitrary number, which is why it carries no significance in economic theory. The last “correction” occurred on February 8, when the S&P 500 also closed 10% lower than that afore mentioned January 26 high. The index then proceeded to rise 8% over the next month before retracing its path back to that February 8 level today.

Perhaps a more useful way to view recent events is as the return of volatility after a year of unusual calm. And what drives volatility in the stock market? More than anything else, it’s uncertainty. Uncertainty is always present, of course – the future is fundamentally unknowable – but policy uncertainty is not a given. Policy uncertainty, however, is what the White House seems to specialize in these days.

While we don’t subscribe to facile explanations for why the markets do what they do on any given day, we’re sure that policy uncertainty is playing its part. Will the government try to take down some of our biggest tech firms, including Amazon? Will we have a trade war with China? Maybe, though recent experience suggests that the White House is also good at reversing itself when the chaos gets bad enough.

You know that we believe in the fundamental resilience of the U.S. and world economy, and the markets that reflect them, even in the face of policy uncertainty. And we also strive to build resilience into your portfolio and the rest of your financial affairs.

But that doesn’t mean it won’t be a bumpy ride. Buckle up.

Hello volatility my old friend…

Economy and Investingon February 6th, 20181 Comment

As was surely inevitable, volatility has returned to the markets after an historically quiescent couple of years. As this is being written, markets in Europe are down nearly 5% after a similar drop in the US on Monday.

What should we make of this and what, if anything, should we do?

The answer to the first question is that it’s not possible to point to any simple explanation, notwithstanding the fact that your newspaper this morning is bound to be filled with articles declaring that rising inflation and interest rates are the culprit. Maybe, but things in economics are rarely as simple as that and besides, markets have flourished in the past with interest and inflation at much higher levels than today. The short-term answer is the less precise but more accurate villain known as sentiment. Markets are social constructs and, like a school of fish suddenly banking in unison and setting off in a new direction, investors often follow a new trend en mass with no precise trigger to point to. Not that we’re saying one day (or even two or three) constitute a trend.

What we do know is that the pace of economic growth has been ticking up worldwide this past year in a demonstration of synchronized advance the likes of which haven’t been seen in years. The rest of the world is still playing catch up to the US, both in terms of duration of recovery and market valuations. If US markets decide to take a breather, they’ll depress everything else for a while (sentiment knows no boundaries) but underlying realities will ultimately rule the day. And the ultimate underlying reality is that the US and world economies are always biased toward growth, even if they take the occasional breather.

As for the second question above, to the degree we’re likely to see a continuing rise in interest and inflation rates, we factored that in some months ago when we shifted all of our bond allocations to ultra-short maturities, leaving them insensitive to rising rates. Beyond that, a continuing commitment to rebalancing and cash management is the order of the day. That discipline led us to take considerable funds “off the table” over the past six months and will continue to serve us going forward.

So, we’ll all watch the markets with interest in the coming days (or not, it’s certainly not required) and read the daily stream of opinion with a skeptical eye. In the meanwhile, be well!

What is Bitcoin actually worth?

Economy and Investingon January 25th, 20182 Comments

Having risen from $1,000 per coin to a high of nearly $20,000 in the past 12 months (although as we write, it has fallen back to $11,000), Bitcoin has garnered more than a little attention and spawned a host of imitators. We recently came across a post by a gentleman who blogs under the name The Unassuming Banker that we think did a particularly nice job of both explaining what Bitcoin is and why it and the 1,400 other cryptocurrencies that have sprung into existence, whatever their current market value, have an intrinsic value of zero.  We thought we’d share.

“Lately it’s hard to go a day without someone asking me a question about Bitcoin. What is it? Why is it so valuable? Should I buy some? How do I buy some? The guy down on the corner in the pawn/gold exchange shop said he can buy me one (yes, this is actually happening!).

It seems Bitcoin and the crypto-currency craze has truly reached the mainstream and the implication of that are as of yet unknown. What we do know is that it’s attracting every shady crook and scam artist in the world. And why not? There really is tons of money to be made. I hope the following sheds some light on what Bitcoin is and isn’t.”


And just for fun

We also recently discovered a very funny video on the topic. In this video (Ultra Spiritual Life, episode 86), JP tells you all about Bitcoin, how it works, and why it’s guaranteed to be the best investment of your life.

The Coming Bear Market

Economy and Investingon October 20th, 2017No Comments

This is the title of a recent article by economist Robert Shiller in which he discusses current economic and market conditions in the U.S. and compares them to prior times when markets declined. Shiller is notable for having published a book titled “Irrational Exuberance” in which he “predicted” the Great Recession. He seems to have been predicting another one ever since and runs the risk of exemplifying the broken clock syndrome. One thing that’s important to remember is that someone is always predicting bad things for the economy and the markets, every day, every year, so someone is always going to be able to claim prescience when the markets take a tumble. The reality is much messier, however, and prediction is usually a fool’s game. The economy and the markets are so complex and chaotic that they defy easy prediction. Even Shiller says not to base any investing decisions on his metrics, which leaves us wondering why he insists on regularly trying to scare people. For him, it seems, economics really is the dismal science.

Accepting as our starting point the folly of prediction, we can nonetheless examine conditions on the ground in order to assess the state of the world. First, the U.S. economy has been chugging along at a plus or minus 2% growth rate since the end of the Great Recession and doesn’t seem headed for anything but more of the same. The reason that economic expansions come to an end, historically, is that imbalances build up from one source or another. Low unemployment leads to wage inflation, for example, which spreads throughout the economy until the natural rise in interest rates – or a rise due to intervention by the Federal Reserve – tamps down economic activity, often leading to a recession. As we look around, we do find low unemployment, although it’s deceptive because the “participation rate” – the proportion of the workforce actively looking for employment – is also quite low by historical standards. Which means there’s a lot of room for new workers to decide to rejoin the game. In any case, we’re seeing modest rises in wages but nothing scary. Interest rates remain low and the Federal Reserve is being extremely circumspect in how it returns to a more “normal” monetary environment. The stock market has had an impressive rise and is sporting valuations, as represented by the price-to-earnings ratio, that are above average. Of course, when interest and inflation rates are well below average, you’d expect market valuations to be above average. And the rise doesn’t look like investors are building Castles in the Air, a phrase used by economist Burton Malkiel to describe conditions where investors are playing a greater fool game of buying just because they think prices will go up rather than on fundamentals. The reality is that earnings for U.S. corporations have been extremely strong.

Just as importantly, overseas markets, which represent half of your portfolio, are at a much earlier stage of recovery than the U.S. and have much further to go. And your overseas returns have been enhanced by a weakening dollar. Having said all that, it’s important to note that any significant decline in U.S. markets would likely be accompanied by declines worldwide. In the short-run, everything moves together but in the long-run, valuation levels will drive outcomes.

Finally, no matter what conditions look like, trying to time these things is not a winning strategy, especially if, as we do, you believe in the fundamental resilience and propensity for growth of your fellow human beings. And not only are human beings resilient, but so is your portfolio, which is designed to have a stable reserve that can carry you through six to seven years of a downturn if necessary. Which is to say, as long as you can weather a short-term decline – and you can – markets will always recover and grow in the long-run.

There will be a bear market, we just don’t know when, and nor should we care when, because it will only be a blip to be endured, not a permanent cause for harm.

“Our deepest fear is not that we are inadequate. Our deepest fear is that we are powerful beyond measure. It is our light, not our darkness that most frightens us. We ask ourselves, Who am I to be brilliant, gorgeous, talented, fabulous? Actually, who are you not to be? Your playing small does not serve the world. There is nothing enlightened about shrinking so that others won't feel insecure around you. We are all meant to shine. And as we let our own light shine, we unconsciously give others permission to do the same. As we are liberated from our own fear, our presence automatically liberates others.” ~Marianne Williamson