The first part of this Blog goes out to Mike. I am indeed very sorry that I won that dollar bet. I would much rather have lost it.
To bring you all in on this, at the beginning of last week, I bet a friend and well respected portfolio manager a dollar that the U.S. 10 year treasury bond would go below 1.5%. He took the other side. The bet had some seriousness behind it, but I didn’t think I would win any time soon and he was encouraged by his chances of getting a buck off me. I even told Mike that I was going to hedge my big bet by selling some of my intermediate term bonds. I sold some bonds, and unfortunately on Friday I also won a dollar. The U.S. 10 year ended the week at 1.46% (first time ever below 1.5%).
I say unfortunately because of what signifies about how investors are viewing the strength of the global economy (rates on 2 year German bonds went below zero). You also saw this through the equity market drop by more than 2% on Friday.
The stock market always seems to make larger headlines, but equity investors can be short-term in nature. The day-to-day moves of the stock market often do not tell us much about what the future may bring. Bond investors tend to have longer-term time horizons, however, and movements in interest rates can sometimes give an indication of what lies ahead. Investors demanding only 1.5% on a 10 year loan to the U.S. government tells you what they think about the risk / return opportunities going forward in other areas.
Last weekend I posted a Blog that, due to some technical difficulties with a network solutions server, did not got out to everyone. Who knows, maybe it was the length of it. I did get a little wordy. If you have a moment, please consider taking at least a scan at the link below. It will hopefully give you a useful indication of our thoughts.
At the end of this Blog, I have also re-posted links to recent commentary that I feel is worth a read and added a good piece from Bill Gross.
As an update on my thoughts from last week, I am still suggesting that investors not make any big changes to asset allocations beyond what we have been encouraging our clients to do throughout the year. In summary, the following are our long-term and current recommendations:
Have A Long-Term Plan and That Is Designed to Meet Your Individual Goals
– Investing should not be a competition
– Unless your goals have changed, do not throw out a good plan with a bad market
Set Investment Policy Max. and Min. Ranges For Various Types of Investments
– Everyone will be wrong from time to time
– Set limits on the upside and downside before you invest
– Max. and Min. ranges should help to control emotions and hence risk
Try to Think Outside the Box and Consider Being Contrarian
– Wall Street’s herd can be wrong ( see Are Wall Street Earning Estimates Good Barometers )
– Large flows into and out of an asset class are often a sign of a top or bottom
Always Place a Premium on Liquidity
– Don’t invest in illiquid investments unless the rewards being offered are compelling
– Why do investors tend to pay higher fees for lower liquidity?
– Carefully evaluate return and risk opportunities being offered when taking on illiqudity
Use History As a Guide But Don’t Get Anchored on Past Returns or Risks
– Are traditionally low risk bonds going to be much higher in risk going forward?
– With rates at 1.5% on the 10 year bond, risks going forward could be high
Understand True Risk Exposures of All Investments
– Do high yield and emerging market bonds and distressed debt have the same risk as other bonds?
Currently Consider Reducing Interest Rate Risk and GDP Risk
– Don’t double down on the 10 year bond going much lower
– Even though we were early on reducing a few bonds at 2% levels, we are selling more
– Commodities and Emerging Market Stocks can be linked to GDP growth expectations
– We started recommending reductions in Commodities and EM equities early this year
– World GDP could continue to slow
– It is not too late to reduce Commodities and EM equities
Unlike last weekend, I have not been looking out the window at glorious sunny days this weekend. Rain has moved in, which might have us all in the Northeastern part of the U.S. thinking gloomy thoughts. All storms eventually clear though and certain areas of the market will continue to provide solid long-term investment opportunities. A true long-term investor ( who will in practice come in for the most criticism ) will continue to be rewarded for keeping a steady hand on the tiller.
Now, I am off to enjoy weekend time with SJM (Susan, Jack and Meghan).
I hope everyone had a nice weekend. Please do consider a read of the articles below.
GMO – Flaws of Finance – “Why We Need a Hippocratic Oath in Finance”
James Montier again has put out a great piece that will probably not be popular with some of his investment peers. It is long but worth a scan of at least the first and last sections.
Richard Bernstein – Diversification Remains Difficult
Richard Bernstein – An Alternative to Alternatives
Like Montier at GMO, Rich is not afraid to take the path less traveled and question the industry. In these pieces, he lays out the importance of a well diversified long-term plan and then suggests, as I also believe, that we need a back to the future look at alternative investments (hedge funds, etc.). He nicely points out that many (not all) alternatives investments can be bettered by good old fashioned asset allocation among stocks, bonds and cash. The old fashioned way, however, has the advantage of high liquidity, high transparency and low fees.
WSJ – How to Play the Bond Market Now
I have been meaning to post this for quite some time. It gives a good overview of the current risks in the bond market. Going forward, bonds might not be as low risk as they have in the past.
Bill Gross – Wall Street Food Chain
Gross is again out with a good thought provoking piece. The week, a good client and friend suggested that I read Chapter 23 of Moby Dick. His piece in general, and the following quote, makes me think Gross might be dusting off a copy himself: “Bond, equity and all financial assets, which are structurally bound together by this dynamic ( leverage ), must lower return expectations. Maintain a vigilant watch matey!”