We are in different economic times than most anyone who is still alive has ever lived in. All the investing advice that has become bog standard over the past decades has been developed in the economic and political stability of the post-WWII liberal global order and the subsequent fall of the Soviet Union and the cementing of American hegemony. Since 2008, we have been in what I like to call “The Long Depression.” Things were just beginning to improve for real people when the pandemic, a truly black swan event, reared up and erased much of the gains being made by people.
Over the pandemic, governments spent money on various programs to help people and printed a great deal of new money to do it. This is why inflation is not just an American phenomena but a global phenomena. Combine that with a complete collapse of supply chains and the end of globalization as we knew it and suddenly the entire economic order of things has changed in just 2.5 years. This has led to the present oscillations in the markets that are now worrying investors from small-time retail investors to large banks.
Stocks and Bonds
Stocks and Bonds are very different investment vehicles. Stocks are small portions of publicly traded companies and generate a return based on productive use of capital. Bonds is just a fancy word for debt. Money gets loaned out and the person loaning out the money gets a set return (interest rate) on the money loaned out that forms the bond. There are all kinds of bonds. The US Treasury Bond is US government debt for example. There are also municipal bonds and even investment grade corporate bonds.
In the past, the 60/40 (stocks/bonds) split worked so well because if the stock market fell, bonds would go up in value. If bonds went down in value then that usually meant the stock market was going on. The performance of the portfolio would be less over time but it would be more stable since Stocks and Bonds never went down at the same time. 2022 has completely broken that model. Anyone with a “traditional” portfolio has lot money this year as both Stocks and Bonds have fallen. Why have Bonds taken a turn with stocks at the same time for the first time since the Great Depression? It all has to do with interest rates.
When interest rates rise, any bonds (debt) issued with the higher return will attract more money to get that better return. Right now, bonds with the previous lower interest rates are falling value as bonds at higher interest rates enter the market. This is particularly true in US Treasuries. This is a unique situation because the Federal Reserve is raising interests so high and so often after a decade (plus) of low interest rates. This has created turmoil in the bond markets as low yield bonds find tougher markets and capital flees into higher yields. This is combined with a complete destruction of value in the stock market.
The stock market has been a victim of many trends this year that have destroyed value. Where to start? Supply chain logistics, rising interest rates, inflation, demand destruction on the consumer side, geopolitical upheaval, and a technical recession have all sent stocks lower. The stock market spent several years being nowhere near its fundamentals. During the pandemic, the stock market actually moved higher not because earnings were that great but merely on the story of how some companies were doing. This was especially true with names like Tesla who don’t trade anywhere near their valuation but trade entirely on hype and potential. This isn’t to stay that stocks don’t trade on potential, they do, the stock market is an indication of future value. A higher stock price will usually be several times earnings. However, I’ve said for the past 1.5 years that the stock market will need to come back to earth at some point and start trading on fundamentals like revenue, EBITDA, and earnings. That time has finally come and the fall in prices has less to do with weakness in the overall economy but far more to do with finally bringing prices down to where they should be: a multiple times forward earnings.
What To Do With Your Money Now
So if the 60/40 portfolio split is dead then what should investors do with their money now? That is not an easy answer and I would advise you to run, not walk, to your nearest investment professional. There are very few places with a good return right now. Waiting in cash is a loser as inflation eats away at the value there by the second. If you haven’t sold anything, don’t bother now. The market may be hitting bottom although where the bottom of the market may be is anyone’s guess. If you have cash sitting on the side and are looking to investment, equities (stocks) are likely your best bet at this point. Stocks will recover faster than bonds and will do better over the long-term.
That being said, bonds have not fallen as much as stocks and will likely bounce back faster than stocks. So despite the numbers, there may be some interesting buying opportunities. Bonds do generate consistent income and that can be an attractive part of a portfolio. The only piece of advice I would say is important now is to not sit in cash: inflation came in higher than anticipated and cash is literally losing money as we speak. Now is the time to make sure that any funds that need to be put to work are doing just that.
More Change and Returns
There will be opportunity for investors in the course of all these changes. It will be difficult to tell what those opportunities are but given the collapse of the crypto markets, it clearly will not rely on the blockchain. We are moving into a market environment that most people alive have not lived through. Bonds have had the worst year they have had since 1926. Even people like Warren Buffett and Charlie Munger are not old enough to understand our present market. What’s worse is that the market probably won’t stabilize anytime soon. There is simply too much going on. Inflation is going to continue to plague consumers and drive consumer spending downward despite the Fed’s best efforts. Interest rates will likely continue moving ever higher making housing out of reach for many (rent prices will move higher and mortgages won’t even be a possibility). That being said, returns will still be available, investors will just have to do better research and keep a closer eye on markets. The days of the “set it and forget it” investment portfolio are over.
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