3rd Quarter Client Note – Stay Away from the Rocket Science

The first half stock market rally stalled in the 3rd quarter. The S&P 500 (Total Return) Index fell 3.27%, reducing its YTD return to 13.07%. Overall, value stocks continue to underperform. But lost less (1.91%) than growth stocks in the quarter.

Overseas, developed market stocks lost 3.8%, while emerging markets fell 1.54%

Commodities gained 4.71%

Fixed Income

With interest rates continuing to increase, bonds also lost ground. The yield on the benchmark 10-year treasury bond increased from 3.8% to 4.6% during the quarter. Consequently, the Bloomberg US Aggregate Bond Index fell 3.23%. Bonds are on track to suffer their second straight year of losses.

Our friends at Dimensional Funds provide detailed quarterly data and commentary in their Quarterly Market Review.

Transition to Schwab

The purchase of TD Ameritrade by Charles Schwab resulted in a change of recommended custodian for our clients. The anxiety is over and all things considered, the transition over Labor Day weekend has gone relatively smoothly. We had been with TD from the founding of RightPath  – fifteen plus years ago – and were very happy with their approach and service. While there are some subtle differences in the back-office technology (Schwab needs to catch up) and certain policies, the team at Schwab has been responsive and helpful in navigating us along.

Higher for Longer?

The bond market is experiencing what could be described as a generational shift. Beginning with the 2008 financial crisis and lasting until the beginning of 2022, the Fed had kept interest rates at historically low levels to combat the possibility of prolonged economic weakness. But the Covid induced supply chain bottlenecks, coupled with expansionary fiscal policy, caused a bout of inflation that the Fed has been battling for the past year and a half. Short term rates have increased from near zero to around 5%. The yield on the ten-year Treasury bond has gone from under 2% to 4.75%. And inflation has recently subsided (from nearly 9% to around 3.5%) with a recession being avoided; so far.

At some point, the Fed will begin to stop raising and likely reverse course. But nobody knows when and to what end point. Despite (because of?) the fact that bonds have performed poorly recently, investors shouldn’t be afraid to continue to utilize investment grade bonds for their intended purpose in portfolios: 1) for ballast; to reduce the even greater risk of stocks and 2) to provide income. In exactly what proportions and maturities is a matter of individual preference.

Investing Is a Science, an Art, and a Practice

David Booth, the founder of Dimensional Funds (and now the namesake of the University of Chicago’s School of Business) is always worth listening to. In this essay, he describes the three components of a successful investment strategy.

The reliable science proved a couple of fundamental basic principles. Diversification reduces risk. And conventional active management isn’t worth the cost.

The art of investing involves the application of human judgment at both the fund manager and individual advisor levels.

The practice of investing means putting the art and science into action in a common sense and disciplined manner.

Words of wisdom.

An Ignominious Anniversary – Stay Away from the Rocket Science

Speaking of science, September 23rd marked the 25th anniversary of the collapse of the highly leveraged hedge fund Long Term Capital Management. LTCM was founded in 1994 by a group of Wall St. veterans and Nobel Prize winning economists. For half a decade, it’s nearly incomprehensible, computerized strategies purportedly designed to eliminate the risk in high-risk strategies were the superstars of the investing world; obtaining annual returns of nearly 40%.  LTCM attracted investors from all over the world; creating a systemic perfect storm when its strategies ran into a series of unanticipated financial crises in 1997 and 1998 – and imploded – losing billions. LTCM had to be bailed out by the Fed and some of Wall Street’s biggest banks.

The lesson for me is to be careful about what kinds of science and technology to rely on when making investment decisions and to carefully monitor how much risk you want or need to take in order to achieve your financial goals.

The Upshot

The most important thing remains to have a well thought-out, written down, investment strategy and the discipline to stick to it.

And here is a piece of ironic advice. Don’t pay much attention to the first couple of paragraphs of these notes. They’re just the noisy news we use to introduce the really good stuff.

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