Making Moves: What Does the Investment Process Look Like at TEN Capital?

In this week’s video Jake walks us through Ten Capital’s investment process and how it impacts our strategy construction.

FIVE THINGS YOU SHOULD KNOW

1. Equity Markets – were mixed this week with U.S. stocks (S&P 500) up 0.33% while international stocks (EAFE) fell 2.07%.
2. Fixed Income Markets – moved lower this week with investment grade bonds (AGG) down 0.52% while high yield bonds (JNK) fell 0.25%.
3. Debt Ceiling Talks Continue – President Biden and House Speaker McCarthy continued to negotiate a resolution this week for averting an imminent US debt default with both sides expressing optimism that a deal will be reached soon. Republicans and White House negotiators have begun creating a framework for raising the debt ceiling and cap spending for two years. While the amount of the cap remains undecided, it does appear initial reports suggest a 3% increase to defense spending next year and a commitment to upgrading the nation’s electric grid to accommodate renewable energy.
4. Fed Leaning Towards Pause – While still far from being decided, Federal Reserve officials have suggested a pause in interest rate hikes is likely at their upcoming June meeting. Minutes from the May meeting showed policymakers are uncertain on how impactful additional tightening may be and are monitoring the likelihood of a credit crunch following the banking turmoil we’ve seen so far this year.
5. Key Insight – [VIDEO] In this week’s video Jake walks us through Ten Capital’s investment process and how it impacts our strategy construction [ARTICLE] A quick discussion on process vs. prediction, at a time when investors grow more and more anxious about the disfunction in D.C., including a great guest article on the situation and what it means for investors.

INSIGHTS for INVESTORS

“This time is different.” An oft-used expression that usually feels right in the moment, but usually is proven wrong the majority of the time. Therefore, it’s a frequent but dangerous premise upon which to build an argument or decision-making process to help guide one’s investments.

Many investors are understandably concerned regarding the disfunction in Washington D.C. these days, as neither refusing to pay one’s bills nor continuing to spend beyond one’s means would be deemed responsible by most anyone in the “normal” world.

And yet, such circumstances are not new, and likely not all that different at all in time. As the great article below from DFA summarizing the situation points out below, this predicament has arisen dozens of times before since 1960. Furthermore, a failure to raise the debt ceiling is not the same as a government default as portrayed by many in the media.

The key thing is that using prediction to guide your portfolio is a huge mistake that people sadly talk themselves into time and time again. Such investors rarely call it a prediction, they call it being prudent, but the distinguishing factor is whether one’s path is based on feelings or a process.

Clients understandably ask how is making any decision about a future direction/investment all that different? Again, it’s the process and reasoning behind it. Put another way, a solid investment decision isn’t about a guaranteed outcome, but improving probabilities based on perspective.

Consider the difference in the following:

Selling an asset today because of what Congress may or may not do in the next few weeks is a prediction built entirely on feelings, fear and with no long-term game plan.

As opposed to say when we sold most of our investment grade corporate bonds in 2020 (see our commentary from August 7^th, 2020) that wasn’t about predicting but a process that looked at the real returns of bonds yield 1% or less in a world where inflation was just 2-3% at that time (which still resulted in a negative real return), and the probability of a positive outcome over the next 3-5 years for clients, which we didn’t see as being very high if rates rose at all from near 0% levels. Thus, we made the decision to find alternatives that could better position our clients. A quick synopsis of a long process, but importantly none of it was about feelings.

Jake does a nice job discussing other aspects of our process and the wonderful partnerships (internally and externally) we rely on to hold ourselves accountable as well.

What’s your plan, what’s your path and what’s your protection from the inevitable volatility along the way? Success in defining and accomplishing all three is quite possible, and it even helps you feel a little better on the journey as well.

Have a wonderful Memorial Day weekend as we all remember those that gave all!

Tim and the team at TEN Capital

Mind over Matter: Perspective for Investors on the US Debt Ceiling

KEY TAKEAWAYS

• The debt ceiling is the amount of money Congress has authorized the government to borrow. The ceiling has been raised 78 times since 1960.
• It’s not clear how the debt ceiling fight will be resolved or how it will impact investors.
• We believe a diversified mix of equity and fixed income investments and a long- term horizon are likely to be the best tools to ride out uncertainty.

If ongoing debate over the debt ceiling is giving you a dizzying sense of déjà vu, you are forgiven. The debt ceiling, or limit, reflects the amount of money the United States (US) Congress has authorized the government to borrow, and Congress can authorize increases when the government nears or reaches the existing limit. According to the US Treasury Department, Congress has acted to effectively raise the debt ceiling 78 distinct times since 1960.1 Occasionally, policymakers have struggled to reach consensus to authorize increases.

The US effectively reached the debt limit in January, triggering “extraordinary measures” by the Treasury Department to allow continued servicing of existing debts and obligations. But Treasury Secretary Janet Yellen has issued a warning that the “X-date,” when these extraordinary measures may be exhausted, could come as soon as June 1.2 As the X-date approaches without a political consensus to raise the debt limit, many investors are wondering how a breach of the debt ceiling could impact their investments.

The debt limit negotiations are one of many factors that impact security prices.

While debt ceiling debates can be nerve-racking, the implications for investors are uncertain. Historically, Congress has always raised the debt limit, and even if Congress failed to increase the limit in time, it is not clear what that would mean in practical terms. A range of payments could be impacted, from salary payments for federal workers to interest and principal payments on federal debt. But trying to predict likely scenarios is largely unproductive, given that markets have priced in the potential range of outcomes. Sticking to a sound investment plan that is designed to achieve long-term goals can help investors see beyond the current turmoil.

PRICES OVER PUNDITS

As the X-date nears without a clear path to political resolution, we may observe reactions and heightened volatility in both the equity and fixed income markets. The debt limit negotiations are one of many factors that impact security prices. In the debt ceiling crisis of 2011, US Treasury yields declined during the period surrounding the culmination of the tense negotiations that resolved in August (see Exhibit 1), despite S&P downgrading the credit rating on US sovereign debt from AAA to AA+.3

Exhibit 1

Falling Yield

Daily 5-Year US Treasury Yield, 2011

Past performance is no guarantee of future results.

Source: US Department of the Treasury.

Looking at past examples cannot tell us what will happen in the future, but it can provide an important reminder that trying to outguess the market is a fool’s errand. An investment approach that incorporates current price and yield information allows investors to harness the market’s collective wisdom and real-time adaptation to changing market conditions.

FLEXIBILITY OVER FORECASTS

Market volatility is part of investing. Facing uncertainty is a prerequisite to earning risk premiums, and times of heightened uncertainty can often bring heightened volatility. Planning for uncertainty with a flexible and adaptive investment process can help you navigate volatile market environments while staying focused on your goals. Reacting to short-term uncertainty may be a quick way to derail progress toward long-term goals.

An investment approach with built-in flexibility enables portfolio managers to adapt to changes in market prices or credit spreads in real time. It also allows for sensible ongoing portfolio management to potentially avoid unnecessary trading during times of heightened volatility. Certain types of investment strategies, like traditional indexing, may face constraints that limit their flexibility due to having to closely track an index regardless of current market conditions.

Designing investment portfolios and processes with flexibility can help give portfolio managers and traders additional tools to sensibly manage ongoing risks, potentially reduce costs, and maintain a focus on higher expected returns even during times of heightened market volatility. This year, measures of interest rate volatility on US Treasury securities have been elevated (see Exhibit 2), though these levels are influenced by a range of factors, including expectations for the federal funds rate.

Exhibit 2

Interesting Times

Interest rate volatility on US Treasury securities, 1988– April 30, 2023*

Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.

*Based on ICE BofA MOVE Index, a yield-curve-weighted index of normalized implied volatility on 1-month Treasury options

Data sourced from Bloomberg on May 18, 2023. ICE BofA index data © 2023 ICE Data Indices, LLC.

DIVERSIFICATION OVER DEBATES

When investors face uncertainty, diversification remains one of the most important risk management tools available to them. Although a US government technical default likely would trigger reverberations throughout global markets, we believe a balanced asset allocation of global equity and fixed income investments combined with a long-term investment horizon are the best tools investors can use to help ride out short-term and close-to-home uncertainty.

1. “Debt Limit,” US Department of the Treasury. 

2. “Debt Limit Letter to Congress Members,” US Department of the Treasury, May 15, 2023. 

3. Credit rating agencies like Standard & Poor’s Corporation (S&P) rate the credit quality of       debt issues. S&P’s scale is from AAA to D with intermediate ratings of (+) or (-) offered at     each level between AA and CCC.

DATA, JUST THE DATA

Data points this week included:

• U.S. New Home Sales – surprisingly jumped 4.1% in April for a seasonally-adjusted rate of 683,000, the highest level since March of last year. For the month, the median sold prices were $420,800, down almost $30,000 from the same time last year.
• U.S. Jobless Claims – the number of initial jobless claims last week rose to 229,000 but still came in well below expectations for 245,000. Continuing claims on the other hand fell to 1.794 million, the lowest in 3 months.
• U.K. Retail Sales – rebounded up 0.5% in April and exceeded expectations. Retail sales for the trailing 3 months now sit 0.8% higher than the year prior.
• U.S. Durable Goods Orders – rose by 1.1% in April following an upwardly revised 3.3% improvement in March. Orders for non-defense capital goods (a strong measure of business spending plans) rose 1.4%
• U.S. Composite PMI – saw an increase to 54.5 in May for the 5^th consecutive month of growth. This reading signals the fastest pace of expansion in the country’s private sector since April of 2022.