Part III with Stephanie Link – Her Thoughts On, and Approaches to, Common Investment Dilemmas & Concepts

Five Things You Should Know

1. Equity Markets – moved lower this week with U.S. stocks (S&P 500) down –0.85% and international stocks (EAFE) falling –0.12%
2. Fixed Income Markets – made gains with investment-grade bonds (AGG) up 0.27% and high yield bonds (JNK) moving higher 0.35% 
3. Inflation Steadies – Stocks rose in Friday trading on news that the PCE index was up 2.5% year-over-year, a slight drop from May’s 2.6% figure and edging closer to the Fed’s long-term target of 2%. This crucial data point likely sets the stage for upcoming Fed activity, with markets now fully pricing in an expected rate cut in September.
4. Crowdstrike Fallout – The cybersecurity company behind the massive global IT outages we’ve seen over the last week stated that a bug in their quality assurance tool allowed for critical flaws to pass through validation. When the company pushed through an update across all Windows machines last Friday the critical errors were sent out. While the full impact of this outage is yet to be determined, many industries such as airlines continue to struggle with delays and cancellations.
5. Key Insight – [VIDEO] In Part III of our sit down with Stephanie Link, we get her thoughts on common investing dilemmas, such as deducing whether an investment is an opportunity or “value trap”, as well as other guiding principles she follows to help improve outcomes. [ARTICLE] With a market seemingly priced for perfection, and volatility picking up as earnings disappoint sky-high expectations, investors should take a second look at their allocations as well as the role today’s fixed income opportunities could play in helping their likely risk-adjusted returns.

Insights for Investors

As market volatility picks up a bit after headlines championed new highs for many US equities, investors are left with many questions; however, they may be missing the key questions worth considering when deciding how to approach today’s markets.

After this week’s disappointing earnings from some of the so-called Magnificent 7, markets sold off in notable fashion with the Nasdaq dropping nearly 3% on Wednesday alone, and S&P down around 2% bringing their respective declines from the prior highs to approximately 6% and 4% respectively.

While there are long-term potential catalysts for equities in the form of automation and AI, there are also legitimate concerns about the current valuations and top-heavy nature of many indices into just a handful of stocks.

The key for clients to remember is there are a number of investments to consider beyond just US stocks. We touched on the importance of alternatives in our video & article from May 24^th of this year, but old fashion bonds are likely worth a look as well.

As PIMCO CIO Dan Ivascyn touched on in piece entitled Why Investors Should Switch Their 60/40 to 40/60 (see here), bonds present a unique opportunity and diversifier at current levels for many investors.

A while ago we cautioned investors from blindly following the standard 60/40 approach (see August 7^th, 2020), due to our negative view at the time on bonds, which proved to be correct. Post 2022’s bond sell-off, in addition to signs that the Fed’s hiking campaign is coming to a close, investors can likely reduce their volatility, improve incomes, and possible near-term returns (or at the least allocation flexibility) by giving the asset class a fresh look.

As Dan Ivascyn similarly states, “A few years ago, bonds were expensive and stocks looked comparatively inexpensive,” but now, “we’ve had this massive repricing.” This repricing has resulted in some attractive yields (see chart below), and likely returned fixed income to its status as a good equity risk mitigator/offset. With the 10-year Treasury hovering around 4.25% of late, other corporate high-quality fixed income and credit opportunities can provide even greater levels of income some in the high-single to low double-digit levels depending on the opportunity.

While the diversification and risk mitigation are two of the key reasons to give the asset class another look, especially during a period of elevated equity valuations, there is a solid return story for the asset class as well. As Ivascyn helps explain, “Typically, the starting yield of a high-quality bond portfolio is a pretty good approximation for the floor of what you’ll earn over a five-year period.”

Author Sarah Hansen summarizes her view of the outlook stating, “investors who move beyond Treasuries and other core bond holdings into high-performing assets (like agency mortgage-backed securities) can construct a high-quality, diversified portfolio of bonds that yields 6% or even 7% before any price appreciation. ‘That historically has been a pretty good return.’”

Perhaps an investor builds out and holds some fixed income/bond positions for a number of years, or perhaps one does so with the idea to use the position to weather equity volatility and be in a position to use their bond holdings to increase future equity holdings in the event of a deeper pullback. There are many reasons to consider a bond allocation, and as she concludes “You don’t need to out-return equities for this asset class to make a lot of sense.”

While many clients think of “safe” as a lack of volatility to an investment’s nominal value, it is also imperative for them to consider the impact of inflation and one’s long-term purchasing power (see chart below). With high-quality bonds providing income/yields in excess of current inflation they once again should serve not only to dampen an investor’s overall portfolio volatility but do so while still protecting one’s purchasing power vis a vis inflation.

Source: TEN Capital calculations, 7/26/24

Making money is of course the primary goal of an investor, but how one makes money should not be ignored. Proper diversification not only can reduce one’s volatility, but also one’s likelihood of having a counter-productive emotional response to volatility that hurts one’s returns. Beyond that, but no less important, is reducing one’s anxiety around markets and the pull to watch the day-to-day fluctuations of markets that don’t have to have any bearing on their long-term success but can make the journey notably more miserable.

For a great read on the topic of “tuning out the press” here is a great WSJ article from an author I really respect and have cited before, Jason Zweig, that I would strongly encourage you to read as well entitled “What I Learned When I Stopped Watching the Stock Market” (see article here (or here).

Our goal for our clients is to of course help them achieve their goals, but to do so while mindful of the journey and helping their overall experience to be as full of clarity and calm as we can.

Have a wonderful weekend,

Tim and the team at TEN Capital

Data, Just the Data

• U.S. Initial Jobless Claims – fell by 10,000 to 235,000 on the period ending July 20th. This was below market expectations of 238,000. 

• U.S. Mortgage Application – fell by 2.2% in the third week of July. This trimmed the five-week high expansion of 3.9% in the earlier period and marked the third drop in mortgage demand in the last four weeks. 

• U.S. Durable Goods Orders – slumped 6.6% MoM in June of 2024. This came after four consecutive monthly increases and missed market expectations of a 0.3% increase. 

• U.K. Composite PMI – rose to 52.7 in July of 2024. This exceeded expectations of 52.6 and indicated a strong upturn in private sector activity. This marked the ninth consecutive month of expansion. 

• Eurozone Manufacturing PMI – increased by 1.0 points from the previous month to -13 in July of 2024. This was the highest level since February of 2022 and surpassed market forecasts of -13.4.