Fear of the Moment, Hope for the Future

Fear of the Moment, Hope for the Future

In light of some recent losses, Tim discusses TEN’s mission to help people live their best lives and people’s innate tendencies to think they can achieve that without defined goals, a partner, and a genuine understanding that tomorrow isn’t promised for anyone.

Five Things You Should Know

1. Equity Markets – were higher this week with U.S. stocks (S&P 500) up 0.05% while international stocks (EAFE) rose 0.71%.
   
2. Fixed Income Markets – were higher with investment grade bonds (AGG) up 0.61% while high yield bonds (JNK) rose 0.80%.
   
3. Domestic Oil Opened Up – in an attempt to lower oil prices which have seen gas hit $4.23/barrel (compared to $2.87 this time last year), President Biden announced the United States will release 1 million barrels per day from the nation’s strategic petroleum reserves over the next 6 months. The president communicated his hopes that the announcement will see gas prices fall by “anything from 10 cents to 35 cents a gallon”. Oil futures dipped this week on the news.
   
4. European Inflation Rages – headline inflation metrics for the month of March hit all-time highs in Germany and France, with Spain hitting a 40-year peak. As a whole, Euro-area inflation was up 7.5% last month following February’s 5.9% uptick, suggesting the ECB’s inflation projection for the year of 5.1% is becoming further unlikely. Money markets are now pricing in more than 50 basis points of tightening by year-end.
   
5. Key Insight – [VIDEO] In light of some recent losses, Tim discusses TEN’s mission to help people live their best lives and people’s innate tendencies to think they can achieve that without defined goals, a partner, and a genuine understanding that tomorrow isn’t promised for anyone. [ARTICLE] We discuss the latest fears around the yield curve, including what should give investors some pause about why hitting the panic button may be premature.

Insights for Investors

Intro

Every week brings something new for investors to fear. The equity market’s track record of resiliency could and should be rightly viewed by some as sufficient to ignore the endless cavalcade of potential problems that always lurk somewhere. However, we always want to give our clients greater understanding around the possible paths ahead and the reasons why some of those paths have higher probabilities than others.

Outside the rumors around a ceasefire in the Ukraine, the big headline “fear” this week was about the treasury yield curve momentarily inverting and the history of such an event preceding prior recessions. Like most of what the media chooses to share with respect to supposed market facts, the facts around the “sound bite” aren’t quite as simple as they may seem.

As the folks at Bespoke note in the great piece we share below “recessions have always been predated by inverted yield curves, but not all inversions have led to recessions. It's kind of like the square-rectangle phenomenon (as in a square is always a rectangle but a rectangle isn't always a square).”

Read their piece at the end for more information on the topic of yield curve inversions and recessions, particularly the vital importance of which points on the yield curve are inverting (none of which you’ll see in the financial media for the masses).

An Investor’s Hope for the Future

We mentioned above equity markets’ history of resiliency in the face of many challenges and difficult periods of time, so let’s look a little deeper at just how resilient they’ve been as well as how adding diversification and income to one’s plan can give investors a high degree of confidence about the future especially during uncertain times.

Investors tend to have a subconscious and mostly illogical fear of “losing it all.” As the folks at Bespoke point out in their following comments, even for an investor simply diversified among U.S. large caps not only are such fears unfounded, but even losses in general become pretty unlikely with even a little bit of time.

They state, “Below is a graphic from that Chart of the Day last August showing the consistency of positive returns for the S&P 500 total return index from one month all the way out to 30 years. The results are pretty clear. The longer your holding period, the more likely you are to show positive returns. Over all rolling one-month time frames, the S&P has been higher 62.8% of the time. That's still much better than a coin flip and certainly better than any odds you'll find at a casino, but the consistency of positive returns increases quite dramatically when you look at periods of years rather than months. As shown, the S&P total return index has been positive over all rolling two-year periods 82.5% of the time, while it jumps to 94.2% over all 10-year periods. While not shown in the chart, the first point on the annual curve where 100% of the rolling periods have been positive is 16 years, meaning all rolling 16-year periods in the S&P 500 total return index's history have been positive.”

Some of you may look at the chart above detailing the historical facts around the market’s incredibly high probability of posting positive returns over various time frames, and understandably find yourself thinking, “Yeah, but what if I need money while the market is down?!”, and saying something similar to the quotes from the various people in the run-on-the-bank scene from It’s a Wonderful Life such as, “My husband hasn’t worked in over a year and I need money” … “how am I going to live until the bank reopens” … “I have doctor bills to pay” … “I need cash” … “I can’t feed my kids on faith!”.

One’s fear of loss and inability to time markets or many life events are why we continue to point investors back to the two things we will stress until the day we are done: 1) diversification and 2) generating income.

If you look at the chart below, you’ll see that by simply adding an asset class like fixed income you’ve been able to reduce both the range of outcomes as well as odds of a negative return over time, and consequently the danger of having to sell something at a loss. Please note, we have been on record for two years (and correctly so) advocating for diversification beyond just bonds, due to recent interest levels, by adding in other alternative asset classes (e.g., real estate, credit) and strategies (e.g., market neutral, buy-write, etc.) to one’s investment mix.

The last major piece to one’s armor against volatility and corresponding potential to have to sell positions at a loss, is building a portfolio that generates sufficient cash flow for your needs. Sequence of returns risk is only a significant problem if one’s financial success is predominately connected to counting on capital appreciation that may or may not be there during the period you need it.

Knowledge of the market’s resiliency, diversification to narrow your range of outcomes, and income to buy you the time you need for markets to rebound is both a recipe for financial success, as well as for turning the fear of a moment into a hope for the future.

Have a wonderful weekend!


Tim and team at TEN Capital


P.S. If news about the impending doom signaled by “any” yield curve inversion has caught your attention, then the article below by Bespoke is a must read. One of the most thorough pieces on the much-discussed topic, while also being understandable specifically due to some wonderful graphs and charts.

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Yield Curve Inversions: It’s All About Quantity – Bespoke Research

With yield curves flattening, investors are getting flashbacks to 2018, when the headlines were filled with fears over the inversion of 10-year vs 2-year yields. As we noted in numerous prior reports, recessions have always been predated by inverted yield curves, but not all inversions have led to recessions. It's kind of like the square-rectangle phenomenon (as in a square is always a rectangle but a rectangle isn't always a square). Investors are rightfully concerned that inversions raise the probability of a recession, but recession alarm bells shouldn't really start ringing when just one part of the yield curve inverts. Instead, the odds of a recession rise as an increasing number of points in the yield curve invert. For instance, while 2s10s is flirting with inversion, the three-month vs 10-year curve is nowhere even close to inverted and was just recently at its steepest level in five years. Historically speaking, when just a few points of the yield curve invert, the probability of a recession barely increases. It isn't until the majority of points in the curve invert that a recession in the next two years becomes increasingly inevitable.

In the chart below, we took all possible combinations of the 1m, 3m, 1y, 2y, 5y, 10y, 20y, and 30y points on the constant maturity Treasury curve and calculated how many of those curve points were inverted on any given day going back to 1970. As you can see from the chart below, the economy has gone into a recession in the two years following every point at which more than half of the points in the yield curve that we tracked inverted. Based on historical trends, with just a few points in the yield curve inverted (7.1% of the points we tracked), there's little in the way of a recession warning, but should more points on the curve invert, investors will need to brace themselves.

Not all yield curves should be treated equally. The table below outlines the probability of a recession based on each unique point in the US Treasury yield curve. There are seven yield curves that, when inverted, have historically resulted in a recession at some point in the following two years 100% of the time, and all seven of those points on the curve remain relatively steep with a minimum spread of 93 bps and all the others at more than 200 bps. Conversely, as of Friday's close, just two points on the Treasury yield curve had inverted (10Y vs 5Y and 30Y vs 20Y). Inversions of the 10Y vs 5Y spread have been followed by a recession at some point in the following two years 92.7% of the time. The other point on the curve that had inverted as of last Friday was the 30Y vs 20Y spread, and of all the points on the yield curve we tracked, this one was the least reliable in forecasting a recession at some point in the next two years. Lastly, the 10Y vs 2Y spread nearly inverted on Tuesday, and while that point of the curve hasn't been 100% reliable in forecasting a recession, at 98%, it has had a pretty good track record. Looking ahead, we'll need to see more points on the Treasury curve listed at the top of the table start to invert before fully expecting a recession.

Turning to equity market performance, the matrix below outlines the S&P 500's forward one-year performance from any day where any of the yield curves shown are inverted. Based on this data, the weakest equity market performance has followed periods when the 2Y vs 1M, 30Y vs 3M, 2Y vs 3M, 10Y vs 3M, and 1Y vs 1M invert. At any point when these curves are inverted (not just the first time in each period that the curve inverts), the average forward year performance is negative across the board, which is significantly below the average of 9.4% since the start of 1970. Based on the summary performance outlined below, forward performance for the S&P 500 when any point on the curve is inverted is generally weaker than average across the board. The only points on the curve that buck that trend are the 20Y vs 10Y, 30Y vs 10Y, and the 30Y vs 20Y spreads. However, underperformance is relatively marginal after inversions of the 30Y vs 20Y, 30Y vs 5Y, and the 20Y vs 5Y points. Based on the results below, inversions at the long end of the Treasury yield curve have been much more benign for equity returns than inversions between the long and short end.

Data, Just the Data

Data points this week included:

• U.S. Jobless Claims – jumped up by 14K to a count of 202K for the week ending March 26^th. The overall claims remain near record lows. The 4-week moving average has decreased to 208.5K.
  
• U.S. Jobs Added – the economy added 431K non-farm payrolls in March – below forecasts of 490K and far below the previous month’s addition of 750K. Leisure and hospitality continue to roll adding 112K jobs, as professional and business services added 102K. Job growth has averaged 562K per month in Q1 and the unemployment rate has dipped to a new pandemic low to 3.6%.
  
• U.S. Consumer Sentiment – Univ. of Michigan consumer sentiment reading dipped from 62.8 in February to 59.4 in March. This marks the lowest reading since August 2011. Inflation is weighing on sentiment and many consumers claim to see ‘reduced living standards’ due to rising costs.
  
• U.S. GDP – the economic growth rate expanded on an annualized basis of 6.9% for Q4 2021. This officially marks the strongest expansion since Q3 2020, as private inventories contributed 5.32%. Exports moved slightly lower to 22.4%, as imports trended up to 17.9%. With Q4 completing the 2021 picture, the economy expanded 5.7% YoY.
  
• U.S. ISM Manufacturing Index – fell to 57.1 in March, after an index reading of 58.6 the month previous. This marks the slowest factory activity growth since Fall 2020. New orders have contracted from 61.7 to 53.8, along with a dip in production from 58.5 to 54.5. Employment expanded at a healthy rate, but price pressures surged from 75.6 to 87.1.
  
• U.S. Personal Income – improved to 0.5% in February – slightly higher than the small January gain of 0.1%. This aligns with market expectations, as a rise in private and government wages has been offset by decreased social benefits and rising costs in healthcare.
• U.K. PMI Manufacturing – fell slightly to 55.2 in March, which points to the lowest factory growth since this time last year. Output and new orders were reduced, along with new exports business. Employment has been lessening and ongoing supply shortages along with rising costs are adding to the index woes.