The Cordant Blog

What are Interest Rates Forecasting for Stocks?

by Isaac Presley, CFA on August 24, 2016

What are interest rates telling us about the current state of the economy? And, more importantly for investors, what are they telling us about the markets?

A few weeks back Ben Carlson had a good post addressing the first question. He asks what interest rates (specifically the spread between 2-year Treasury yields and 10-year Treasury yields) are telling us about the likelihood for a recession. Here's Ben:

The indicator most industry observers pay close attention to in terms of bonds and recessions is the spread between 2 year treasury yields and 10 year treasury yields, which you can see here: 

 

When the 10-year yield falls below that on 2-year treasuries it’s called an inverted yield curve, and Ben writes:

You can see that every single time that 10 year yields have fallen below 2 year yields it has preceded a recession (the shaded regions). This data only goes back to the late-1970s but is impressive nonetheless. 

 

Next, he correctly points out that just because something is a reliable historical indicator, to expect it to work in the future, there must be a sound, fundamental explanation of why. Again from Ben:

In this case there is a logical reason for using the yield curve as an economic signal. Bond yield spreads are typically used to gauge the health of the economy. Wider spreads between long-term and short-term bonds lead to an upward sloping yield curve, which can indicate healthy economic prospects — most likely higher growth and inflation in the future. Narrower spreads lead to a flatter or even negatively sloped yield curve, which can indicate poor economic prospects — most likely lower growth and inflation.

 

His accurate conclusion is that we should pay attention to this indicator. We aren't yet at an inverted yield curve with the current spread around .80%, but, with the spread falling, it is worth watching.

However, I was left wondering about the second question. What do interest rates and the yield curve mean for the markets (as opposed to the economy) going forward? If an inverted yield curve means a recession, that’s probably pretty bad for stocks, right? Well, not quite. Let’s take a look.

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Stick with It: The Key to Factor Investing (Or Any Investing Strategy)

by Isaac Presley, CFA on August 16, 2016

In a series of articles about factor investing we’ve defined what we mean by factor investing, we listed the factors and examined their performance, and last time we examined how a strategy can still work when everyone knows about it. The next question we get is, if a strategy works, why doesn’t everyone do it? Why doesn’t everyone earn a factor premium?

This is a great question to ask about any investing strategy and the answer is twofold: First, some people remain skeptical about systematic investing strategies in general. Many continue to think, no doubt encouraged by the plentiful marketing dollars of Wall Street, that traditional stock picking is the only way to outperform. Next, even those pursuing an evidenced-based strategy don’t tend to stick with it over time. This includes both individual and institutional investors.

Unknown or secret strategies aren’t plentiful. There isn’t some holy grail of investing to be found that magically delivers alpha (i.e., outperformance). What matters is having enough confidence in your strategy that you can stick with it through various market cycles. As Brendan Mullooly of Mullooly Asset Management recently wrote, “If your investment strategy is based upon strong evidence (I hope it is!), you need to hang in there.”

But, sticking with your strategy can be difficult as earning a premium over other investors requires being different than other investors. This can be painful, especially when a strategy is out of favor. And just because everyone knows about a strategy, it doesn’t make it easy to get the premium. Phil Huber, the Chief Investment Officer for Huber Financial Advisors, puts it like this: “An unfortunate truism in our industry is that investors tend to abandon ship on an asset class or strategy right around the same time they should be piling into it.”

It’s easy to make the claim that investors don’t stick with their strategy, and this probably makes intuitive sense, but are there any data to back this up?

Let’s take a look at a few examples from both individual and professional investors. Then we will conclude with a few ideas on how, as investors, we can stick with our strategy.

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Taking Action Now Costs Less Than Being Forced To Later [Announcing an Upcoming Retirement Transition Seminar]

by Isaac Presley, CFA on August 08, 2016

"Avoiding a problem with foresight and good design is a cheap, highly leveraged way to do your work.

Extinguishing a problem before it gets expensive and difficult is almost as good, and far better than paying a premium when there's an emergency.

Fretting about an impending problem, worrying about it, imagining the implications of it... all of this is worthless.

Action is almost always cheaper now than it is later." ~Seth Godin on Problems

***

This spring Intel announced and began executing on a plan to reduce as much as ten percent of its workforce. For most, the rapidity of this round of layoffs was jarring. Mike Rogoway, writing in the Oregonian, paints the following scene:

It happened, typically, in one of Intel's windowless conference rooms, at the end of a long table under droning white fluorescent light. A supervisor arrived, along with someone from human resources.

We've got some bad news, they'd say: You're being laid off. They would pass paperwork across the table and tell you it's time to go. Right then. You might have passed a friend on the way out, pausing just long enough to share the news before handing over your Intel badge and walking out the door, for good.

 

In hearing from and talking with many people dealing with the layoffs or voluntary separation packages, one thing was common: the speed at which the layoffs were announced and the pace at which Intel required a decision be made was challenging. It made for a stressful period with inadequate time to plan—there wasn't much warning.

What’s more, according to the Oregonian these layoffs fell disproportionately on older workers. Many of these people likely considered retirement still a few years off but now they were left with uncertainty. Can I afford to retire now? Can I afford to work less or take a lower paying position?

When it comes to preparing for the future, and knowing where you stand, action now is better than action later.

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Factor Investing: No Secret, So Will It Continue to Work?

by Isaac Presley, CFA on August 04, 2016

“More investors don't copy our model because our model is too simple. Most people believe you can't be an expert if it's too simple." ~Charlie Munger when asked why more investors hadn't copied Berkshire Hathaway's approach to investing[1]

***

Value and other forms of factor investing aren’t new. They’ve been around for a while now and are widely documented in the academic research. So, if systematic investing based on these factors isn’t a novel concept to any attentive observer, how can the strategies still work?

For anyone considering factor strategies this is a good question to ask and one Cliff Asness, the founder and CIO at investment firm AQR, addressed in the September 2015 issue of Institutional Investor with an article titled How Can a Strategy Still Work If Everyone Knows About It?”

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Getting Comfortable with Being Uncomfortable

by Isaac Presley, CFA on July 26, 2016

Investing well, like any significant endeavor, requires some level of pain to succeed.

In a recent article Brad Stulberg, a writer for Outside Magazine and Runner’s World shared the advice he received from his marathon coach. To succeed as a marathoner, he “would need to learn how to be comfortable with being uncomfortable.” Stulberg says he, “didn’t know it at the time, but that skill, cultivated through running, would help me as much, if not more, off the road as it would on it.”

The importance of developing the discipline to press on when things are painful, and to execute on what’s right in front of you, goes beyond running. This trait carries over to accomplishing anything difficult in life and being a successful investor as well.

With investing the “pain” tends to come from two areas: 1) Paying attention to the fundamentals (i.e., the “boring” stuff) which is required to minimize errors, and 2) being different from other investors. Let’s take a look at each.

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An Introduction to Factor Investing: Part II

by Isaac Presley, CFA on July 19, 2016

Last time we reviewed the advantages of index funds and introduced the concept that different stocks may have different attributes (called “factors”) which lead to different returns.  This time, we will specify the four primary factors identified in the research and look at the differences they make to returns. Then we will discuss some drawbacks or things to be aware of when incorporating factors into your portfolio. You should come away with a better understanding of factors and how they may, or may not, fit into your portfolio. 

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Q2 Investment Update: When Stocks Go Nowhere

by Isaac Presley, CFA on July 13, 2016

Despite the shock Britain's historic vote to leave the EU delivered to the financial markets, the second quarter saw most asset classes deliver positive returns. International stocks were the only major asset class down in the quarter. The best performing asset classes were long-term bonds, REITs, and Commodities. 

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An Introduction to Factor Investing: Part I

by Isaac Presley, CFA on July 08, 2016

Factor | noun | fak·ter | A characteristic or element that contributes to a result or outcome.

Forty years ago Vanguard founder, Jack Bogle, created and launched the world's first index mutual fund (the Vanguard 500 Index Fund). This fund, and the many index funds created since, have provided an overwhelming benefit to investors and have recently picked up, even more, momentum. According to Bloomberg, since 2011 index funds have seen $1.7 trillion of inflows compared to $5.6 billion of outflows from actively managed funds.

But, while there are many benefits to index funds, the question is, can they be improved upon? The answer appears to be “yes” as academic research has revealed a few characteristics, or factors, of individual stocks that have led to increased returns compared to a simple market cap weighted index. 

We will explore these factors, but first, let's look at the advantages of index funds (the benefits we want to preserve), define what we mean by factors, and see how indexes treat these factors. 

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Social Security Planning

by Scott Gerlach on June 29, 2016

Whether you’re approaching retirement or already in it, you probably have questions about Social Security and how it impacts your retirement plan. Social Security is as complex as it is important. The income stream can be an integral part of a well-thought out financial plan and the myriad of options often lead to sub-optimal elections by otherwise well-informed folks. Social Security goes beyond retirement income and provides workers and their families with disability and survivors insurance benefit as well; however, this post will focus on the following key points of Social Security as part of retirement planning: 

  • How benefits are calculated
  • Solvency of the program
  • Recent changes to popular claiming strategies
  • Social Security as part of your retirement plan

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Brexit: Keep Calm and Carry On

by Isaac Presley, CFA on June 24, 2016

Good morning! Chances are you woke up today to news of Britain voting to leave the European Union, and more than one ALL CAPS headline screaming that financial markets are plunging. Here’s some perspective:

  • As of this morning, The S&P 500 index is still up 1% year-to-date
  • US Small-cap stocks (IWM) are up 0.7% YTD
  • Emerging Markets stocks (VWO) are up 3.4% YTD
  • Bonds (AGG) are also up 3.6% YTD
  • The stock market in the UK is down, sure. But, only down to the levels of late February of this year
  • Same thing for European markets
  • After one of the largest one-day moves in the British Pound ever, it’s also it back to the level seen way back in February of this year
  • World stocks markets (ACWI) in total are down only 1.3% YTD

While the financial markets don’t like uncertainty (and this vote definitely creates some uncertainty), and traders are likely going to sell first and ask questions later, it’s important to remember that we are investors, not traders. Our time frame as investors (and your goals, objectives, and financial plan) is years and decades, not hours, days or even weeks. This vote, or any market move over a week isn't going to deter a well-designed financial plan or investment strategy.

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