Meet T.I.N.A.
I had a friend that worked at two of the big New York banks in a non-investment role during the years after the great financial crisis (GFC) had been worked out of the country’s economic system. This person would attend wealth management conferences as part of that gig. Naturally, I would ask what their takeaway was after one of these conferences where registered investment advisors and other investment professionals would hobnob.
What a normal person1 heard within those walls was professionals saying over and over in different ways, “Bonds are bad. Stocks are good.”
What my friend was hearing can be paraphrased to say when bonds are yielding little to nothing “there is no alternative” to stocks. Whether that is too simplistic or not, T.I.N.A. was born. There Is No Alternative to stocks.
I laughed at the simplicity of the statement. But, with honestly, I didn’t fully understand that perspective in the moment. There must be a place for bonds in some portfolios, I thought.
It Wasn’t Always Like This
In the fall of 2007 I took an undergraduate economic course called something like “Money and Banking”. I have a few Word documents with notes that have survived these 15 years since. There is a section in my notes called “Managing Interest Rate Risk” and features a subsection with the following bullet:
- Duration analysis – examining the sensitivity of market value to changes in interest rates
During the fall of 2007, the 2-year U.S. treasury yielded ~4.0%. Although I did not appreciate it at the time, this was an interesting point in history as we were about to topple over an economic cliff in what would become the GFC.
On the other side of that cliff? Near zero percent interest rates.
Because of that, coming out of the GFC, duration analysis seemed a bit of a “theoretical” or “academic” theory. Using the 2-year treasury as a guide, interest rates would not come near a 4% yield again until this very year — 2022 — a full 15 years after I first learned of how interest rates impact different asset classes via duration analysis.
It is downright scary to think that almost all of these last 15 years, with extremely accommodative Fed policy, are the outlier rather than the norm.
When the yield on a risk-free treasury is nonexistent, those with capital still seek a return on their money. During times when interest rates are low, people are inclined to put more money into riskier assets. Meaning, basically, folks have to get creative in seeking investments that produce a return.
Borrowed money was essentially free, so investment borrowers and corporate borrowers took advantage of this and used those monies to drive stock prices and corporate profits up.
Looking at the green line above, shows how much the US equity market has increased both since the GFC and during the preceding decades. Additionally, it shows that the investing environment going all the way back to the 1980s was one of decreasing rates with the coup de grâce that was the GFC.2
That is not to say all of the increase in stock prices is unwarranted. The well-run businesses took this “free money” and built enduring businesses. But the less well-run business took this money and will ultimately not be able to pay it back as the business continues to lose money in perpetuity.
Many people understand that the Fed’s policies had at least some impact on asset prices such as publicly traded stocks.
A subset of those people are of the mind that rates are unlikely to go that low again in the short-term, even if and when all the undesirable inflation is pushed out of the system.3
But even fewer people comprehend that even marginally higher rates, which are likely to persist, have permanently changed the value of assets relative to when rates were held unnaturally low. This includes stocks, of course. But it also may include assets like real estate. Hello, duration analysis.
🔸🔸🔸
2022 Portfolio Asset Allocation
With rates lifting off zero, is asset allocation back?! There is an alternative to stocks?!
For a relatively young retail investor, public equities continue to be the critical component of one’s portfolio. Hands down. Reflecting that, at this time last year, our portfolio was very much influenced by precisely the T.I.N.A. sentiment. Majority stocks. A hefty portion of other very risky assets, e.g., bitcoin. While the allocation to any fixed income, e.g., bonds, was so minimal that it was a rounding error that didn’t warrant inclusion in the pie chart. That has changed somewhat this year.
While the cash and equities positions are directionally the same, crypto’s price action has lead to a significant decrease in the percentage of the portfolio it occupies.
The main story is the fixed income portion. An increase from under 1% to over 7% is a pretty meaningful change. With that said, the underlying assets in that bucket are generally still liquid and flexible. 4
The other significant change, is that the interest rate on cash has gone from under 1% a year ago to ~4%. That means this significant, nearly 20%, portion of the portfolio is no longer completely parked on the sideline and is now earning a guaranteed return. Exciting! And a simple example of why riskier assets are being repriced.
2022 Portfolio — Overall Return of Public Equities
For the year, the publicly traded stocks in the portfolio were down 28% compared to the S&P 500’s -18% return.
The 3-year annualized return for the portfolio is 15% against an S&P 500 return of 8%.
The above is apples-to-apples. Public stock portfolio versus the most the most broadly used stock index. 5
2022 Playbook Review and 2023 Playbook Ideas
I am happy to say I accomplished the three things I discussed in last year’s playbook. First, initiate weekly purchases of ETFs tracking US publicly-traded companies. Second, reinitiate a small hedge against equities in the short-term. And, third, preserve a healthy cash position to be deployed as opportunities arise. It would have been easy to over allocate during this year.
I will also take the victory lap on the title and tone of last year’s year-end note. It was titled The Year Number Went Up (Again). The insinuation being it was unclear if the fundamentals supported the recent positive price action in stocks (and everything else).
At this time last year, I wrote that it’s prudent to ask if the good times can last. I specifically stated that my most immediate concern was the impending rate hikes stemming from a more hawkish Fed creating a new macroeconomic environment.
These calls may look obvious now. But even during Q1 of 2022, let alone Q4 of 2021, this was not consensus thinking. As I disclosed at the time, before the downward price action, I had already opened a short position while legitimately smart analysts were bullish on risk assets. For example, here’s what a Morgan Stanley analyst had to say about growth/technology stocks in late February 2022:
We are less negative on growth than we have been, given the magnitude of recent underperformance vs. the broad market. In many ways, the chase into growth/technology stocks after the COVID-19 lows reminded us of the NASDAQ bubble of 2000. We thought that once the bubble burst, it was going to be ugly, which it has been. However, the more established mega-cap technology stocks never traded to the same frenzied level—that is how the environment today is different than in 2000. Recent underperformance despite numerous impressive earnings reports means many of these large-cap growth names are now trading at very reasonable valuations.
That’s from February 2022! February! As I disclosed months earlier, before significant downward price action, I opened a short position. It’s things like this that make me feel confident in saying reading this blog over the last few years has provided more signal than noise. While, on balance, I know that will not always be the case, it’s something I take pride in at the moment.
Here is the plan for 2023:
- Get even more long-term bullish on U.S. stocks — I do think markets can get worse before they get better. There is a ton of negative sentiment out there is December 2022. On the flip-side, when I hear people talking about actually getting excited about a 3% interest rate on their FDIC savings account, it’s getting to be about that time to buy stocks. Those conversations have started. The mindset we must cultivate is that this market is providing longterm buying opportunities.
Action: increase dollar value of weekly ETF purchases. - Simplify the stock portion of the portfolio by decreasing the number of individual company holdings — with the opportunities presented through the COVID-19 drawdown, the portfolio ballooned to have too many individual positions. I truly believe my “skills” in investing align better in a non-zero interest rate environment. That’s to be proven over the next several years. Time will tell.
Action: selectively sell shares over multiple transactions with the ultimate goal of having less individual stock positions at the start of 2024. - Embrace short-form content — throwing in a third item that isn’t portfolio specific. As I continue to learn and write, shorter-form content could be a good way to explore more ideas, embrace new learnings, and even spur more interaction with readers.
Action: start posting shorter blogs.
Happy new year and welcome to 2023!