Quarterly Update

The first quarter of 2022 (Q1) felt like the start to a year when investors couldn’t catch a break. We finally seemed to be turning a corner from the pandemic and there was a sense of guarded optimism as the new year opened. It didn’t last long. Inflation concerns grew, but the real drop in sentiment came when Russia invaded Ukraine. Investors quickly sold off stocks, especially those that had performed best last year. Investors also had to contend with the Fed raising interest rates for the first time in years and, in the quarter’s waning hours, the bad omen of an inverted yield curve. Quite the quarter indeed!

Here’s a roundup of how major markets performed during the first quarter:

  • US Large Cap Stocks: down 4.6%
  • US Small Cap Stocks: down 7.5%
  • US Core Bonds: down 5.9%
  • Developed Foreign Markets: down 6.5%
  • Emerging Markets: down 7.6%

Stocks had been down modestly to start the year but turned sour as chances grew for war in Europe. Noticeable dips for the S&P 500, the typical benchmark for US stocks, occurred during late January with the increase of rhetoric and troop buildup, and then again a month later on news of the invasion itself. At its lows, the S&P 500 was down over 12%, technically a correction, and the tech-heavy NASDAQ dropped a hair over 20%, technically a bear market. Both indexes regained ground in March to end the quarter with relatively modest losses.

With swift nearly-global condemnation of Russia, a major oil and gas exporter (as well as other important commodities), oil prices rose dramatically, sending the US energy sector up 39% for Q1. Utilities were up almost 5% for the quarter, but all other major sectors finished Q1 in the red. The worst performing sectors were Consumer Discretionary and Tech, down 9% and 8%, respectively, both top-performing sectors during 2021. Foreign stocks and emerging markets had begun the year well, but quickly turned south on news of the invasion.

And then there was the bond market. Bond prices had struggled throughout much of 2021 and limped into Q1. The main issue last year had been the prospect of inflation and the eventual response by the Fed to try and contain it. When inflation started to take off last Fall, bond prices reacted negatively. This worsened during Q1 as inflation reached 7.9% in February. Add uncertainty about further inflation and the Fed finally starting to raise short-term interest rates in March, and you have a gloomy environment that saw core bonds fall almost 6% during the quarter. Short-term bonds and long-term bonds fell about 2.5% and 10.6%, respectively. This poor performance is tough to swallow because high-quality medium-term bonds are typically an anchor in our portfolios during turbulent times.

But that’s when we’re not also contending with potential runaway inflation potentially leading to faster Fed rate increases, that potentially lead to a recession. Put simply, the outlook for all three is uncertain. Bonds of different maturities and interest rates (yields) are compared to each other to gauge how investors are feeling (and acting) about economic growth, inflation, and the expected path of interest rates over a certain time horizon. Comparing bond yields like this creates a variety of “yield curves” and, although different inferences can be drawn from watching the shape of the curves over time, people mostly watch them for recession risk. The most popular curve is the difference in yield between the 2yr and 10yr Treasurys. Normally this curve slopes upward from the lower yield of the 2yr to the higher yield of the 10yr and is a sign of expected smooth sailing. But briefly, and by a small amount, the curve inverted right as Q1 ended.

One of the reasons the 2yr/10yr curve is so popular is that its inversions are said to have predicted six out of the last six recessions. To be clear, inversions don’t cause a recession, but are coincident with them. An inverted yield curve also doesn’t say much about the depth and breadth of a recession, it’s more of a warning sign. It’s possible that an upcoming recession could be mild, more a response to the ongoing shockwaves from the pandemic and consumers exhausted (financially and emotionally) from all their recent spending, and not deep structural issues such as what led to the Great Financial Crisis. Why would we expect a recession amid all the news of rapid economic growth, rising prices, and low unemployment? Bond investors may be getting ahead of themselves, but the general thinking is that the Fed could fight too hard to slow inflation and raise interest rates too quickly, essentially torpedoing our recovery. For its part, the Fed plans to stair-step the short-term benchmark rate it controls higher throughout this year and into next and will be sensitive to how this plays out in the economy along the way. Bond investors are skeptical.

The timing of yield curve inversions typically leads recessions by a year or so, and the inversion itself needs to stick around for a while to be more predictive. Stocks typically do well post-inversion and bond prices already have much of this Fed/recession risk priced in. What’s a long-term investor supposed to do in an environment like this? You should have a good plan and stick to it. Stay diversified. Rebalance by adding to stocks on weakness and don’t be shy about adding to bonds, especially as interest rates rise. You can also harvest losses in non-retirement accounts. Oh, and try not to get swayed by the headlines. Nothing to it, right?

Have questions? Ask me. I can help.

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The stock market finally performed well last week. This is great to see after such poor performance this year. Investors favored what had been most beaten down while selling energy stocks, the only sector that had been positive lately. It’s common to see stock prices tail off a bit after a strong short-term run and markets are gyrating this morning, so don’t be shocked if this week isn’t a repeat of last (but I’ll take it, don’t get me wrong…).

So-called core bonds can usually be expected to pick up some of the slack when stocks are down, but not this year. So far in 2022 bonds have been down with stocks, falling about 5% with variation around that depending on the bond index. Stocks had been down 12% going into last week but the 6% move has halved that, dimming the light further on bonds.

Stocks and bonds march to different tunes, or at least sometimes different steps to the same tune. Before Russia’s invasion of Ukraine investors had been focusing their concern on interest rates and inflation. The outlook has obviously gotten more complicated since. The situation in Europe seems to be settling in for a longer-duration conflict, underlining the question mark investors have for the weeks (or months?) ahead. And the Fed has started raising short-term interest rates, bumping the benchmark rate by 0.25% last week. The Fed seems set to keep raising like this a handful or more times this year. Had Russia not invaded Ukraine the Fed may have started moving rates up faster. And they’ve indicated not wanting to tighten economic conditions too quickly amid high levels of global uncertainty, even though there’s lots of uncertainty here at home due to inflation. How’s that for a tough job!

While anxiety around all this feeds into the stock market, it absolutely continues to permeate the bond market and is why bonds haven’t performed as well as they’d be expected to when stocks were down. So let’s finish up our discussion from several weeks ago of typical bond alternatives.

To clearly state my bias, I’m not suggesting you dump your bonds and go on a bond alternative buying binge. I like high-quality fixed-rate bonds and have used them in client portfolios for many years. And I don’t see this changing dramatically, even though we’re still going through an interest rate-driven adjustment phase with the bond market.

That said, there’s room to add additional safety through diversification for some portfolios, just as there’s room to raise risk a bit to increase investment income in other portfolios. That’s why we’ve looked at annuities, preferreds, convertibles, even REITs, as alternatives for some of your core bonds. Now let’s round out our list by looking at “floaters”.

Floating Rate Bonds –

Floaters, as they’re often called, are shorter-term bonds issued mostly by corporations but also by governments, even ours. A key point is the interest rate paid to investors is variable, based on a fixed spread over an index such as LIBOR or one of the Fed or Treasury indexes. Floaters are said to be good in a rising-rate environment because, unlike typical bonds that pay fixed interest for the entire term, payments from floaters rise as their benchmark rate rises. The increase is often capped, however, so if rates took off chasing runaway inflation, for example, floaters wouldn’t entirely keep up.

So far this seems like a near-perfect combination for our current rate environment, right? Maybe, but with a few key caveats.

First, floaters with more attractive terms are often issued by companies with higher credit risk than fixed-rate borrowers. This means the benefit of rising interest payments as rates rise can, and sometimes quickly, be counteracted by increased investor concern over creditworthiness. As an extreme example, the main floater index lost almost 29% during 2008 compared to core bonds rising about 5%.

Second, according to Vanguard, floaters have tended to outperform core bonds while interest rates are rising but then underperform in the year(s) following a rising cycle. This can happen due to the first issue (credit worthiness and spooked investors) or, ironically, changes in interest rate expectations. Both factors conspired to thwack floaters during the early days of the pandemic. To be fair, core bonds also fell, but by maybe half as much as floaters.

And third, floaters pay low interest rates compared to core bonds until rates rise, then often step up gradually. The iShares Floating Rate Bond Fund, ticker symbol FLOT (a good option in this space, by the way), paid a 12-month yield of 0.41%, compared with about 2% for core bonds. Maybe floaters close that gap this year, but who knows? Also, one could certainly argue that they lost less than core bonds during the same period, but hindsight is 20/20, as they say.

Essentially, investing successfully in floaters requires timing the right entry and exist points over a relatively short period, maybe a couple of years or less. The speculative nature of that kind of runs counter to the reasons for owning bonds in the first place, but maybe floaters are better thought of as add-ins, or satellites, for diversification within a core bond portfolio. If so, maybe they occupy a fifth, or perhaps a third, of your bonds if you want to be more active as rates rise.

Have questions? Ask me. I can help.

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Commodity Inflation and Other Updates

Inflation, Fed policy, the stock market, the bond market, how Russia’s invasion of Ukraine will continue to impact each one, and the human cost of war. All are on the mind of investors again this week. Oh, and lest we forget our hopeful emergence from the pandemic as well; there’s no rest for the weary.

With all this going on it’s natural for investors to feel nervous, anxious, maybe even panicky. I mean, the word “nuclear” has popped up in different contexts in recent days. The price of oil briefly spiked to $130 per barrel (currently down to $122) and local gas prices are getting ridiculous. And this has been reported in the news with lead-ins like, “Not since 2008 has oil…”. Now, the reporters were likely only referencing the roughly $180 per barrel oil price that year and how it coincided with the Great Financial Crisis, but the connection is enough to make all but the most hardened investors wince.

The GFC was mostly about the structure and incentives of our financial system. Systemic problems and largely unchecked risk-taking allowed millions of consumers to become woefully overburdened by housing debt and led to enormous numbers of defaults. Borrowers were allowed, and even incentivized, to use excessive leverage by big financial companies that were themselves gambling extensively. Then the music stopped and the risk of these too-big-to-fail companies reneging on their agreements to each other caused the system to grind to a halt before almost imploding. Those were white-knuckle times indeed and a reminder of how fragile our modern financial system was and perhaps still is in some ways.

But is the current environment 2008-esque? Russia’s invasion of Ukraine certainly could spiral out of control, directly involve NATO, and lead to more and wider bloodshed. But unless that happens it’s not a structural issue for our economy like the GFC was. Instead, its economic impact seems to be indirect, linked to rising prices for commodities, such as oil and wheat, and how that impacts global demand. Bad timing, of course, because our main issue right now is inflation. But ours was caused in large part by massive amounts of government spending during the pandemic, and Russian aggression/commodity-induced inflation is relatively small when compared to that.

I don’t pretend to know what the future holds, but we can at least check some things off the list of what the current situation isn’t. That said, stock prices could certainly keep grinding lower. (It’s tough to be optimistic with my screens full of red as I write this.) So is it time to throw up our hands, cry uncle, and start looking for advantageous spots in the yard to bury our savings?

Of course my answer is no. I think the best investment strategy is to remain disciplined and focus on rebalancing as our portfolios suggest it’s time to do so, such as buying stocks in modest amounts when they’ve fallen past predetermined thresholds. This has worked throughout all kinds of inclement market weather, and I expect it will continue to do so.

I wanted to share some additional information from JPMorgan and Bespoke again this week (emphasis mine). The former provides us with a look at rising energy prices and the potential impact on American consumers. And the latter provides some updates on the situation in Ukraine.

From JPMorgan…

When it comes to economic growth in the United States, the consumer is key, accounting for nearly 70% of gross domestic product (GDP). Following the initial pandemic shock in early 2020, the consumer came back with a vengeance, as stimulus checks and enhanced unemployment benefits stabilized balance sheets across the U.S. and spending on goods accelerated meaningfully. However, with food and energy prices rising, there is a risk that the composition of consumer spending will begin to shift. Looking at energy spending as a percentage of total spending, we are able to model a scenario in which crude oil prices rise to $120 per barrel. In aggregate, however, the model forecasts energy spending would increase to 5.0%, which is only slightly above the 2021 average of 4.8%.

That said, the devil is in the details. To an extent, economic growth has been solid and inflation has been elevated due to stimulus that lined the pockets of lower-income individuals. This group has a much higher marginal propensity to consume – put differently, if they have extra money in their pocket they are more likely to spend than save. As we show in the chart of the week, this cuts both ways. If oil prices spike to $120, energy spending may rise to 13.9% of total spending compared to an average of 10.1% in 2021 for the lowest earning individuals, limiting their ability to consume other items. This could in turn lead to slower economic growth than expected, but also a more rapid decline in core inflation. While we still expect the Federal Reserve (Fed) will hike interest rates at its March meeting, this dynamic may allow the Fed to tighten more gradually than markets currently expect.

From Bespoke Investment Group yesterday morning…

No substantive forward progress has been made by Russian forces in Ukraine since Friday with the exception of a push west towards the Kyiv suburbs on the east side of the Dnieper. It’s not clear whether that lack of progress is due to preparations being made for a new push or if the combination of Ukrainian resistance and Russian logistical ineptitude is driving the slowdown. One significant fact about the fighting over the weekend is that the Russian air force has taken significant losses from Ukrainian surface-to-air missiles and remaining aircraft. The New York Times reported on Sunday that the US alone has already delivered more than 17,000 anti-tank weapons to Ukraine, and that’s only a small slice of the overall military support the country is getting. US intelligence has also reported that Russia has now committed roughly 95% of the forces amassed prior to the invasion, roughly 15% of total military personnel. Outright conquest of Kyiv and most of the country’s landmass is impossible at this point unless something changes significantly. The Russian Ministry of Finance has signaled that it will pay foreign investors in rubles which would ultimately trigger a wave of defaults.

From this morning…

Russian advances remain very slow and deliberate over the last 24 hours. Russian forces are largely consolidating in the south of the country having been pushed out of Mykolaiv (between Crimea an and Odessa) and having made no progress to fully takeover encircled Mariupol. In the northeast, major cities Chernihiv, Surny, and Kharkiv are being bombarded but are not encircled as the advance has stalled out. Slow progress has been made in the west of Kyiv, and Russian forces have advanced from the east in a salient that bypassed Surny. Kyiv is not encircled, and ground lost to Russian forces has been bitterly contested with significant losses imposed by defenders in terms of both material and lives. The Russian military is clearly trying to encircle Kyiv for a siege but has not been able to do so despite progress. Ukrainian units are lighter, more mobile, and are able to avoid large-scale engagements outside of cities, meaning that while Russia has been able to advance, their rear areas are not secure and the supply situation in terms of equipment and consumables is tenuous.

That supply situation is further threatened by the fact that they have not been able to establish air superiority and are vulnerable to strikes from both Turkish-supplied TB2 drones and Ukrainian air force jets. The current situation is therefore a race between the two countries to sap Russian logistics enough that front line troops can no longer hold ground they’ve taken. Despite triumphant social media posts trumpeting Ukrainian success, Russian gains are very real. That said, their logistical situation is dire, morale is unsteady (especially given the loss of at least three generals since the war began, something that almost never happens on modern battlefields), and Ukraine is resisting to a degree that will make outright conquest of the entire country impossible if it continues. We should also note that the US intelligence community now believes Russia has committed all pre-positioned troops and equipment to the fight, meaning that military is getting close to its limits on available manpower.

And some historical perspective, also from Bespoke this morning…

With the entire world focused on the Russia-Ukraine war and possible scenarios under which President Putin can either ratchet up or dial back the tensions, it’s ironic that today marks the 105th anniversary of the start of the ‘February Revolution’ which essentially ended the reign of czarist rule in Russia when Nicholas II abdicated his throne. Historians cite a number of factors for the February Revolution including frustration with government corruption, a poor economy, and autocratic rule, but the Russian military’s poor performance in World War I was the primary catalyst for the Revolution. Russians came out in droves to protest the conditions and despite an attempted crackdown Russian police and ultimately the military, the protestors refused to back down. Within less than a week, Nicholas II abdicated the throne ending the era of czarist rule in the country.

Not long after Nicholas abdicated, Vladamir Lenin returned from exile in Switzerland to lead the Russian Revolution, and as he is often credited with saying, “There are decades where nothing happens, and there are weeks where decades happen.” During the February Revolution, it took less than a week for protests to lead to the abdication of the throne by Nicholas II and usher in the communist era. The current Russia-Ukraine war hasn’t even been two weeks yet, and several years from now, with the benefit of hindsight will we be looking back on this period as another one of those moments where ‘decades’ occurred within a matter of weeks?

Here are links to JPMorgan and Bespoke…



Have questions? Ask me. I can help.

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What to do About Inflation?

Inflation is on everyone’s mind these days. And how can it not be? Prices on everything seem to be higher (or the same price with smaller packaging – sneaky shrinkflation) and, perhaps worse, there’s growing concern about how high prices could be later this year, next year, and beyond.

It’s concerning as well, of course, when the smartest minds in the room seem to have gotten it wrong. For much of last year economists and forecasters mostly called for a short-term, or “transitory”, bump in prices followed by a quick decline. Instead, we’ve seen a multi-month run leading to average consumer prices at 40-year highs. And that was only through February.

Shuttering much of the economy and then force-feeding consumer spending had never been tried before so, in a way, maybe we ought to cut the forecasters some slack. Also, I wonder if they may have been wrong in their initial time estimate but ultimately right in their view of the path for inflation (a surge higher followed by tapering off). But how long until inflation peaks and what price hikes will prove sticky?

The typical consumer remains in pretty good financial shape, which implies capacity to spend more, but continued supply chain issues, global uncertainty, and now the Fed raising short-term rates, might slow demand given that the free money tap has been turned off.

Uncertainty around all this raises many important questions for our economy and markets, but also some practical questions like:

I eventually want to replace my windows. Should I do it now even though prices have seemed to skyrocket in the past year, or should I wait for prices to get back to normal?

What does “get back to normal” even mean in this context?

I’m retired and need to know how long I can afford higher levels of inflation. What, if anything, should I do about it in the meantime?

These sorts of questions don’t have one right answer. Past inflation, and fear of more to come, can alter our psychology around money and our plans for the future. This, perhaps ironically, can help turn inflation expectations into a self-fulfilling prophecy. I’m not making light of inflation, just that we should be careful about changing too much today based on inflation fears that may not end up being fully realized, or at least not as much as some of the more inflammatory talking heads on TV and the internet suggest.

Some manufacturers are reporting a slowing in new orders but still have heavy backlogs to work through. Pending home sales have started to trend lower, as has consumer confidence. All three areas are still high relative to history, but the winds may have started to shift. Maybe inflation starts to peter out later this year like experts suggest? We’ll see.

While it makes sense that government cash stimulus drives retail sales, the following article segment and chart from my research partners at Bespoke Investment Group shows the relationship clearly. The chart also seems to imply that demand should wane as the effects of massive government spending dissipate. But it was a lot of spending creating a lot of demand, so it’s understandable if it takes a while.

From Bespoke…

When COVID-19 was officially declared a pandemic by the World Health Organization (WHO) on March 11th, 2020, no one knew what to expect. As uncertainty about the future grew, people across the globe scrambled to purchase canned goods, personal protective equipment, and weapons among other things. President Trump called for all Americans abroad to return home and restricted travel and trade from China in an attempt to mitigate the spread of the virus. In the early days of the panic, investors sold off their equity positions aggressively, resulting in a market crash and a peak VIX reading of over 85. Panic filled the streets, and everyone across the globe feared for their health, livelihoods, and net worth.

Regardless of your opinions regarding the effectiveness of various federal and state government COVID policies, there is no question that restrictions on activity (both enforced and voluntary) along with the stimulus provided by the federal government and the Federal Reserve dramatically altered the course of the economy. Whether it's elevated levels of inflation, supply chain constraints, or labor shortages, many of the headwinds our economy faces today can be attributed to the pandemic. In 2019, a Federal Reserve survey found that nearly 40% of Americans wouldn't be able to cover a financial 'emergency' of even $400. Two years after a catastrophic pandemic that sent the unemployment rate surging from 3.5% up to 14.8% in just two months, consumer balance sheets are now healthier than they were pre-pandemic. The various stimulus programs meant to combat the pandemic created massive waves of demand, and it's no coincidence that after each of the three rounds of stimulus checks hit consumer accounts, Retail Sales surged.

The COVID response from the federal government (stimulus, payroll protection, easing tax burdens, etc.) and the Federal Reserve (lowering interest rates to near zero, expanding the balance sheet, etc.) helped to shorten what would have likely been a prolonged recession or depression into a short downturn and a massive boost to financial markets […]

Here's a link to Bespoke’s website.


Have questions? Ask me. I can help.

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Opposing Your Gut

It’s tough out there, no doubt about it. The headlines are coming in fast and furious, and only a fool would scoff at it all and profess not to be worried. But amid the bad news we have to remind ourselves that investing is a long-term proposition requiring us to go against the grain. Not all the time, that would be exhausting. Just when it matters. And this, of course, is what makes it so hard. Others will be reacting, hollering, “Sell!”, and somehow we have to ignore them, hold firm, and perhaps even offer a measured response of, “Buy.” Not easy.

Through yesterday, the S&P 500 is down just shy of 12% so far this year. We’ve dug into gains of the past 12 months, but most diversified investors should be doing better than the broad market. And recency bias is starting to kick in, worsening an already sour mood. But we don’t have to go back far to see the positive returns that now seem like a distant memory to some. The same stock index is up about 59% in the past three years and has nearly doubled in the past five years. Ten years… 270%.

It was easy to be bullish back then, or at least it was in hindsight. Just think of all the events investors had to contend with during those years. Would anyone blithely report being bullish 100% of the time? Of course not. But what did you do about it? Many sold during the numerous lows and were never able to buy back in. Let’s the rest of us hope that with enough time, and enough hindsight, that we’ll be proven right for holding on now just as we have been many times before. Again, that sort of all-weather patience and persistence isn’t easy, nor is it for everyone, but it’s required to be a successful long-term investor.

And there’s good news out there too. One example: We’re all aware that oil prices shot up dramatically on Russia’s invasion of Ukraine. But they've since come back sharply. Bespoke Investment Group reports that the price of West Texas Intermediate (the US oil benchmark) rose over 30% in just over a week earlier this month but has since fallen about 22%, potentially setting up the largest decline from a WTI highpoint over a week ever. Among other things, this illustrates how investor sentiment and market prices can change rapidly, and it goes both ways. Assuming oil stays at these levels, prices at the pump should eventually come down as well. And that would be welcome indeed.

As a helpful reminder of how hard investing can be, and perhaps license to cut ourselves some slack, here’s an excellent article by Jason Zweig of The Wall Street Journal from a few days ago. He packs a lot of truisms into a short piece that’s worth reading a few times. I’m reproducing it here minus the variety of embedded hyperlinks, but a link is below if you’d like to read in full.

In the fall of 1939, just after Adolf Hitler’s forces blasted into Poland and plunged the world into war, a young man from a small town in Tennessee instructed his broker to buy $100 worth of every stock trading on a major U.S. exchange for less than $1 per share.

His broker reported back that he’d bought a sliver of every company trading under $1 that wasn’t bankrupt. “No, no,” exclaimed the client, “I want them all. Every last one, bankrupt or not.” He ended up with 104 companies, 34 of them in bankruptcy.

The customer was named John Templeton. At the tender age of 26, he had to borrow $10,000—more than $200,000 today—to finance his courage.

Mr. Templeton died in 2008, but in December 1989, I interviewed him at his home in the Caribbean. I asked how he had felt when he bought those stocks in 1939.

“I regarded my own fear as a signal of how dire things were,” said Mr. Templeton, a deeply religious man. “I wasn’t sure they wouldn’t get worse, and in fact they did. But I was quite sure we were close to the point of maximum pessimism. And if things got much worse, then civilization itself would not survive—which I didn’t think the Lord would allow to happen.”

The next year, France fell; in 1941 came Pearl Harbor; in 1942, the Nazis were rolling across Russia. Mr. Templeton held on. He finally sold in 1944, after five of the most frightening years in modern history. He made a profit on 100 out of the 104 stocks, more than quadrupling his money.

Mr. Templeton went on to become one of the most successful money managers of all time. The way he positioned his portfolio for a world at war is a reminder that great investors possess seven cardinal virtues: curiosity, skepticism, discipline, independence, humility, patience and—above all—courage.

It would be absurd and offensive to suggest that investing ever requires the kind of courage Ukrainians are displaying as they fight to the death to defend their homeland. But, for most of the past decade or more, investing has required almost no courage at all, and that may well be changing.

Inflation rose to a 7.9% annual rate last month, the highest since 1982, and some analysts think oil prices could hit $200 a barrel.

In early March, Peter Berezin, chief global strategist at BCA Research in Montreal, put the odds of a “civilization-ending global nuclear war” in the next year at an “uncomfortably high 10%.”

In another sign of the times, a 22-year-old visitor to the Bogleheads investing forum on Reddit asked plaintively this week: “I can’t get over the thought that by the age of 60 will earth still be livable? Should I be using [my savings for retirement] somewhere else and live in the ‘now’?”

Yet the S&P 500 has lost less than 1% since Feb. 24, the day Russia launched its onslaught. Over the same period, according to FactSet, more than $770 million in new money has flowed into ARK Innovation, the exchange-traded fund run by aggressive-growth investor Cathie Wood.

That’s a familiar pattern. On Oct. 26, 1962, near the peak of the Cuban missile crisis, The Wall Street Journal reported that “If it doesn’t end in nuclear war, the Cuban crisis could give the U.S. economy an unexpected lift and maybe even postpone a recession.”

From their high in mid-October 1962, U.S. stocks fell only 7% even as the world teetered on the brink of nuclear war.

Nevertheless, a grim era for investing was not far off, in which stocks went nowhere and inflation raged. Had you invested $1,000 in large U.S. stocks at the beginning of 1966, by September 1974 it would have been worth less than $580 after inflation, according to Morningstar. You wouldn’t have stayed in the black, after inflation, until the end of 1982.

That shows two things.

First, glaringly obvious big fears, like the risk of nuclear war, can blind investors to insidious but more likely dangers, like the ravages of inflation.

Second, investors need not only the courage to act, but the courage not to act—the courage to resist. By the early 1980s, countless investors had given up on stocks, while many others had been hoodwinked by brokers into buying limited partnerships and other “alternative” investments that wiped out their wealth.

If it feels brave to you to rush out and buy energy stocks, you’re kidding yourself; that would have been courageous in April 2020, when oil prices hit their all-time low. Now, it’s a consensus trade. Courage isn’t doing the easy thing; it’s doing the hard thing.

Making a courageous investment “gives you that awful feeling you get in the pit of the stomach when you’re afraid you’re throwing good money after bad,” says investor and financial historian William Bernstein of Efficient Frontier Advisors in Eastford, Conn.

You can be pretty sure you’re manifesting courage as an investor when you listen to what your gut tells you—and then do the opposite.

Here’s a link to the article. The Journal has a soft paywall, so let me know if you can’t access the site and I can send it to you from my account.


Have questions? Ask me. I can help.

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Another Update

Russia’s invasion of Ukraine is taking a real human toll. The stories and pictures we’ve seen have mostly been horrific, but there are also those of heroism and enduring humanity. While the ins and outs of geopolitics are well beyond my area of expertise, these events continue to impact markets and sentiment more broadly, so of course we need to pay close attention to the details.

In another break from our recent look at bond alternatives, I want to share portions of analysis from my research partners at Bespoke Investment Group and some of a weekly update from JPMorgan. I know you’re getting information from a variety of sources, but these are two that I trust. Bespoke’s is on the longer side but provides a good summary of the situation. [Bracketed notes are mine.]

First, from JPMorgan looking at last week…

Following Russia’s invasion into Ukraine, markets saw a sharp sell-off in risk assets, while safe-haven assets (i.e. Treasuries, USD and gold) outperformed. Russia-linked commodities popped with European natural gas +60% and Brent prices crossing $100/barrel. However, by the end of Thursday, markets largely reversed their course with only minimal moves to the 10Y (-1bps) and WTI (+$1).

Looking ahead, markets will be sensitive to sanctions and Russia’s counter response to them. This is a balancing act as the West wants to punish Russia, but not at the expense of other economies. It is further complicated by the fact that Russia is the 2nd largest producer of oil and natural gas and a major commodities supplier (i.e. fertilizer, wheat, aluminum). As of Friday, sanctions have involved Russian oligarchs, new Russian sovereign debt, Russian banks and Nord Stream 2. But, they have not yet involved Russian oil and gas.

For U.S. consumers, this crisis is likely to dampen sentiment and has the potential to delay peak inflation. Despite these headwinds, Americans are coming into this at a fundamentally healthy position – consumer demand has been robust (i.e. January retail sales surprised to the upside despite Omicron concerns) and consumer balance sheets have been strong. While we might see price pressure on energy and food in the near term, they do not have the same capacity to shock as they once did. [Energy] and food spending now represents much less of Americans’ overall wallet share – 12% of total spending vs. an average of 23% throughout the 60s/70s. Furthermore, America has a greater degree of energy independence and the luxury of natural resources that Europe does not, which should also soften the blow.

In terms of investment implications, remember that staying invested in a diversified, goals-aligned portfolio has paid off through countless geopolitical crises and should continue to do so. Ultimately, portfolios should benefit from quality stocks with durable profits and fixed income for portfolio ballast. We are not advocating for broad rebalancing at this time, but rather are seeking balance between value vs. growth and U.S. vs. international. Diversification will remain key as we ride out volatility. [Your portfolio likely has limited direct exposure to Russian stocks since the country occupies only a few percentage points of the main emerging market indexes.]

And now from Bespoke as of yesterday and again this morning…

[Yesterday] morning in Ukraine, fighting is intensifying around major cities. A residential neighborhood of Kharkiv was hit with a barrage of rocket artillery, while the Russian army is still trying to encircle the capital of Kyiv in the north. Over the weekend, Russian forces mostly laid off heavy urban areas after probing attacks were broadly smashed last week. That may be changing, and Russian doctrine may be getting less concerned with minimizing civilian casualties. For now, the Russian advance remains bogged down, and while Russia has claimed air superiority, Ukraine’s air force has continued to fly sorties. That air force may last much longer than anticipated given the shocking decision by the EU to directly supply fighter aircraft from military reserves of several countries. A broader torrent of small arms including anti-tank weapons and hand-held surface-to-air missiles is flowing into the country via EU borders even as a torrent of refugees flow west.

On the Russian side, losses have mounted. Estimates are difficult to nail down, with conflicting reports between Russian sources, Ukrainian sources, third country intelligence agencies, and open-source intelligence, but at this point the Russian casualty count is in the thousands and hundreds of fighting vehicles (including large formations of tanks in some cases) have been lost to the fight. Russian forces have moved roughly at the same pace as US forces did during the 2003 invasion of Iraq, but in doing so they’ve been hit far harder than the US coalition was at the time, and have been able to secure their supply lines and rear areas to a far lesser degree. While the situation in military terms is still at best dire for Ukraine, the Russian military has underperformed all estimates of its ability to establish air superiority, overwhelm the Ukrainian military, seize cities, and perform basic logistical operations all while taking far larger-than-expected losses.

One possible explanation for this phenomenon is that Russian units are intentionally fighting poorly or even abandoning the field when they are confronted with the reality of stiff Ukrainian resistance. Simply put, convincing Russian units to fight a group of people they broadly view as cousins and friends may be much harder than war planners assumed, on top of Ukrainian resistance being much more effective than anticipated and the poor strategy and doctrine Russian generals selected for the invasion. Hopefully, the peace talks underway in Belarus between Russia and Ukraine as we type this note will yield at least a temporary cease-fire, but given the relatively weak Ukrainian position and the incentives for Russia domestically, we are skeptical anything will come of them permanently.

Western sanctions over the weekend were of the “shock-and-awe” variety, with a broad coalition of countries (including the US, EU, UK, Canada, and others) limiting Russian access to the SWIFT payments messaging system for Russian entities, blocking access to a wide range of Russian reserve assets, and starting the process of evicting Russians linked to the most powerful elites from their respective countries. The Central Bank of Russia [the CBR] has responded by banning sales of foreign equities in the Russian market, hiking interest rates from 9.5% to 20.0%, establishing a trading band for the ruble, and requiring sales of hard currency by corporates.

At the lows overnight, [Russia’s currency, the Ruble] traded down 30%. It has since rallied to a 20% decline versus Friday’s close (still one of the largest drops from any emerging markets currency on record), as the CBR has apparently been able to defend its ruble trading band for now, but it’s not clear how long it can do so given that its access to reserves held outside Russia and held in a range of developed market currencies has now been sharply curtailed. For US investors, [Russia-specific] ETFs like ERUS or RSX are down ~24% pre-market, and their underlying holdings cannot be liquidated under the CBR regulation change, even if markets were open in Russia to sell those holdings […]

An incredibly important side effect of Russia’s aggression in Ukraine is to pull European countries together for common defense and policy. This week, the Finnish parliament will consider a popular initiative to join NATO while even the Swiss are signaling that they will mimic EU/US/UK sanctions on Russia. EU-level policymaking has been unified despite some wobbles initially and has been expanded to include arms transfers. The biggest shift, though, has been Germany, where a huge swath of key policy approaches ranging from low military spending to bans on arms transfers to tight fiscal policy to closures of nuclear power plants have been effectively reversed over the course of a single speech from Chancellor Olaf Scholz on Sunday. Russia’s invasion of Ukraine has given every European country on its borders a huge imperative to join the alliance while driving Europe together to sanction Russia, unwind reliance on Russian energy supplies, and expand fiscal and military capacity on a joint basis. The policy specifics are quite lengthy, but at the end of the day, this weekend was the largest step forward for EU integration since at least Mario Draghi’s “whatever it takes” response to the Eurozone crisis in 2012, and possibly since the adoption of the euro. This unity has implications both for the response to the current conflict and far beyond it, with the unlocking of more fiscal capacity, more EU wide investment in resilience, and a more cohesive EU-wide grand strategy for dealing with geopolitical challenges.

China has so far tried as hard as it can to avoid explicitly backing or condemning Russia over Ukraine, and it remains to be seen how much the [People’s Bank of China] works to accommodate the CBR as a source of liquidity (for instance, sales of gold reserves) given sanctions on other Russian reserve assets.

[And this morning…] A re-evaluation of Russia’s doctrine and tactics appears to have temporarily at least slowed the pace of ground fighting in Ukraine. After leaning heavily on deep strikes and relatively light columns earlier in the war, Russian units now appear to be massing to use overwhelming combined assaults to gain ground. This has the unfortunate side effect of larger potential for loss of civilian life, especially around cities. Large bombardments are much harder to control, and the Russian military could be running low on the sorts of precision guided munitions which limit (though do not eliminate) civilian collateral damage when hitting targets. In concrete terms, the UK released a public assessment this morning describing the Russian advance as stalled, reporting more shelling in civilian areas, and still citing a lack of Russian air superiority. Ukraine is receiving reinforcements of MiG-29 fighter jets from Poland as well as shipments of TB2 drones from Turkey, so the air war may not end any time soon.

With respect to civilians, we’re seeing increasing numbers of videos showing non-violent resistance across the country, with groups of civilians blocking convoys and shaming invading troops. In practice, this is not a dramatic hindrance to the Russian ground assault, but it illustrates how much opposition there is on the ground to invaders...fertile ground for a bloody insurgency even if Russian troops are able to capture Kyiv, kill President Zelensky, and declare a puppet government. We also note that calls from aggressive commentators in US and Europe for a “no fly zone” in Ukraine enforced by NATO are thankfully falling on deaf ears. That policy would lead to direct NATO-Russia airborne combat, and dramatically increase the odds of a full-blown war between those belligerents with a substantial risk of nuclear exchanges. While a “no fly zone” may sound like an attractive way to protect innocent civilians, the potential costs that it would include are extreme to say the least and no serious, informed international relations commentator we are aware of is calling for one. A different step that the UK is reportedly exploring this morning: removing Russia from the UN Security Council.

[…] On sanctions, this morning shipping giant Maersk reported it would stop accepting bookings to Russia except for food, medical supplies, and humanitarian supplies. [This is on the heels of other major western companies making similar moves in recent days. Essentially, these companies are independently setting aside their profit motive in favor of making a strong statement against Russia’s actions.]

Finally, an update on Russian markets: equities remain shuttered, but Russian equity tracker funds in Europe continue to plunge this morning with a London-traded MSCI Russia fund down 23% (80% in total since the invasion).

Here’s a link to Bespoke if you’d like to check them out.


And here’s a link to JPMorgan’s Weekly Market Recap.


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