1st Quarter Market Performance
- Investments in most areas had positive returns in the first quarter.
- For the first time in a while, U.S. stocks were not the best place to be.
- Commodities were down in the quarter, but still serve a role in the portfolio.
Investments in most areas (i.e., asset classes) were up in the first quarter of 2015. But, it was the first time in a while that U.S. stocks didn’t lead they way. They’ve done quite well over the last few years making almost any form of diversification feel, at least a little, painful.
However, just as trees don’t grow to the sky, no single asset class will outperform forever. The first quarter of this year is a good reminder of this fact.
As you can see, the first quarter of 2015 was a good quarter virtually across the board. International equities performed quite well—lead by the stock markets in Pacific market countries (e.g. Japan, Australia, Korea, Hong Kong, Singapore, etc.). This, despite the drag caused by the appreciating US Dollar (up 8.1% in the first quarter against a mix of major currencies).
Commodities were the lone asset class with a negative return. If inflation picks up, it should help to have this exposure in the portfolio. However, right now it’s proving true a line from investment writer Ben Carlson who recently wrote, in a piece titled You Should Hate Some of Your Investments, “To be broadly diversified, there will almost always be some investments that you hate at any moment.”
With bonds, interest rates held stable allowing longer-term bonds to outperform short-term bonds. But what will happen when rates do go up? Let’s take a further look at this question.
Investment Topic: Rising Interest Rates
- Stocks have performed well in periods of rising interest rates.
- It’s difficult to time when rising rates will begin and end.
- You should base the decision to own short-term vs. longer-term bonds on the difference in yield (i.e., valuation) and not on timing interest rates.
Bond prices move inversely with interest rates. Meaning, as interest rates go up, the price of a bond falls. And the longer-term a bond, the more sensitive it is to interest rate movements.
For example, the price of a 10-year bond will move roughly two times as much when interest rates change, as a 5-year bond. This “bond math” paired with low interest rates cause many to worry: what happens to their portfolio when rates rise? Clearly the value of bonds investments will drop.
However, this line of thinking neglects one thing. By and large, rising rates is a sign the economy is improving. It should bode well for other parts of the portfolio.
So what happens when the Fed does finally start to raise rates? What impact will this have on your portfolio?
Going back to 1982, there are six periods of “Fed Tightening” (i.e., raising their target Federal funds rate) as noted in red in the following chart.
So, the questions are: 1) should you worry about rising rates? And, 2) does being in short-term bonds help during these periods?
The chart below lists the average performance of: 1) stocks, 2) intermediate-term bonds, 3) short-term bonds (less sensitive to interest rate moves) and 4) two simple portfolios (60% stocks and 40% intermediate-term bonds, and 5) 60% stocks and 40% short-term bonds) over these six periods.
What you notice is stocks did well in these rising-rate environments. Returning on average, over 11% annualized in these six periods. And, while short-term bonds did outperform bonds with longer durations, both had positive returns. The difference between the two 60/40 portfolios was a non-extreme 1.3%.
An extra 1.3% is not bad, though, if you can get it. However, it depends on getting the timing right: forecasting when rising rates start and when they end. To illustrate that sensitivity, let’s take another look. This time we will run a scenario of moving into short-term bonds a year before interest rates rise instead of getting the timing perfect.
In this scenario (moving into short-term bonds a year before interest rates go up), both the intermediate and the short-term bond portfolios have similar returns.
It’s difficult to get the timing of interest rate moves right. And, because of that, what makes more sense is to base your decision to buy a longer-term bond on valuation—how much you are getting paid (via the interest rate)—rather than on where any one person, or group of economists thinks interest rates are headed and when.
Right now, the extra yield paid to a holder of a 10 yr US treasury over the yield paid to a holder of a 2 yr US Treasury is about 1.4%— one of the lowest spreads since the 2008 financial crisis. This means the premium paid for taking interest rate risk is currently low.
Given the low incremental compensation, it’s reasonable to have some short-term bonds in your portfolio. However, if this premium increases, a shift to longer duration bonds likely makes sense.
Stay turned for part 2 of the quarterly review where we will give an overview of the managed futures asset class. You will learn what managed futures are, what drives returns in this area, and some things to look out for.
If you are a client and have any questions regarding anything covered in this quarterly investment review, please send us an email or give us a call.
If you’re not a client of Cordant, we focus on managing wealth for current and former employees of Intel. If you want to learn more about how we work with our clients you can do so here or feel free to give us a call at 503.621.9207.
 Board of Governors of the Federal Reserve System (US), Trade Weighted U.S. Dollar Index: Major Currencies, retrieved from FRED®, Federal Reserve Bank of St. Louis https://research.stlouisfed.org/fred2/series/DTWEXM/, April 15, 2015.