As our firm's Chief Investment Officer, I am frequently asked about current market conditions, the direction of the economy, and our portfolio strategies. I'm pleased to provide our responses to some of the most FAQs.
Looks like our portfolios are doing well to start the year. What's behind the better performance?
After a difficult 2022, in which both stock and bond portfolios had negative returns, we are off to a better start this year. Through April 30th, US stocks were up about 9.2% (S&P 500)1, with international stocks doing even better, up 11.1% (MSCI World ex USA Index)2. Stock investors have been encouraged by the perception that the Fed is close to the end of its interest rate hiking cycle, and that the likelihood of a deep recession resulting from the hikes has lessened.
On the bond side, the 10 year Treasury started the year with a yield of about 3.8%, and by April 30th, the yield had dropped to about 3.5%, leading to strong performance. The main reason -- bond investors perceived that an economic slowdown and weakness in banks may cause the Fed to "pivot", and possibly cut rates later this year or next.
How are you responding to today's market environment?
As long-term investors, we do not tactically change our strategies based on market forecasts. Research repeatedly demonstrates that timing strategies are not effective, and the impact of being wrong can far outweigh any perceived benefits. At the same time, we will occasionally make changes to our portfolios based on longer-term strategic thinking, and we did initiate such a move earlier this year.
As the Fed has raised rates continually throughout 2022 and into 2023, the yield curve has become inverted, meaning that there is a higher yield on cash and short-term bonds than on longer-term bonds. The yield on Schwab money market funds is now approximately 4.6%. We have responded by shortening the duration (maturity structure) of our bond portfolios, and including a healthy component of cash as part of the fixed-income allocation of a balanced portfolio.
Will a debt ceiling deal be reached, and if not will the US default on its debt?
Investors generally perceive a deal will be reached between President Biden and congressional Republicans to increase the debt limit, preventing the US from not meeting its obligations. While there isn't a specific date by which a deal needs to be completed, most analysts look to June or even July as the time that the Treasury may be unable to pay all of its bills, absent legislation.
The back and forth is likely to go to the last minute and it's quite possible that markets will be volatile as we get closer. Congress has never failed to raise the debt limit, doing so nearly 80 times since 1960, under presidents of both parties and with different balances of power on Capitol Hill.3
Will the Fed's rate hikes cause the economy to head into a recession later this year? If so, what will the effect be on stocks?
It's unclear. Economic growth slowed during the first quarter, decelerating to just a 1.1% annual rate from 2.6% the prior quarter. The causes -- higher interest rates hurting the housing market, turmoil in banking causing less lending, and businesses reducing their inventories. At the same time, consumer spending, which represents 70% of the economy, remained strong, and unemployment remains low.
While we may be headed into a downturn, there is also the potential for a "soft landing", with the Fed hikes slowing growth enough to bring down inflation, but not so much as to throw us into a recession.
We're certainly not going to try to time whether to lower stock exposure based on short-term predictions. Markets around the world have often rewarded investors even when economic activity has slowed. This is an important lesson on the forward-looking nature of markets, highlighting how current market prices reflect market participants’ collective expectations for the future.
Given the uncertain economic outlook, is now a good time to add cash to the markets?
Consider dollar-cost averaging into the markets. This means spreading out additions to your investment portfolios in equal installments over a set time period.
Here's how it works. Let's say that you get a bonus of $100,000 that you'd like to invest for the long-term. Instead of investing all at once, add $10,000 each month for the next 10 months. What day each month should you invest? It really doesn't matter much, just be consistent.
The benefit -- you have "diversified" your entry into the markets with smaller sums over different dates. That should give you peace of mind, and also prevent "investment paralysis", meaning not taking any action at all.
Why own international stocks?
International stocks represent about 45% of the global stock market -- that's an amount that's too large to ignore4. Having a healthy allocation to stocks trading outside the US has a diversification benefit. While the last 10 years have favored the US, there have been other 10 year periods that have favored international stocks. Recently, over last 12 months, international has outperformed the US. Will it continue? We certainly don't know, but global diversification gives you a chance to participate in whatever region is outperforming at a given time.
Currently, international stocks are trading at much cheaper valuations than their US counterparts. That's a key reason many analysts, including Vanguard, project higher long-term (10 year) returns from international stocks, relative to US.
With yields so high on cash, do I need to own bonds?
We have been proactive in adding cash as a component of an overall balanced portfolio. But selling all of your bonds and moving to cash is a market timing decision, that in the long-run may have negative consequences.
Moving entirely from bonds to cash means potentially missing out on capital gains in a scenario where yields decline. Bond prices often rise when stock markets drop and investors seek a safe haven -- the classic "flight to quality". So our response is to own both cash and bonds in a diversified portfolio.
How safe are my accounts, including cash, at Schwab?
Extremely safe. Schwab, as well as other regional banks, has been in the news in light of the recent failure of Silicon Valley Bank.
A few points -- Charles Schwab & Co. is not technically a bank, though it does offer banking services through its affiliate Charles Schwab Bank. Its financial situation is quite different than the regional banks it may be compared to. We are extremely confident that Schwab does not and will not have similar liquidity issues.
Having said that, in the unlikely event that Schwab did run into problems and the unthinkable happened, they collapsed, all your accounts are segregated and not on Schwab's balance sheet. Another firm would most likely take over Schwab's custodial business, with no effect on your accounts.
Cash invested in Schwab's money market funds are segregated and custodied outside of Schwab as well. Cash (not invested) in a brokerage account is held at a Schwab bank, and subject to FDIC insurance ($250,000 per account).
So, bottom line, your funds at Schwab are extremely safe.
Do you have additional questions? Please drop me a note below. Thanks!
David Rappaport, CFP®
David is the Co-Founder and Chief Investment Officer of Rappaport Reiches Capital Management. He acts as personal CFO to entrepreneurs and corporate executives, providing organization and clarity in their finances. Please connect with David below. He loves to talk about investing, financial planning, and Aspiritech, a non-profit hiring individuals on the autism spectrum.