They’re Back: Revisiting Interest Rates

It has been a couple months since we’ve addressed interest rates and today we find that the 10 year treasury bond (often considered the benchmark of bond yields) has hit 3% again.  With the recent economic data surprising to the upside there continues to be the possibility for rates to rise.  As economic conditions improve many believe there could be a rotation out of bonds and into stocks.  In addition, the Fed has recently come out with news that they are going to begin tapering their bond purchases.  Many believe this is the first step that inevitably leads to raising short-term interest rates.  If this occurs we would see bond prices fall and yields rise.  For those investors who are thinking that bonds don’t lose value, they could be disappointed.  Here is the chart of the 10 year treasury yield for the past couple years to give you some perspective:

Chart forCBOE Interest Rate 10-Year T-No (^TNX)

This post is not meant to be a prediction.  We have no idea where interest rates are going over the next month, year or decade.  But as an investor it is important to know how rising rates could impact your portfolio.  Generally, longer term bonds will get hit harder than short term.  We continue to manage portfolios with caution, focusing on shorter-term bonds, as we believe that risk should be taken with your equities, not fixed income.

The Stock Market Does Not Equal The Economy

The economic data coming out these last few weeks have been spectacular.  Whether it be employment, manufacturing or consumer spending, the economy really seems to be on a roll.  Before you go out and buy some stocks as an early Christmas present, it is important to remember that the economy is not the stock market.  We’ve talked about this before and we’ve posted a great chart from The Business Insider (originally Vanguard data) that shows this to be the case:

stocks economy cotd

 

You’ll see that there is no real correlation between a country’s stock market return and GDP growth.  Why is that?  First of all, the market as a whole is pretty smart.  Most situations where a country’s economy is going to slow down or expand is known well advance by market participants and is already priced into the market.  Second, just because a country is doing well economically, it may not mean that the companies that are domiciled in that country are experiencing the same growth.  If they are multinational companies they may be experiencing growth or contraction in other areas of the world.  

Just look at Thailand and Turkey on this chart.  Over the past 42 years they have experienced almost identical GDP growth, but Turkey’s stock market has grown at 12% per year while Thailand is growing at less than 1%.  Please remember this chart when you hear a pundit talking about how the market is going to perform because of some prediction he is making on the economy.  They aren’t correlated directly and it is dangerous to make investment decisions on such factors.

What Is The Best Vehicle To Accumulate Wealth?

What is the best vehicle for accumulating long-term wealth?  This is a question worth thinking about as an investor and a recent Gallup poll shows that only 37% of those surveyed believed that stocks were a good method for accumulating wealth.  This isn’t surprising.  Over the past 13 years we’ve lived through two stock market crashes of 50%+ with very little overall growth over that period.  But let’s take a longer term view of this.  From the Investors Friend blog, we see this chart comparing the returns of stocks, bonds, gold and the dollar.  It is pretty clear who the winner is of these options:

 

So, are stocks the only game in town?  No, other investments to consider would be real estate and private businesses.  Active ownership of a private business is probably one of the riskiest and most effective methods for accumulating wealth.  If you go through the list of the richest people on the planet, most acquired their wealth through this method.  Realize that most private businesses fail, so for every successful entrepreneur out there, there are probably 20 or more that have either seen their business fail or have not generated significant wealth through this endeavor.  Stocks are one of the better choices for most investors since they allow you to take a passive stake in a company versus some of the other options that require more active participation.  

This chart is another example why every investor should have some portion of their portfolio allocated to stocks.  They allow you to participate in the profits of some of the best and well managed companies in the world.  In addition, the long-term results speak for themselves.

Average Returns Are Not Common

We are getting into prediction season!  Every major wall street firm will send out their chief strategist with their 2014 year-end price target on the S&P 500.  If history is any guide, we’ll see most of these strategists predict a market gain of around 10%, or what the historical average has been.  The ones that are most bullish might predict a 15% gain, while the bearish strategists will probably predict a 5% gain.  While their predictions are pretty tightly clustered, actual results over time are anything but.  Take a look at this chart from the Abnormal Returns blog:

The US stock market goes up over 20% one out of every three years.  In addition one out of every three years posts a negative return.  The idea that the markets will average 10% over time is probably pretty accurate, but how it gets there is typically a wild ride.  Please ignore strategist predictions.  They never predict the inevitable volatility in the market.  Realizing how much volatility there can be in any given year and accepting that as the bumpy ride you must take in order to reach your destination is one of the best strategies you can take to managing your investments.

 

So, You Still Think Analyst Recommendations Matter?

A common theme of this blog is showing how difficult it is to pick stocks or beat the market over time.  Having started in this business as a broker at a major firm, I can tell you that we were taught to sell this fallacy.  From a sales perspective it sounds terrific.  “Our analyst covering this stock is the best in the industry and has a tremendous track record.”  Or, “this fund manager has outperformed his peers in each of the last 5 years and has beat the market by 2 percentage points per year.”  To an unsophisticated investor, this sounds pretty tempting.  The idea that “insiders” can generate better results seems intuitive.  Once I started to do my own research I realized how investors were being duped.  Here is some more evidence from the Motley Fool about how accurate wall street analysts were this year:

sell stocks

 

The divergence really is spectacular.  The ten stocks with the highest number of sell ratings were up an average of 75%, while the ten stocks with the highest number of buy ratings were up an average of 22%.  During this same period, the S&P 500 was up 27.4%, so the highest conviction stocks from wall street’s analysts could not even keep pace with the broad market.  

In addition to telling us how lousy and unreliable stock analysts are at predicting returns, this study also tells us something else.  There can be value in going against the herd.  Investing in companies that are unloved.  There is substantial academic evidence that shows that value stocks (which can often be thought of as the unloved area of the market) tend to outperform growth stocks.  Greenspring has embraced this philosophy, not just because WE think it is right, but because there is compelling evidence that has shown this strategy to generate higher returns for clients throughout history.   

Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.