Why aren’t long-term yields coming down?
This was the thesis. The Fed will hike interest rates, inflation will subside, and after a period of disinflation, the global economy will return to the inevitable - deflation.
Yet here is the 10-year US Treasury, walking hand-in-hand with the 30-year, failing to drop below 3.5% and instead briefly popping back above 4.0%.
I thought this was the year I was supposed to make money on my long-duration bonds!
Maybe. There is still time to emerge from the range-bound movement in rates.
But rates could just as easily march higher. Real rates might even expand. To presume the opposite might come from recency bias, rates have been low for a long time. Or, it could be loss aversion, as many bond investors sit on large capital losses.
But if bonds have done nothing, what about stocks? Surely they are still in a bear market?
Even though short-term rates have continued to increase and long-term rates haven’t come down, stocks have rallied, with global markets increasing about 12.5%.
Here’s the point: it is deceptively easy to get caught up in our narratives about what is occurring in markets.
I’m not sure we are aware of our narratives most of the time. Yet, even though we may decry forecasting to our clients, most of us have secret theses. And, since we are confirmation bias machines, we continually reinforce these biases and inevitably make decisions based on our expectations.
What were your expectations as we entered 2023?
Better yet, how did they guide how you advised clients the last six months?
Did you think housing prices would collapse? Or maybe you thought mortgage rates would drop? Neither, of course, has occurred. House prices remain firm(ish) depending on the location (as they always should! Real estate is LOCAL), and average mortgage rates are back near 2022 highs.
Did you think a recession was inevitable? Or maybe you believed in the soft landing thesis? Both have been irrelevant. A glance at economic numbers shows that no one intends to land anytime soon. Equity investors agree.
The 60/40 has done well this year after a demoralizing 2022 for fixed-income investors but look at the following chart. 100% stock investors have already done better than a global 60/40 portfolio (Using ‘VT’ for stocks and ‘AGG’ for bonds).
Watching markets has taught me humility. As I reflect on the dominant themes from early 2023, I find myself wondering the following:
Are we sure that long-term rates, including mortgage rates, will collapse?
Are we sure the Fed can lower short-term rates as fast as it increased them?
Are we sure inflation will cooperate and gently fall to a comfortable 2% run rate?
Are we sure a recession is imminent?
Are we sure the job market can’t stay strong?
Are we confident stocks can’t rally despite it all?
No. We aren’t sure. Not you. Not me.
Like any curious investment professional, I have macro and micro-investment theses. I try my damndest not to invest according to them. You should too.
An Ode to International Stocks
I’m an advocate of global investing. As Larry Swedroe recently wrote, “…it’s simply not logical for investors in every country to believe their home market is going to outperform. It may be patriotic, but it sure isn’t rational.”
…it’s simply not logical for investors in every country to believe their home market is going to outperform. It may be patriotic, but it sure isn’t rational. ~ Larry Swedroe
Swedroe recently published one of the best primers on the ‘why’ of international diversification that I have ever seen on Kitce’s site.
First, let’s tackle the gorilla in the room. Yes, international stocks have underperformed US stocks for the last 15 years.
It is easy to question their role in our client’s portfolios. Yet, to conclude anything after only fifteen years of data is recency bias at large.
Remember, past performance does not guarantee future results. But written in large red pen just underneath is: ESPECIALLY TRUE FOR RECENT PERFORMANCE.
Here are a few reasons international stocks belong in your equity portfolio1.
Smooths the Ride
Research unambiguously argues that more diversification is gooder.
Something about volatility was mentioned, but ‘gooder’ sums it up in my book.
Reduces the probability of a lost decade.
Do you know what performed well during a flat decade for stocks at the beginning of the 2000s? International stocks!
Do you know what performed well after the Japanese bubble collapsed in the early 1990s? US stocks!
In other words, international diversification helps solve the inevitable ills of home bias.
International stocks are cheaper than their US counterparts.
Remember, if US stocks feel ‘safe’ or ‘less risky,’ they have lower expected returns. If international stocks feel ‘risky,’ they likely come with higher expected returns.
Valuations confirm this. International stocks are much cheaper than their US counterparts. Could the recent exceptionalism of US markets continue? Of course, it could for a time. But eventually, the cycle must turn.
Factor diversification
Factor investors, like me2, receive a bonus from international diversification:
…low cross-country correlations of factors provide diversification benefits reducing the tail risk to investors, as do the low to negative correlations of the size, value, momentum and profitability/quality factors not only with the market, but with each other.
Final Thought
This is a great chart. Notice how outperformance tends to flip back and forth every decade or so.
How much? I’m partial to the market portfolio. Currently, US stocks make up about 60% of global equities. Ultimately, anywhere between 50-70% US stocks seems reasonable.
I mainly use Dimensional and a smattering of Avantis funds with my clients.