“The easy money has been made” is a very dangerous sentence. It implies that whatever gains you have now, were easy to achieve – whereas any future gains are going to be much harder to come by. I love this chart from Morgan Housel* that shows various financial news outlets and the date when they said the easy money in US stocks had been made. Maybe the point is that looking at past returns looks easy in hindsight. In real-time, it is anything but easy.
Investing is HARD. Putting your hard earned dollars to work in the financial markets is hard. Staying with your asset allocation through any number of market drops and geo-political events is hard. Owning bonds when stocks are soaring is hard. Owning stocks when stocks are dropping is hard. Owning international stocks when US stocks are soaring is hard. Yup, investing is tough to do.
Even though we have established that investing is never easy, maybe it has been a little too easy the last few years. US stocks have been positive EVERY calendar year since 2008**. Not one negative year. Investor’s safety net, quality bonds, have also had a great run. The Bloomberg Barclays Aggregate Bond Index has only had one year (2013) in ten where returns went negative**. Foreign stocks have had a rockier ride, but for diversified investors its been hard to notice when both your US stocks and your bonds are up every year.
2018 has thrown investors a curve ball. The US Federal Reserve is raising interest rates, causing quality bonds to drop in value. However, US stocks have continued their trend – they are up nicely year-to-date as of this writing (10/9/18). Some investors, spoiled by “easy” returns in a well diversified portfolio, are now questioning why they own bonds at all.
The answer lies in how economic cycles work. At this point in the cycle the FED is raising interest rates. This takes money out of the financial system and raises the borrowing costs for individuals and businesses. While the FED is doing this, bond prices (which move inversely to interest rates) drop in value.
In the next part of the economic cycle, the higher borrowing costs hurt businesses, individuals and possibly other countries. The economy slows down and positive growth turns into economic contraction. Contraction is not what stocks want to see and investors sell stocks in anticipation of reduced corporate profits.
To counteract the economic slowdown and stimulate the economy, the FED then lowers interest rates. This is great for bond prices! When stocks are getting killed because of an economic slowdown, quality bonds should be doing great because the FED is lowering rates to cushion the blow to the economy.
So why do I own bonds? Because at the exact time you NEED portfolio protection, bonds should be protecting your portfolio by rising in value due to falling interest rates.
I hate to say it, but maybe the easy money HAS been made in the financial markets. Maybe the days of both bonds and stocks rising together have come to an end. Maybe now comes the hard part. Accepting losses on bonds in the short term so that they are there to protect your portfolio when stocks start dropping. That is a hard thing to do. But one that should benefit investors when things fall apart.
Charles Brown is a Portfolio Manager and Financial Advisor at M. Brown and Associates in Naperville, Illinois
**Returns are from Morningstar.com
***The above article is informational in nature only and is not a recommendation to buy or sell securities. All information is gathered from sources believed to be reliable, but neither Charles Brown nor Ausdal Financial Partners, Inc guarantees the accuracy of the information. All investments carry a degree of risk. Individuals should consult with their tax and investment professionals before making changes to their investment portfolios.
****Securities and advisory services offered through Ausdal Financial Partners, Inc., 5187 Utica Ridge Road, Davenport, IA 52807 (563)326-2064. Member: FINRA/SIPC. M. Brown & Associates, Ltd. / M. Brown Financial Advisors and Ausdal Financial Partners are independently owned and operated.