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Commentary – 2019 1st Quarter


Here we go again. If we wrote a book titled “the economy is not the stock market,” these past three months would be chapters 1 through 5. But for the sake of time, we are focused this quarter on violent market swings, computerized trading, and the Federal Reserve. Second, in what has become our typical structure for this letter, we are addressing a financial planning topic that we think will be of particular interest based on recent market volatility. And lastly, we will leave you with a thought about the true meaning of a “safe investment.”

The Tortoise and The Hare

In our last quarterly letter, we pointed out the peril of “consistent and persistent” declines in equity markets. This is not to be confused with the three main points illustrating current market conditions [1] –

  • The S&P 500 posted a 19.36% decline from the high on September 20th to the low on December 24th
  • Since the low on December 24th, as of January 23rd, the S&P 500 is up by 12.38%
  • In 2018, the S&P 500 had a daily change (up or down) of 1% or more 65 separate times

While these violent swings show short-term volatility, the S&P 500 posted a negative total return (including dividends) on the calendar year for only the 14th time in the past 58 years [2]. The preceding 13 times were either during or before a recession. Bearish investors will also be quick to point out that as short-term interest rates rise, and long-term rates remain flat, the dreaded “yield curve inversion” looms—the one truly reliable indicator of a recession.

A technical bear market is defined as a 20% decline in the stock market. In very similar fashion to the past few months, the S&P 500 declined by 19.3% over just 6 weeks through the low on August 31, 1998, missing bear market territory by less than [3]. The bull market remained intact and came roaring back over the next 2 years as the pace of technological innovation thrust the growth of business forward. The sentiment of this comparison is certainly not lost on bullish investors.

As we pit the arguments of the bulls and bears against each other, our focus is on a major difference when comparing historical trends to today—money and information move much faster. Index funds and computerized trading account for 85% of the daily activity within the stock market. As news and data become accessible within seconds, markets start to price in any threat, opportunity, or sentiment in real-time. We can’t help but identify a key change which occurred approximately when the market started going haywire—the Federal Reserve doubled down on their hawkish position on interest rates.

It has been a longstanding policy, since the Banking Act of 1933, that the Federal Open Market Committee meets eight times per year to discuss economic conditions, interest rates, and banking requirements. Central bankers have long-term, big picture perspectives and by most measures are economists, not market tacticians. Listening in to their conversations about monetary policy would put most people to sleep (think Ben Stein in Ferris Bueller’s Day Off).

However, in this era of Google searches and Twitter updates, immediate answers are expected. Investors clamor to read the Fed’s meeting minutes and hang on every word of Jerome Powell. While the Chairman’s job has nothing to do with the stock market, it seems that any public statement which implies a policy opinion translates directly to trading activity.

For example, there were a total of four interest rate hikes in 2018 [4]. During the first two, investors didn’t blink. Then, at the peak of the market in September, the Fed raised rates, stated that the economy was slowing down to a normal growth level, and communicated that they would continue further increases. This seems reasonable at face value, but it sent the market into a tailspin.

To illustrate the point, investors then hung on the Fed’s every word (literally) at the December meeting. The meeting was on December 19th, three business days before the S&P 500 hit a low and aggressively snapped back. The Committee decided to increase interest rates and reiterated that the economy was slowing down to a normal growth level. But this time, the official statement said that some future rate increases would occur. And the trading bots rejoiced.

Rest assured that the Federal Reserve’s decisions are not informed by market activity. They are doing the right thing by increasing interest rates, which have been too low for too long. The U.S. business cycle is in a mature phase and rate increases are necessary to manage an eventual cyclical downturn. While this slows current economic growth, a recession will require decreased interest rates to encourage future economic growth. If interest rates were kept at near-zero levels, then the laws of economics reach their antithesis—negative interest rates. This happened in Japan and they are still recovering three years later.

With the ability to sustain normal interest rates and key indicators that are mostly healthy, the economy appears to still be fundamentally strong. Fickle investors will likely continue fueling volatility and calling for a bear market. We suggest staying focused on the long-term and taking a page from the Fed’s playbook—don’t fear the bear.

An Ode to The Long-Term Investor

We always talk about the importance of being a long-term investor. Not understanding the context of the bigger picture can lead to inappropriate, and at times costly, financial choices. The lack of a long-term perspective is also associated with emotional decision-making (or “buying high, selling low syndrome”). But if the human element is taken out of the equation, the risk of financial markets can mostly be boiled down to one thing—price variability. It is important to remember that this risk is only reflected on paper until an action is taken. For example, a portfolio invested in the S&P 500 which lost 60% of its value during the Great Recession would have been back to its pre-recession value by March 2013 if there was no sale activity [5].

This type of analysis helps us conceptually but is not always realistic—managing a portfolio requires activity. There are income requirements to be fulfilled, savings goals to be addressed, and tax deadlines to be met. Market volatility can have a positive or negative effect depending on when you take the picture. The long-term investor, however, understands that movements in price provide the opportunity for an investment portfolio to meet financial objectives.

First consider a portfolio which is in the retirement accumulation phase. Dollar-cost averaging is a technique that involves buying a fixed dollar amount of a particular investment on a regular schedule. As a result, the investor ends up purchasing more shares when prices are low, and fewer shares when prices are high. The net effect is that the average price paid per share is less than if the investor were to do a one-time purchase. Ironically, the more volatile the markets, the better this strategy works.

Unfortunately, when a retirement portfolio is providing income distributions, the dollar-cost averaging concept works in reverse—the investor sells more shares when prices are low. For this reason, portfolios should contain an appropriate combination of high and low risk investments. Keeping a strategic allocation to investments with a stable price (i.e. cash and equivalents) is what enables the long-term investor to meet immediate needs without sacrificing investment returns.

In a broader sense, any predictable cash need, whether for retirement or otherwise, can be considered short-term if it will occur within three years or less. Historically, since the 1960s, the average time from the peak in an up market to the trough in a down market and back up again has been approximately three and a half years for the S&P 500. Future downturns may differ, but three years is a good rule-of-thumb cushion that can help manage risk in most markets.

Consider a portfolio for an investor who is near or in retirement. This is unique because there is not one, but several time horizons. Each should be addressed with specific investment types based on risk:

Time Horizon How to Allocate
Money You’ll Need in The Next Year Bank Cash and Money Market
Money You’ll Need in One to Three Years CDs and Treasuries
Money You’ll Need in More Than Three Years Stocks and Bonds


For liquidity needed in 12 months or less, the solution is simple—stay in cash. It will earn an interest rate comparable to a checking or savings account. Predictable liquidity needs within 36 months can earn an enhanced return with certificates of deposit and U.S. Treasury securities. These are also low risk but are locked in for a specific period with laddered maturity dates based on retirement income requirements.

A portfolio which is structured to meet short-term needs is not forced to sell stock or bond positions during a market downturn. This is imperative, as any losses would be on paper until a sale is made. Therefore, the rest of the portfolio can be invested in stocks and bonds based on risk tolerance. Since income needs are covered, the long-term investor can now reasonably weather volatility in this part of the portfolio without sacrificing the investment returns necessary to continue their lifestyle.

Beauty Is in The Eye of The Bondholder

Speaking of “safe” investments, we came across a particularly interesting piece this past quarter which we would like to share. As we just laid out, cash and bonds typically are considered the low-risk portion of any portfolio allocation. Their value is stable, return is fairly predictable, and the loss potential is extremely low compared to stocks. Cash would of course be subject to the risk of the government becoming insolvent. FDIC insurance for bank deposits uses the language “backed by the full faith and credit of the U.S. government.” Most individuals will interpret that to mean that the value of one dollar will remain one dollar.

However, not all bonds should be considered safe, as they are subject to the same risk of default specific to the issuing entity. Some examples of entities who issue bonds are federal governments, corporations, state governments, local municipalities, and many other public or private agencies. There are a wide range of different factors (not all bonds should be considered safe) that effect whether a bond can be paid back. One bond may be written by Coca-Cola and another by the government of Malaysia. Both promise to pay over 30 years, but most investors will realize that a U.S. company that has been around for over 100 years will have a better track record of paying back debts than an emerging market government.

30 years is a long time to be paying a debt for an individual or a company—it is typically the longest term for a bond. But for governments, especially those in developed countries, there are abundant historical precedents for bonds which extend beyond 30 years. Less than two years ago, in September 2017, Austria publicly sold 1 billion euros of 100-year government bonds, just one year after Ireland and Belgium raised over 100 million euros in privately placed 100-year bonds [6].

Securing an obligation for a stable government to pay interest over 100 years certainly seems to fit the definition of a “safe” investment. But at Yale University’s Beinecke Rare Book and Manuscript Library resides a living artifact from the Golden Age of Dutch finance—a perpetual bond.

One of only five known to exist, this bond was issued by the Dutch water board on May 15, 1648. At the time, the officials were landowners and leading citizens who managed the dikes, canals, and a 20-mile stretch of the lower Rhine River in Holland. They used the money raised to pay workers at a recently constructed series of piers near a bend in the river that regulated its flow and prevented erosion.

The bond is written on goatskin (yes, goatskin) with all interest payments recorded directly on the skin. According to its original terms, it would pay 5% annual interest in perpetuity. The interest rate was reduced to 3.5% and then again to 2.5% in the 17th century. Once every several years, the museum curator travels to Amsterdam and still, to this day, collects interest payments on the Dutch water bond 371 years later.

We hope you enjoyed our comments. If you have any questions, please do not hesitate to contact us. We welcome the opportunity to discuss our thoughts in greater detail. Thank you for your continued confidence in Planning Capital Management.

[1] “S&P 500 Total Return Real-Time Price”, Yahoo! Finance, January 16 2019

[2] Gregory Zuckerman, “Behind the Market Swoon”, The Wall Street Journal, December 25 2018

[3] “Drops of 10 Percent or More in the S&P 500”, Fox Business, February 8 2018

[4] Eshe Nelson, “The Fed is Feeling a Tiny Tinge of Anxiety”, Quartz, December 19 2018

[5] Rob Williams, “Market Volatility: What If You Don’t Have Time to Recover?”, Schwab Center for Financial Research, March 9 2016

[6] Emese Bartha, “Austria Thinks Long: Announces 100-Year Bond”, The Wall Street Journal, September 12 2017