This Year Shows Why Risk Management Is So Important!

If anything should have become clear these last few months it’s the critical importance of sound risk management.

It’s a lesson that tends to be forgotten by most investors at the tail-end of bubbles and re-learned the hard way when the bubble pops.

We forget this lesson after many years without a reminder and as everyone around us seems to be getting rich off skyrocketing asset prices. So, we chase performance without an understanding of risk or the extreme prices we’re paying for those assets.

In fact, about a year ago I shared a quote from J.P. Morgan that perfectly addresses this concept, “Nothing so undermines your financial judgement as the sight of your neighbor getting rich.”

I had a lot of people last year asking if we should be more aggressive, questioning if we were doing the right thing by being relatively conservative.

I consistently answered “yes” to that question because if we were relatively conservative there was a reason for it. Either (1) they didn’t have the financial capacity for the potential losses that could ensue meaning a certain level of losses would jeopardize their financial independence, and / or (2) they didn’t have the emotional capacity for the losses that could ensue, and / or (3) most risk assets were / are extremely overvalued (as I’ve written about many times).

Many of the trendiest assets that were being chased by retail investors (cryptocurrencies, meme stocks, overvalued tech stocks) are now down 70% or more from their all-time highs. Broad market indexes are down around 20% on the year.

Some people will respond, “But many of those assets are still up a lot from where they started years ago.” Unfortunately, that misses the point. The money invested in those speculative opportunities is relatively tiny early on. Bubbles suck money in near the top causing wealth to vanish when the bubble pops.

The prevalence of this boom-bust cycle throughout history is why I rely so heavily on time-tested economic principles…namely, that an asset’s price must ultimately reflect the long-term cash flows provided by the asset. Continue reading “This Year Shows Why Risk Management Is So Important!”

First Trust: Stocks and Bonds Falling Together: What Happens Next?

Today I received a chart from First Trust with very interesting information.

The chart shows all the quarters since 1976 where stocks and bonds declined together and then provides forward return data for the subsequent 6 months, 1 year, 3 years after each event.

I’ll share the chart below then point out a couple things I find noteworthy. Click on the chart to expand…

Continue reading “First Trust: Stocks and Bonds Falling Together: What Happens Next?”

Price/Sales is Better Than Price/Earnings…for forecasting future returns

Executive Summary

  1. If we’re going to use valuation metrics to make important financial planning and investment decisions why wouldn’t we use the most reliable metrics at our disposal?
  2. The Price/Sales ratio has a much higher correlation to actual subsequent returns than Price/Earnings.
  3. Price/Sales, and other reliable metrics, indicate the U.S. stock market is more expensive than it’s ever been in history.

Continue reading “Price/Sales is Better Than Price/Earnings…for forecasting future returns”

On Interest Rates: The Federal Reserve is in a Difficult Position

The most common discussion with clients recently has been about interest rates (and bonds) as interest rates have been rising swiftly as of late.

It’s a popular topic because interest rates impact our lives in various ways; rising interest rates causes bond prices to fall, rising interest rates means things purchased with borrowed money cost more (houses / mortgages, autos / auto loans, credit cards, etc…), future cash flows from investments / projects become less valuable, etc… 30-year mortgage rates have doubled to over 5% from 2.5%

On the other hand, rising rates also motivate us to save more as savings vehicles yield more and motivate us to take on less debt / pay down debt faster. When’s the last time we’ve earned any notable interest in our checking and savings accounts? Many young people probably don’t even realize that banks used to pay interest on those checking and savings balances. Continue reading “On Interest Rates: The Federal Reserve is in a Difficult Position”

Quarterly Market Update: All That Glitters is Gold…

This has been a strange period in that both traditional bonds AND stocks are down around 7%-8% simultaneously. Historically, if stocks were down like this bonds would at least be holding up, if not appreciating, and vice versa.

A couple months ago I wrote a commentary about why we own treasuries in portfolios referencing the fact that since 1928, treasuries and stocks have only been down simultaneously in the same year three times! Historically, stocks and treasuries have been great complimentary, non-correlated assets. In fact, they have about a negative 0.40% correlation.

At this point, if nothing were to change for the rest of the year, we could have our fourth year in almost a century where both bonds and stocks are down simultaneously. Continue reading “Quarterly Market Update: All That Glitters is Gold…”