- The post-pandemic world will be different. Cross-currents are everywhere and how this settles is anything but clear, but ultimately everything resolves and typically not at the extremes.
- The economy is recovering, but persistent government intervention continues to cause market distortions. This has led to excesses in markets and very high asset valuations.
- As portfolio managers, we need to adapt to these issues and our intention is to increase portfolio diversification by adding uncorrelated asset classes. The goal is to reduce portfolio volatility and allow compounding to better work in our favor.
It seems that investors are being pulled in opposite directions with greater regularity these days. Confusing cross currents are not unusual, but the sheer number of them hitting at the same time makes today a more confusing time than usual. Here are a few examples:
- Is the pandemic getting better or worse?
- Are chip shortages going to linger or resolve quickly?
- Will unemployment remain elevated or correct when extra benefits end?
- Will the current inflation prove to be transitory or persistent?
We suspect that the answer to all of the above questions is – Yes.
There are no easy answers here. Depending on where you are, the pandemic could be getting better or worse, and that has implications for global growth prospects. Some industries will recover from the chip shortage quickly while others will continue to have problems. The pandemic relief for the unemployed has apparently provided a one-time opportunity for lower wage workers to start new careers and unemployment is elevated despite millions of job openings. Some inflationary price increases are clearly unsustainable, like used car prices equaling new car prices, but many others are not so clear cut. Some inflation will likely be persistent.
The world is changing quickly. Shopping habits are moving online at a faster rate than ever before. Work habits are changing the places where we choose to live. In sum, we are cramming what would normally be years of supply and demand changes into months and that is not likely to progress smoothly. We need to navigate these cross-currents, both personally and professionally.
The important thing to remember is that all of these things eventually resolve and they usually resolve ‘in the middle’. By that, we mean that the changes that come are unlikely to be as extreme as we might fear, but are equally unlikely to return to the way things were. It’s time to adapt.
Valuations Also Suggest It’s Time to Adapt
The Fed continues to employ extraordinary measures to ‘stabilize’ the economy. Specifically, the Fed continues to buy about $40 billion of mortgage-backed securities each month, which helps to keep mortgage financing costs down for consumers. In addition, the Fed is purchasing about $80 billion of Treasury securities each month. This keeps a lid on Treasury interest rates and is designed to further stimulate the economy as it recovers from the effects of the pandemic. Lower interest rates are generally good for promoting economic growth. However, this market intervention has been on-going since late 2008 at the depths of the Housing Crisis, and that’s a problem.
These purchases artificially increase demand and that tends to increase asset prices – stocks, bonds, real estate, commodities, everything. Precisely how that happens is unimportant here, but the result is that valuations can get too high. We have been beneficiaries of that, but once again, it puts us in a cross-current. This has gone on for a long time and it can’t go on forever.
Diversification Is More Important Than Ever
Portfolios have long been structured with stocks and bonds because these are uncorrelated assets, which simply means that most of the time, when one goes up in value, the other goes down. This reduces the volatility (variability) of the total portfolio. This is desirable because we believe the way to grow wealth is to allow your investments to compound returns for as long as possible.
Investment losses interrupt compounding. Logically, the smaller the interim loss you incur, the easier and faster you can get back to compounding your wealth. Thus, improved diversification may help achieve your long-term investment goals.
At PWM, we take the diversification approach to another level by having consistent allocations to both gold and commodities. These are also uncorrelated assets. In the near term our intention is to take that a step further by adding more uncorrelated assets in particular, hedge funds and real estate. Our hope and desire is that by adding these assets, we can reduce portfolio volatility further, which is a primary portfolio goal especially when asset prices are very high. Expect us to be calling soon to discuss these additions to the portfolio.
What We’re Reading
There is concern that 10-year yield shows slowing economy (2 min. video)
Seniors could see a much bigger bump to their Social Security benefits next year. However, a bill that has been reintroduced in Congress proposes changing how those annual increases are calculated.
These conversations will differ depending on your relationship and what stage you are in life, but a common theme involves coming to an understanding of what you and your loved ones value.
To lessen the tax bite, families may consider Roth IRA conversions, life insurance, gifting and other strategies.
It’s uncertain exactly what would be covered and to what degree.
Palumbo Wealth Management (PWM) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where PWM and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at www.palumbowm.com
Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this newsletter, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio.
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.Asset Classes, Asset Valuation, Correlation, COVID, Federal Reserve, Minimizing Losses, Pandemic, Portfolio Diversification, Volatility