December 6, 2018: The Return of Risk
A year ago, one of us had a discussion with the owner of his local auto repair shop about bitcoin. At the time, the price of bitcoin had skyrocketed and appeared to be a one-way ticket to wealth. The auto shop owner was extolling the virtues of bitcoin, not only as an investment, but as a medium of exchange. When asked, â€śWould you accept bitcoin as payment for your auto repair services?â€ť the auto shop owner unhesitatingly replied, â€śabsolutely.â€ť Our observer bit his tongue and went on his way, hoping the auto shop owner had not exposed too much of his financial security to bitcoin. Since that conversation, the price of bitcoin is down 75%.
Return of Risk:
We have expressed concerns in prior letters that the Federal Reserveâ€™s extraordinary efforts since the Global Financial Crisis to suppress interest rates and whet investorsâ€™ risk appetites have suppressed risk premiums (i.e., reduced the potential reward for taking risk) and likely artificially reduced the fluctuations of investment markets. As the Fed now attempts to gradually reverse its generous crisis-driven monetary policies and the investment markets grapple with other issues, risk has returned. In fact, this may be the first year since 1972 in which none of the major investment classes returns at least 5%! (source: Ned Davis Research)
We do not wish to sound glib or resort to a clichĂ©, but corrections in the prices of riskier assets can be healthy in a variety of ways. Prior to this correction, we had been concerned that the strong performance of momentum-driven and other risky investment strategies encouraged aggressive behavior on the part of investors and made investing appear to be less risky than it is. Prolonged periods of complacency tend to end badly, so perhaps the current correction will, ironically, extend the life of the bull market that began in 2009.
Although it is impossible to know the short-term direction of markets, we think it is prudent to mentally prepare yourself for further fluctuations in the investment markets in the coming months as they adjust to higher interest rates and slowing economic and corporate earnings growth. As we have described on numerous occasions in the past, we worked extensively earlier this year to upgrade the quality of our bond holdings given the rise in Treasury and money market yields. These investments have recently provided solid ballast in the midst of a significant correction in global stocks, and will provide the necessary dry powder for future rebalancing opportunities.
Past performance does not guarantee future results. Investment strategies discussed may not be suitable for all investors. Diversification does not guarantee against investment loss. The information provided here is for general informational purposes only. The inclusion of specific securities within the context of broad economic commentary is not intended to be a recommendation. Investors should thoroughly evaluate any security before taking action. International investments involve special risks, including currency fluctuations and political and economic instability. Opinions expressed are subject to change without notice in reaction to shifting market conditions. Data contained herein is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.