It All Doesn’t Matter… Until It Does
The markets continue to move upward, despite persistent inflation, ballooning national debt, tariffs taking effect and a general uneasiness both near and far. It’s said that the stock market does not necessarily reflect the state of the world but, instead, simply how corporate profits are doing. This seems a callous reality and at least a bit narrow-minded in scope, but market history tends to support it.
Thus, at some point, it is certainly possible that the disconcerting issues listed above (and perhaps others) could derail corporate profit growth and the markets along with it. This is something investors should be on high alert for (or at least low alert) and l get the idea there’s a sizeable percentage who are not thinking about this. Caveat Emptor!
‘Investors Afraid Fear Index is too Low’
Hmmm … does that phrase make sense? This was an exact recent headline from the highly-regarded MarketWatch website. Though it’s possible the editor overlooked the likely grammatical error, it’s also possible the headline was meant exactly as stated. If so, it’s certainly ironic and perhaps telling of the conflicting schools of investment thought out there currently (the fearful vs. the unconcerned).
Some days the investment world seems to be a giant game of musical chairs where everyone is looking at each other and waiting for the music to stop and then chase the open chairs that might be available (translation: investment safety). Those who are left still standing (i.e.: taking on too much risk) will likely feel a great deal of financial pain. As Warren Buffett is famous for saying, ‘you don’t know who is wearing a bathing suit or not until the tide goes out’.
Regarding a Different Type of Index….
Passive investing – simply buying market indexes instead of selecting particular investments through analysis of potential winners and losers – has continued to grow in popularity. It’s easy to see why. It usually comes with very low management fees and virtually guarantees that you won’t do worse than the market and, on the upside, your investments will grow with the market.
However, there are a few weaknesses of indexing which should be considered. First, indexes represent the market, but not necessarily an even swath of it. As the largest of the large companies’ market value has shot upward, the S&P 500 index is mostly a reflection of about the I 0 largest stocks which represent about 40% of the market (the remaining 60% is represented by the ‘other’ 490 stocks). Further, while indexes are rewarding when markets are going up, during falling markets indexes give you zero protection or other benefit such as a nice dividend.
An element of indexing which may become a growing issue is that as more and more investors utilize them, stocks will correlate more and more and thus either all stocks tend to go up or down more in lockstep (as there will be fewer of us who buy what others want to sell or sell what others are eager to buy). Like any ecosystem, you need various contributors to maintain a healthy balance. Insects are not generally loved, but our world wouldn’t function without them. They play a big role in the food chain and the general health of our ecosystem. Similarly, active investors have a role in the investment ecosystem. Continued movement to indexing could create new problems but perhaps also more opportunities for those willing to direct resources in a different way.
Uncharted (dangerous?) Territory
The President and many of his people want interest rates notably lower, even making a variety of moves to try to influence the Fed to do so.
Removing the huge question of should the Fed continue to be an independent institution (definitely yes, says l), does forcing interest rates lower make sense or even work at this point? Cutting interest rates when inflation is high and the economy is doing well seems a simple sugar high. Yes, cutting interest rates could goose certain parts of the economy such as housing. But you don’t get something for nothing. The downsides of reducing interest rates in this type of environment include risking higher, prolonged inflation, encouraging greater risk-taking in an already speculative period and having fewer tools to help if and when the economy inevitably slows.
Bond Canaries
While the stock market continues to set new highs, the bond markets are indicating a possible different picture. Cracks are appearing in the form of some unexpected bankruptcies and increasing rates of delinquencies with auto loans. Perhaps these are dying canaries in the coal mine.
Even as there’s been speculation (and political influence) that the Fed will bring short-term rates down, bringing long-term rates lower (which are most influenced not by the Fed but by market forces) may be a bigger ‘ask’. These are the rates that most impact things like mortgage and other loans. Using Buffett’s swimsuit analogy, when the economy slows those who are stretched thin and heavily in debt will be the first to show signs of struggle.
America has a complicated relationship with debt. Both rich and poor, small and large often use debt to allow themselves to acquire more than their finances would judiciously suggest (sometimes for necessities but sometimes not). At some point, it would seem we, collectively, will have to pay (literally and figuratively) for our heavy-spending ways; as individuals, companies and as a country. When the bill finally comes due and can’t be avoided, it may not be pretty.
Private Equity and Credit
Two sectors of the investment spectrum are hankering to break into the 40 I k world: private equity and private credit. These investments are not terribly different than public equity and public credit that have been on 401 k investment menus for decades. The biggest differences with these private investments are they don’t provide the same level of transparency and usually have much higher fees. ERISA,
which governs 401k plans to protect investors, will have to justify the higher fees and lack of transparency. Even if ERISA can, it’s not clear that 401k investors are broadly excited by these new possible offerings. Instead, it seems the real interest is with the providers who want to profit by selling their products to a broader group of investors. Count me a skeptic to this being a good idea for 401k investors.
Brian Weisman, CFA,CPA,CFP,CMA
(734) 665-1454
brian@columbiaasset.com
Circling it Back to Christen