Does anyone else know what it is like to have teenagers in your house? The only way parents survive the drama is with the knowledge that these volatile creatures were once their adorable little boys and girls, and will one day be endearing humans once again.
When I take a deep breath and remind myself that our little girl is still in there somewhere, I remember back to when my daughter’s favorite show was a Disney cartoon entitled, “The Lion Guard.” There was one episode in particular when the Lion Guard was trying to help a zebra whose herd was under attack by hyenas. The zebra’s reaction was to panic and run. I can still see my daughter dancing around the house singing, “Panic and run, panic and run!” It made for a cute children’s show, but obviously panic is not really a good investment (or life) strategy. One wouldn’t know that if he was paying close attention to the markets today.
If there is one strategy in investing that is universally preached, it would be diversification. We all know that we shouldn’t put all of our eggs under the same layin’ hen (at least you do if you read the First Quarter 2024 issue of The Quarterly Report). We have to diversify our investments. The theory of diversification rests on owning assets that have low (maybe even negative) correlations with one another. For example, stocks and bonds: The idea is that when stocks sell off, investors should go towards the perceived safety of bonds and therefore bonds will increase in value as stocks decrease in value, helping to reduce the volatility of one’s portfolio.
Asset allocators, whose job it is to figure out how exactly investments should be mixed together to optimize risk and return, obsess over correlations. It does work, most of the time. However, there is one problem: In times of true market distress, all correlations go to one. In plain English: When something really scares the market, such as a financial crisis or a war in the Middle East, all well-conceived investment strategies turn into “panic and run.”
Since the first attacks on Iran on February 28, the S&P 500 is down approximately 4 percent. On February 27 (the day before the attack), the 10-year U.S. Treasury had a yield of 3.97 percent. In other words, the interest rate on a 10-year loan to the U.S. government was 3.97 percent. On March 24, that interest rate is now 4.4 percent. As a reminder, bond yields and bond prices have a see-saw relationship. When yields go up, it means prices have gone down. So, investors are selling stocks and they are selling bonds.
Maybe they are only selling U.S. bonds since we started this war? Nope, the German Bund (German for bond) had a yield of 2 percent on February 27 and now yields 3.03 percent.
I know what you are thinking: Gold is the safe haven, that is where smart people put their money today. Nope, gold was $5,230 per ounce the day before the attack and it is now $4,375 per ounce. Should I keep going?
In times of crisis, correlations go to one and diversification is not of great help. So, what are investors to do? It is at times like this that investors need to know what they own and know why they own it. Great investors are owners of companies, not traders of stocks. While Wall Street is in full panic and run mode, selling almost everything, out here in the real world, life goes on. Apple is still selling phones. Alphabet is still helping people Google the latest information. Have you seen the lines at the airport? Delta is still flying people (or leaving them if they didn’t get through security in time).
Sometimes the best way to handle a storm is to batten down the hatches and just sail through it. This too shall pass. That is the mantra for the day in the market and in all those households with teenagers. The war will end and we will get on with our lives, at least that is what my wife and I keep telling ourselves.
Warm regards,
Chuck Osborne, CFA
