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Inverted yield curve & your portfolio

Amid recent market turmoil and talk of a possible recession, we sent out the following article to Four Ponds clients on Aug. 15. It was written by our outside chief investment strategist Eric Stein, who provided background on the decline and explained our investment approach in turbulent times.

For many economy- and market-watchers, the canary in the coal mine for impending recession is the inverted yield curve, when short-term bond yields are higher than long-term. We have been watching this and commenting on it, along with the detrimental effects of trade- and currency wars, for quite some time now, but the news hit a fever pitch yesterday when the 10-Year Treasury yield fell below that of the two-year for the first time since 2007. This caused an already jumpy stock market to decline and attention-seeking media outlets to sound their alarms.
We must start with a word of caution against letting noise and emotions get in the way. But aside from just advising not to read too much into the hype, and without getting into the technical aspects of why inversion matters (or might not), we just wanted to send a word of reassurance that we are watching over the situation and your portfolios as much as ever, and to remind you about the various ways our philosophy, process and portfolios offer protection in these volatile times.

Primarily through diligent financial planning at the forefront of our relationship, we ensure that no more of your assets are put at risk than necessary. For example, while stock investments may be the growth engine for your portfolio, we only allocate as much to stocks as necessary to help make your financial plan a success. With exceptions for aggressive portfolios, or clients with very long time horizons, a significant portion of your portfolio is invested in bonds that can serve as a counter-balance, because in many cases like yesterday, when stocks sell off, bond prices can rise as investors scoop them up as a safe haven. We also advise maintaining a cash cushion so that assets need not be sold in an emergency to meet your near-term obligations. Not putting all your eggs in one basket is the pinnacle of diversification.

Furthermore, we diversify your holdings within each category. While watching the news may lead one to believe that the Dow Jones IS the market, it only consists of 30 stocks, all large U.S. companies, which combined represent only about 10% of the value of all stocks worldwide. We diversify your stock portfolio into thousands of stocks domiciled in virtually every country of the world, in every industry, and of various sizes. In other words, while the Dow may be an okay barometer, you own much more than that.

While we are on the topic, remember that a stock is not just a piece of paper or ticker symbol; it represents ownership in a going enterprise designed and managed to generate profits, to which you are entitled as an owner. All stocks experience downturns in their price, driven mainly by short-term factors, but we do not believe that all the thousands of companies we own (or even a measurable proportion of them) will go belly-up or cease being profitable; we must put up with volatility to reap the long-term rewards of stock ownership.

In terms of our process, we believe in taking the emotion and guesswork out of portfolio management. Rather than trying to figure out if yesterday’s slide will continue or whether it will reverse, we have systematic processes in place, namely “rebalancing” your portfolio back to its target allocations. This keeps your risk profile in check, but also allows us to lock in profits by selling securities that have appreciated (sell high) and buying securities that have fallen (buy low). By repeating this process over and over, and especially buying in a sell-off through systematic rebalancing, we put you in a better position to gain than trying to guess the market’s next move.

We value the trust you place in us to manage your portfolio and help achieve your financial goals and dreams, and we take this responsibility very seriously.  If you would like to talk in more detail about the current environment or your unique situation, please reach out to us.

The above article was written by Eric Stein, CFA, of East Bay Financial Services, a registered investment advisory firm that serves as an outside investment consultant to Four Ponds Financial Planning LLC.

(888) 285-7705 | info@fourpondsfinancial.com