Sometimes the Higher Yield isn't the Best Yield

“Throughout history, whenever most investors believed the worst about a particular asset class, such has often been the right time to start buying. As we have often discussed, psychological behaviors account for as much as 50% of the reasons investors consistently underperform the markets over the long term.”

- Lance Roberts

Over a dinner not all that long ago, my mother-in-law made a comment about buying a 6-month certificate of deposit (“CD”) from her local bank at 5.50%. She was thrilled as that was her primary means of investing prior to the 2008 Great Recession, buying money market funds and CDs.

I asked her why not buy a 2-year, or better yet, 5-year? Or the longest maturity CD they had? She said the 5-year CD *only* yielded 5.0%. And why would she buy that when she could get 5.50% in a six-month maturity?

Despite my pleading, disputing, and reasoning with her, I could not convince her that a 5-year CD at 5.0% was better than the six-month CD at 5.50%.

The point is, the higher rates go, the more you want to lock them up as a lender to those businesses or the government.

One of the ways I try to think about correct actions is by saying, “Well, what’s the mistake one could make today?” And I believe that the mistake would be failing to take advantage of these rates today.

Investing is all about reversion to the means and allocation of capital. Don’t worry. I’ll explain.

Navigating Long-Term Asset Valuations and Opportunities

Essentially, assets tend to revert to their long-term average valuations. It typically doesn’t happen overnight but over time. In other words, if stocks are trading at 20-times multiples of earnings, and the long-term average is 16-times, then over a long-time frame, we are likely to see those current multiples come down towards the average.

This has implications for which assets are the best places to allocate money (i.e. stocks, bonds, real estate, commodities, etc). The areas of investing that offer the best returns over long periods of time based on the reversion to the mean should garner more of your money.

Notice how I didn’t say ‘all of your money.’ We don’t want to make massive bets one way or the other and effectively gamble.

Right now, bonds are offering up a massive opportunity. That is because of the anomaly that Covid (or the response to it) created.  The Federal Reserve is fighting the massive stimulus thrown into the economy during 2020 and 2021. They are doing this, in part, by raising interest rates.

But once that problem is solved, they will begin to lower rates. The market is anticipating that to start by the end of the second quarter next year.

However, rates can and have fallen in anticipation of those cuts.  It is not waiting for the Fed to act. The most recent Consumer Price Index report showed continued moderation in price growth. Inflation fell from +3.7% in September to +3.2% in October. That was better than expected and the market zoomed.

Between that inflation report and the weaker payroll report the week before, the market believes the Fed is done raising rates.

In response, rates fell sharply. The 10-year yield fell from just over 5.0% to 4.47%. That is very beneficial for our bond strategy.

_{^{Source: YCharts, as of 11/14/2023. Graph illustrating US Consumer Price Index vs Treasury Rate.}}

We will continue to implement this strategy by purchasing long-term individual bonds of high-quality to LOCK IN these yields thereby producing strong cash flows for client portfolios. I feel more strongly than ever that this is the right approach, especially after this recent melt up in the stock market.

As always, we appreciate the faith you have in us.

Sincerely,

Mark J Asaro, CFA

Noble Wealth Management