The Revolution of Bonds

As we commemorate Independence Day, it is important to reflect on the struggles, sacrifices, and unity that were instrumental in securing our nation's freedom. Additionally, let us delve into the profound significance of one of the oldest financial instruments still in use today: bonds. Bonds, also known as “debt,” or “fixed income” investments, involve investors lending money and receiving repayment of the original loan amount with interest. Bonds have been in existence even before the establishment of the United States in 1776. During the American Revolution, colonists courageously challenged one of the world's most powerful empires and declared their independence through the signing of the Declaration of Independence. Financing the American Revolutionary War marked the beginning of the country's debt. To fund the war, some of the founding fathers formed a group and borrowed money from France and the Netherlands. These bonds were essentially bets on America's victory in the war. However, if America had lost, any investors holding these bonds would risk the wrath of the English Crown.

While bonds might not be the most exciting topic in client meetings, their crucial role in achieving financial freedom and independence should not be underestimated. Consider bonds as the unseen gears that keep the financial clock ticking - they are essential, yet often overlooked. Despite their long history, bonds continue to be a fundamental component for investors worldwide.

The Allure for Bonds After Yields Skyrocketed

Bonds have become more exciting in recent years than at any point in the past decade. Both money market funds and investment grade bonds are yielding over 5%, while Treasury Bills and CDs are also offering compelling returns. About a year ago, Series I Bonds, which provide inflation protection and a government guarantee, were yielding over 9.5%! Although those opportunities have since passed, there are still numerous attractive segments within the fixed income market. For instance, high yield bonds are currently offering over 9% on average, and high-quality bonds with maturities of less than two years are yielding more than 4.5%. Finally, bonds are giving investors a reason to be excited!

While the interest rates on bonds might not seem particularly high, they are indeed quite appealing when compared to the anticipated returns of stocks, especially when considering the associated risk. The current price to earnings ratio of the S&P 500 implies mid-single digit returns over the next five years, but with significantly more risk than bonds. The equity risk premium, which measures the difference between the earnings yield of the S&P 500 and the yield of the 10-year Treasury Bond, is currently at its lowest point since the mid-2000s. This metric is used to estimate the expected return of bonds in comparison to stocks. It suggests that the reward for the risk associated with stocks is not as attractive as it once was.

The Clairvoyance of Bonds

Many financial professionals believe that bond investors are more astute than their equity counterparts. Their views on economic growth can be discerned by observing the yield curve and credit spreads. The yield curve, which graphs the yields on Treasury Bonds at various maturities, provides valuable insights into the direction of the economy and the Federal Reserve's stance.

Credit spreads, which compare the interest rates of higher-risk bonds to those deemed risk-free, reveal the risk bond investors are pricing into the stock market. These spreads tend to increase rapidly before recessions and other geopolitical events.

The issuance details of bonds can also provide insight into market sentiment. For instance, when bond investors are willing to waive traditional covenants that increase the safety of the bonds, it suggests a level of market froth. Investors would be wise not to dismiss these signals.

Our Thoughts

Just before Thanksgiving in the previous year, the sentiment among investors was extremely pessimistic, valuations seemed reasonable, and the tide of negative economic news was receding. Despite the challenging decision, we seized the opportunity to reintroduce equity exposure to our portfolios during the week of November 21st, 2022. This move turned out to be beneficial for our clients as the stock market made a strong comeback this year.

When investors talk about good market breadth, they're referring to a situation where a large proportion of stocks are appreciating in value, indicating a robust stock market rally. However, the rally in 2023 tells a different story. The S&P 500 index has risen nearly 16% this year, largely driven by the "Big Seven" tech stocks: Tesla, Nvidia, Meta Platforms, Apple, Microsoft, Alphabet, and Amazon.com.

The lack of market breadth, along with other factors such as tight monetary and fiscal policies, a slowing economy, and cautionary signals from the bond market, collectively suggest that equity investors should proceed with caution. While some of the stock market fundamentals have normalized from the extremes seen late last year, the underlying risks persist, and the stock market is trading at high levels. For these reasons, we have adopted a defensive stance in our portfolios and reduced our equity exposure by just over 10%.

We often jest that we never time the markets unless we're timing the markets. At present, we're not timing the markets; instead, we're assessing the attractiveness of bonds compared to equities. In this context, bonds appear to be a good deal. This isn't just about market dynamics; it's also about aligning investments with our clients' financial goals.

While we still anticipate that the stock market will continue to climb and we don't foresee any immediate disaster, we believe this is an opportune moment to decrease our equity exposure in portfolios and concentrate on managing risk for our clients.

With bonds, your income may be fixed, but the potential to achieve your financial goals is limitless. This makes it an excellent time to reevaluate your asset allocation and ensure your portfolios are designed to help you reach your financial objectives. Despite their reputation as a "boring" investment, bonds offer a plethora of opportunities for those willing to explore beyond the surface. Bonds might not be the most flashy firework, but they certainly deserve a place in the firework stand.

Noble Wealth Pro Tip of the Month

Don’t Be an Advisor Skeptic

While it's true that each individual's results from collaborating with an advisor may differ due to a variety of factors, numerous studies have nonetheless illustrated the multifaceted value financial advisors can offer beyond simply administering a client's investment portfolio.

Conventionally, the assessment of investment advisory services has been centered on "Alpha," denoting the performance exceeding a benchmark index. However, for nearly all individuals, these standardized benchmarks hold little relevance to their unique portfolios and financial aspirations.

The advantages of collaborating with a financial advisor extend far beyond the confines of the advisor's "alpha." Advisors offer crucial support in guiding clients to comprehend their financial positions, risk thresholds, and financial needs in both short and long-term contexts, thereby imparting a measurable value to their clients.

In various research publications, such as those by Hanna and Lindamood (2010), Blanchett and Kaplan (2013), and Grable and Chatterjee (2014), this added value of a financial advisor is referred to as "Gamma." Gamma reflects the role of advisors in facilitating clients' long-term financial stability, over and above mere portfolio growth. These studies indicate that the application of appropriate financial planning strategies could potentially yield an additional 23% return for a typical retiree, adjusted for utility. Implementing these techniques could also diminish wealth fluctuation and boost wealth stability.

Another study by Grable and Chatterjee, utilizing data from the National Longitudinal Survey of Youth, demonstrated that during the Great Recession (2007-09), individuals who sought advice from a financial advisor faced a smaller reduction in wealth—331 basis points lower—compared to those who didn't. This variance is identified as "Zeta."

The comprehensive financial counsel offered by professionals, incorporating all these elements, can translate to considerable monetary gains for clients. The potential financial benefits could be as significant as a 24.72% increment or a 7.5% elevation in income for an average household.

Student Loans Become Due

The Supreme Court struck down the $430 billion plan to forgive student loan debt of over 40 million Americans. For those planning on this lifeline, I’m deeply sorry. While this is unfortunate for many, student loan borrowers need to ensure their cash flows are in order and prepare to start paying back their debt on September 1st. This ruling will have knock-on effects for the economy as many of these borrowers have a higher propensity to spend. We may get a glimpse of the second-order impacts when consumer discretionary companies like Apple report their fourth-quarter earnings early next year.

Fun Facts of the Month

Record Inversion: Through 6/22, the 10-year/3-month US Treasury yield curve has been inverted (10-year yield lower than 3-month yield) for 154 trading days dating back to November 2022. Since 1962, the longest streak with an inverted 10yr/3m curve was 209 trading days ending in May 2008. To break that record, the curve would only need to stay inverted through mid-September of this year (Bespoke).

Time to Plan? 65% of Americans surveyed in Charles Schwab’s 2023 Modern Wealth Survey said they do not have a formal financial plan. Of those without a plan, 21% said it was because it seemed too complicated and 20% said it was too time consuming (Schwab).

City Blues: Job postings in the US, tracked daily by Indeed, are down 21% from all-time highs made on 12/31/21. Major cities with populations above 3 million have seen job postings fall the most at 25%+, while metros with less than a million people have seen postings fall the least at 17% (Indeed).

Ready for a Recession? The Conference Board’s Index of Leading Indicators declined in May for the 14th straight month. Since 1959, the current period ranks as the third longest streak of monthly declines and just the fourth streak lasting a year or more. Of the three prior periods, the economy was already in a recession by the time the streak reached its 12th month (Conference Board).

Housing Surge: US Housing Starts surged 21.7% on a month over month (m/m) basis in May, the largest monthly increase since October 2016 and just the seventh increase of 20% or more dating back to 1989. One year after each of the previous six 20%+ monthly increases, the S&P 500 Homebuilder Index was up every time for a median gain of 36% (Census Bureau).

Low Rate Entrapment: Over the last 12 months, average monthly annualized sales of existing homes have been 4.46 million, the lowest level since August 2012. Supply remains the main culprit as inventories of homes listed for sale fell to 1.08 million, which is the lowest level for the month of May since at least 1999 (National Association of Realtors).

What’s Your Net Worth? In a recent survey, 33% of Americans said they knew the net worth of one or more celebrities, and among younger Gen Z1 Americans, the percentage was even higher at 64%. Despite knowing the net worth of celebrities, more than half (51%) reported that they had no idea how to calculate their own net worth (Credit Karma).

New vs. Old Economy: Through 6/21, the Nasdaq 100 was up 35.9% year to date versus a gain of just 2.4% for the Dow Jones Industrial Average. The 33.5 percentage point spread between these two large-cap US equity indices is easily the widest through the first 117 trading days of any year since the Nasdaq 100 began in 1985 (Bespoke).

A Big Adjustment: A slowdown in the pace of inflation has lowered the projected cost-of-living adjustment (COLA) for Social Security recipients to just 2.7% for 2024, from 8.7% last year. The Senior Citizens League, a nonpartisan advocacy organization, lowered its estimate from 3.1% last month.

Feel Wealthy? Americans called $2.2 million the threshold to “be wealthy” in Charles Schwab’s 2023 Modern Wealth Survey. Of those surveyed, nearly half said being able to afford a lifestyle similar to their friends makes them feel wealthy. If you have more than $2.2 million and you still don’t feel wealthy, one option is to find some new friends ;)

Housing Rebound: New Home Sales in the US rose 11.8% year over year (y/y) in April for the largest gain since April 2021. April’s increase also ended a 13-month streak of negative y/y readings. That was the longest streak since the record 46-month streak ending in September 2009 (US Census).

Unequal Impact: 82% of recent or potential home sellers said they feel “locked in” to their current home because of a low mortgage rate. Gen Z (97%), Millennials (87%), and Gen X (87%) homeowners feel universally “locked in,” but most Baby Boomers said they don’t feel “locked in,” likely because this older age cohort has built up the most equity in their homes over the years (Realtor.com).

Ominous Tech Rally: Through 2023’s first 100 trading days, the Nasdaq was up over 20% year to date (YTD) for just the fifth time in its history dating back to 1971. The four other years where the index was up 20%+ YTD on its 100th trading day were 1975, 1983, 1986 and 1991. In three of those years, the Nasdaq closed the year lower than it did on its 100th trading day (Bespoke).

Megacap Leadership: As of 5/17/23, four US public companies were members of the “$1+ Trillion Market Cap” club: Apple (AAPL), Microsoft (MSFT), Alphabet (GOOGL), and Amazon (AMZN). The $7.7 trillion combined market cap of these four “mega-cap” stocks makes up 21% of the S&P 500, and all four are up more than 30% year-to-date (YTD) (Bespoke).

No Love for Dividends: The large-cap Russell 1000®, the 300+ stocks in the index that pay no dividend were up an average of 9.6% year-to-date (YTD) as of 5/16/23. Conversely, the 230 stocks in the index that began 2023 with a dividend yield of 3% or more had declined by an average of 5.2% YTD over the same period (Bespoke).

Philadelphia Prognostication: The Philadelphia Fed’s regional business outlook was negative for the ninth straight month in May. Since 1968, there have been five other periods where the index was down nine months in a row. In three of those periods, the economy was already in a recession. In one of the other two periods, a recession started one month later, and the other started six months later (Bespoke).

What We’re Reading

Socialnomics - Erik Qualman

This book explores the transformative power of social media in our personal lives and business practices. The book highlights the shift from traditional advertising to consumer-driven word-of-mouth on global platforms, and discusses the opportunities and challenges this presents, including privacy concerns. Qualman predicts that social media will become even more integrated into our daily lives, reshaping the way we communicate, make purchasing decisions, and engage with the world.

Antifragile | Nassim Nicholas Nicholas Taleb

The concept of 'antifragility', which refers to systems that actually benefit from shocks, volatility, and uncertainty, as opposed to merely withstanding them ('resilience') or being vulnerable to them ('fragility'). Taleb argues that many aspects of life, from biological systems to economic structures, are antifragile, and understanding this can help us make better decisions. The book encourages embracing randomness and uncertainty as opportunities for growth and improvement, rather than viewing them as disturbances to be mitigated.