The Obvious Outcomes
I was recently listening to the Tim Ferris interview of Morgan Housel (my current favorite financial author whose new book, Same as Ever: A Guide to What Never Changes, came out on Nov 7th).
In the interview, Housel made the point that some things will be shockingly obvious one year from now. We just don’t know what those things are today.
He gives an example from March of 2020 at the start of COVID. In that moment two outcomes were possible: 1) In twelve months the world will have fallen into a second Great Depression or 2) the economy and prices will have soared higher. In either outcome, it would be easy to look back and decide that the result was inevitable and highly predictable.
This is always the case. Hindsight is always 20/20.
What Does This Mean for Interest Rates?
When we look at the bond market it seems predictable that we would be where we are today. We had inflation, the Fed told us they were going to raise rates and here we are. But 12 months from now we will be in one of three places. 1) interest rates will be higher than they are today, 2) interest rates will be lower than they are today or 3) interest rates will remain unchanged. With any of these outcomes it will be easy to look back and decide that the result was inevitable.
To give you an example of why that predictability is an illusion, we can simply look back to 2022. Less than two years ago the Fed forecasted a year-end rate of 0.9%. Things changed and over the next 10 months, the Fed adjusted that same forecast all the way up to 4.4%.
By the start of 2023, the Fed thought we’d get no higher than 5.1% but even that wasn’t high enough. Here we are today up to 5.6%.
So, while today it may seem obvious that rates were going to rise to their current levels, and it is tempting to believe a good bond investor would have known to stay in cash, the previous forecasts tell a different story.
Interest rates have been unpredictable and will continue to be unpredictable. Given this uncertainty, the only way we know to effectively manage a portfolio is to continue executing our strategy. For clients with bonds, we will continue to manage risk by owning a variety of credits and durations. For clients with equities, we will continue to stay invested, reflecting our belief that the stock market will continue outperforming the bond market over the course of our clients’ retirements.
12 months from now, wherever we end up, there will inevitably be regrets. We may regret not having been longer, we may regret not having been shorter or we may regret something else entirely. But protecting a retirement plan requires diversification and diversification means always having to apologize for something. So that is what we will continue to do. Our long-term success depends on it.