Watch the Webinar: Q1 Reflections with Abacus CIOs
The first quarter of 2023 was eventful, from bank failures and the Biden administration’s first veto defending environmental, social, and governance (ESG) investing, to the Federal Reserve raising rates (yet again) and concerns around the debt ceiling. Through all the noise, the key tenets of our investment and financial planning philosophies held true. The center of that logic? Remain calm and stick with a long-term plan despite moments of perceived market chaos.
As an individual investor – even when the headlines suggested otherwise – this meant keeping your assets invested, having confidence in your long-term investment plan, and trusting the advice from your financial advisor. You were rewarded for this patience.
Despite considerable volatility this quarter from the above factors, broad market performance was positive across the board, rewarding investors who kept calm through all the noise. While we experienced significant differences in monthly returns (see exhibit 1), the quarter ended up positive (see exhibit 2), as shown in the two charts below.
Exhibit 1. First quarter monthly returns, Dec 2022-Mar 2023. Fact Set, (2023). Own work.
Exhibit 2. First quarter returns in USD for US stocks, non-US stocks, US bonds, and global bonds, Jan 2023-Mar 2023. Fact Set, (2023). Own work.
We fully expect ups and downs in the markets and your portfolio, and we integrate those expectations into your long-term plan. The headlines and economic conditions that influence market movements change quarter-to-quarter, and even day-to-day at times, but our long-term view of markets and investment strategy remains.
What does this strategy look like? In collaboration with your financial advisor, we choose an investment mix of stocks, bonds, and real estate according to your risk tolerance, time horizon, and unique financial situation. Over time, it’s essential for us to rebalance your portfolio to ensure your investment mix remains aligned with your investment goals and values. Our trading team regularly looks to rebalance your portfolio by selling certain assets that have performed relatively well and reinvesting those proceeds in other assets that have recently lagged the others. This strategy has been time-tested through decades of different market environments, and countless up cycles and down cycles.
While our recommendations don’t change due to short-term market conditions, we are constantly working behind the scenes to optimize your portfolio and ensure it remains in line with your long-term goals and plan.
Let’s take a deeper look at some events behind the headlines this quarter, how they affected your portfolio, and our outlook on each going forward.
Bank Failures and Risk
The collapse of Silicon Valley Bank and New York’s Signature Bank arguably dominated financial headlines in March 2023. The failures represented specific issues each bank had regarding concentrated depositors and poor risk and investment management, coupled with unfavorable market conditions. For more details, why we’re not concerned about the health of the banking industry at large, and what this means for the financial planning related to your cash deposits, read our blog about what happened with Silicon Valley Bank.
From an investment lens, this is a good reminder of the benefit of one key tenet of the Abacus Investment Philosophy – broad diversification. Diversification means building portfolios that spread client assets across thousands of companies around the world, rather than trying to choose a handful that will outperform. This approach is backed by decades of academic research and we saw the benefits play out in this instance.
The publicly traded holding company of Silicon Valley Bank was a fraction of a percent in our client portfolios, and therefore did not materially affect performance. This is a stark contrast to actively managed portfolios that can have upwards of 10% of an individual portfolio invested in a single company based on predictions and expectations around that company being a winner. You can imagine the aftermath associated with having 10% of a portfolio invested in a company like Silicon Valley Bank.
Rising Rates, Cooling Inflation
Our investment philosophy remains the same whether we talk about making individual company predictions or predictions around macroeconomic events – nobody has a crystal ball. Naturally, many clients have asked how we position our portfolios regarding expectations on changing interest rates? Let’s start with a little background.
The Federal Reserve continued its path of raising the target Fed Funds rate in February and again in March. When they began raising rates to combat inflation in early 2022, not many expected them to have to continue aggressively raising rates over the next year – and yet here we are with another increase to a range of 4.75% – 5%.
The Fed Funds rate is the interest rate at which depository institutions lend and borrow funds with each other overnight to meet their reserve requirements set by the Federal Reserve. Other interest rates in the economy, such as mortgage rates, car loan rates, and credit card rates, are often influenced by changes in the Fed Funds rate, increasing borrowing costs for consumers and businesses, which can lead to a decrease in spending. This, in turn, leads to a decrease in demand for goods and services, which should put downward pressure on prices and inflation.
It’s impossible to predict the future of inflation and interest rates, much less when the Federal Reserve will stop raising the target Federal Funds rate. That said, we are seeing a cooling effect on inflation as a result of the rate hikes over the past year, from a peak of nearly 9% in June 2022 to 5% in March 2023 (see exhibit 3).
Exhibit 3. Percentage change in Consumer Price Index shown month over month from 2021 to Feb 2023. From Guide to the Markets U.S. by J.P. Morgan Asset Management, 2023, p.30, (https://am.jpmorgan.com/content/dam/jpm-am-aem/global/en/insights/market-insights/guide-to-the-markets/mi-guide-to-the-markets-us.pdf ).
The Consumer Price Index, or CPI, is used as a broad measure of inflation in the U.S. It is a measure of the average change over time in the cost of goods and services purchased by consumers. The calculation is extensive and includes more than 200 categories under food and beverages, housing, apparel, transportation, medical care, recreation, education, and communication.
So if we can’t predict the timing of interest rate changes or inflation, what does that have to do with your portfolio?
The Federal Funds rate has a ripple effect across other current borrowing rates, including the rates of the universe of bonds available to you as an investor. When interest rates rise, the fixed interest payments that bonds offer become less attractive to investors because they can now invest in new bonds that offer higher interest rates. As a result, the demand for existing bonds with lower interest rates decreases, causing their price to fall. This is exactly what we saw last year in 2022 – an unprecedented year of broad negative performance in bond markets resulting from consistent rate increases.
And yet, there is good news in 2023. We’ve begun to see stability and the benefits of actively repositioning portfolios to capture the higher rates the market is now offering, all without having to make predictions. As short-term bonds mature, the proceeds are reinvested in higher-yielding bonds. We’re already seeing this concept play out in our bond models. As underlying managers strategically shift portfolios, the Abacus bond portfolios’ yields have exceeded 5% as of March 31, 2023, up from under 4% this time last year.
The Debt Ceiling
The proposed increase to the U.S. debt ceiling, or the limit on the total amount the U.S. government is allowed to borrow (via selling treasury bonds), has also been getting a lot of press. The U.S. government borrows money to meet its obligations, like interest on previously incurred debt, military salaries, and retiree benefits. Simply put, you can think of the debt ceiling as the maximum budget dictated by congress for the U.S. government to continue to run.
This may seem like a relatively new concept amid all the buzzy financial media coverage over the past several years, exacerbated by the partisan nature of the issue and speed at which information is disseminated. In reality, the debt ceiling has been raised 78 times since 1960, most recently in 2021.
So what’s the big deal for investors? Well, as Congress becomes more partisan, getting the budget approved and determining the new ceiling becomes more contentious. If an agreement isn’t met before the government runs out of money, there’s a chance of default on treasury bonds. This is a big deal because treasury bonds are considered to be the safest publicly traded asset and represent significant investor assets across the globe.
The likelihood that Congress would allow this to happen is very low. The only time it came close was in 2011, and Congress pulled all night sessions to find an agreement ahead of the deadline before the government could run out of funds.
Here are a few things to keep in mind as this relates to your portfolio:
- Because of the frequent nature of the debt ceiling rising — and the budget debates being both a common occurrence and widely disseminated — expectations have already been factored into the market and your portfolio’s valuation.
- Historical data shows there hasn’t been a strong relationship to a country’s debt and stock market returns. In addition, at Abacus, your portfolio is diversified across countries around the world, all with different cycles and debt profiles.
The ESG Investing Bill
And finally, among all of the recent financial headlines, there was positive news related to ESG investing.
President Biden’s first ever veto prevented a bill that would have limited the ability of investors in retirement plans to incorporate environmental, social, and governance (ESG) considerations into their investment philosophy. The Department of Labor’s rule in support of ESG investing currently stands. Of course, we will keep an eye on developments.
For a deeper dive, read our exploration of the recent national discussion around investing that considers ESG factors in addition to financial ones.
In Closing
We often spend time offering reassurance and historical perspectives when it comes to market volatility, which we believe is helpful when looking at any one financial event in proper context. That said, we know how disconcerting and anxiety-provoking the ups and downs of the market and financial news can be for our clients. While we continue to stay out of the prediction business, one thing we can say with conviction about the future is this: we will always make every effort to see you and hear you about your unique financial needs.
Disclosure
Please remember that past performance is no guarantee of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Abacus Wealth Partners [“Abacus”]), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from Abacus. Abacus is neither a law firm, nor a certified public accounting firm, and no portion of the commentary content should be construed as legal or accounting advice. A copy of the Abacus’s current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request or at https://abacuswealth.com/.
Please Remember: If you are an Abacus client, please contact Abacus, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. Unless, and until, you notify us, in writing, to the contrary, we shall continue to provide services as we do currently.
Please Also Remember to advise us if you have not been receiving account statements (at least quarterly) from the account custodian. Historical performance results for investment indices, benchmarks, and/or categories have been provided for general informational/comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. It should not be assumed that your Abacus account holdings correspond directly to any comparative indices or categories.
Please Also Note: (1) performance results do not reflect the impact of taxes; (2) comparative benchmarks/indices may be more or less volatile than your Abacus accounts; and, (3) a description of each comparative benchmark/index is available upon request.
