Returns were positive across almost all asset classes in the first quarter. The Barclays Aggregate Bond Index was up 1.6%. Municipal bonds gained 1.0% and TIPS rose 1.4%. Foreign bonds declined by 3.7% due to the strong dollar. US Large Cap stocks as measured by the S&P 500 returned almost 1% while Small and Mid Caps gained 4.9%. Developed Markets shot up 4.9% as well, but Emerging Markets were only up 2.2%. Real Estate continued to rally, up 4.7%. Commodities dropped 5.9%.
After six years of a bull market we are still waiting for the euphoria that signals a top. Investors have been reluctant to put money to work as bearish commentators still rule the airwaves. Today’s news is fixated on predicting dire outcomes regardless of the topic. Any change in the price of oil, economic data, or word count in the Federal Reserve’s policy statement is met with a televised brainstorming session of the worst possible outcomes from talking heads. The financial media seems to be drifting away from Keynesian economics and towards Kardashian economics, promoting sensational fear-driven day trading rather than rational financial planning. What changes should we make to our portfolios in reaction to Federal Reserve press releases? If you have a plan, you shouldn’t need to make any changes at all.
The Federal Reserve dropped the word ‘patient’ from its policy statement in February and the financial media lost its collective mind. Despite howling from pundits on TV, there is nothing that a prudent investor should be doing in reaction to this. In 2013, the Fed floated the idea of winding down Quantitative Easing (QE). This idea of tapering off QE had been around for a while and even though everyone expected the announcement, there was a short freakout dubbed the “taper tantrum” where the stock market dropped by about 5%. The actual taper started and finished as Janet Yellen took over last year. The world did not end. The markets did not implode. The idea of change had more impact than the actual change itself. Investors who overreacted to the speculation leading up to the taper were hurt. Investors who stuck to a disciplined plan benefited.
Today’s Federal Reserve rate hike speculation reads like a script for a teen drama. Will they or won’t they? Some experts heard that Janet’s note means they’ll definitely hike in June. Other experts heard that the doves on the board are having second thoughts. Maybe Ben Bernanke will pass us a note in study hall (he does have a blog now). What we know is that the economic data has been surprisingly strong and has met many of the hurdles the Fed set before it would consider raising rates. Janet Yellen has made it very clear that the Fed’s decision will be based on data. However, the Fed may be moving the goalposts as they have shifted their unemployment target down in light of the strong numbers. What will the Fed do? Raise rates. When will they do it? We don’t know and neither does anyone else. The hardest (and smartest) thing to do in reaction to all this is to stick to a plan. It may help to look at this not as the Federal Reserve raising rates so much as allowing rates to get back to normal.
Our investment committee continues to suggest the following guidance:
- Allow Bonds weighting to drift as much as 5% lower than policy and add foreign exposure if needed
- Allow Stocks weighting to drift as much as 5% higher than policy, favoring international equities