utah778
Answering a question with the words “I don’t know” sounds weak and “wishy washy” like a failure to come up with an answer on a test. Don’t they tell you on multiple choice tests like the SAT to eliminate one absurd answer and guess? At age 22 I enjoyed winging it and thought it was necessary to have a position on every question. Now that I’m almost 78 I have ended up looking like an idiot enough times that I am more willing to resist the impulse. Manufacturing a plausible-sounding answer can not only lead to big mistakes but it can stop you from making progress in finding the right question.
Starting with an admission that you don’t know the answer can be downright empowering. Just remember that “I don’t know” isn’t a final answer. It’s a starting point. The real question is how we make the initial “I don’t know” speak to us in a productive way. My first thought after realizing I don’t know the answer is to ask what I would do differently if I did know the answer. Here are few current questions for which my immediate answer is “I don’t know.” I toss in an extra question which should be implicit in everything you do as an investor. It popped into my head about thirty years ago when my best friend asked me for a bit of financial advice.
1. Is The Market Advance Which Began In June A New Bull Market Or A Bear Market Rally?
Answer: I don’t know.
Explanation:
Vigorous bear market rallies and new bull markets look very similar. Both often involve a “capitulation” of some sort (sometimes a day in which 90% of stocks are down) followed by a breadth thrust (90% of stocks up). Both have the power to blast through moving averages and overhead resistance. A favorite technical indicator is the O’Neill confirmation day popularized in IBD (up in high volume within a few days of the initial move). Does the current market meet these and other criteria? Market bottoms in 1932, 1949, and 1982 did so.
Are valuations supportive of a new bull market? You hear this question less often, but it is a major improvement upon the question above. The hard part derives from the fact that average valuations change from era to era and valuations for the market as a whole are based on operating results which may for various reasons be misleading. How do you factor in profit margins? There’s also the impact of interest rates in determining what future cash flow is worth? At the best buying point ever, July 1932, valuations didn’t help much because backward looking earnings were terrible. The bottom in 1932 just happened when everybody who wanted to sell had sold.
What would I do differently if I knew the answer?
Nothing. Doing nothing is not as passive as it sounds. It assumes that you have a diversified portfolio including adequate cash and near cash reserves. Warren Buffett did this the easy way with the money he left in his will for his wife. It’s 90% in the S&P 500 Index Fund (VFIAX) and the rest in Treasury Bills. You could choose to employ an index tilted toward value or growth. If you have studied the market for years you can assemble a portfolio of individuals stocks or ETFs. Your benchmark should reflect your personal risk tolerance and your personal goals. You should stick with your portfolio through ups and downs.
2. When Will The Federal Reserve Stop Raising Rates?
Answer: I don’t know.
Explanation: There are too many contingent events between now and then, and even if I had a crystal ball printing out future economic data, that would not put me inside the head of Jay Powell and other Federal Reserve Board voting members.
What would I do differently if I knew the answer?
You don’t need to know when the Fed will stop raising rates to take an action. Pay attention to what the Fed is actually doing right now. Raising short term rates is the easiest thing for the Fed to do and the action which has the most immediate impact. For you as an investor this creates an immediate low risk opportunity. I wrote about it here. My suggestion at the time was to get into short Treasuries starting at 50% of what you might eventually deploy. The most recent posting of Treasury Rates, available here on Daily Treasury Par Yield Curve Rates, shows that you can now buy short term Treasuries with returns over 3% at all Treasury maturities from 6 months through 30 years. Here’s the Treasury line as of the most recent close as I write this:
| 1 mo | 2mo |
3 mo |
6 mo | 1 yr | 2 yr | 3 yr | 5 yr | 7 yr | 10 y | 20 y | 30 y | |
| 08/23 | 2.28 | 2.60 | 2.80 | 3.21 | 3.29 | 3.29 | 3.35 | 3.18 | 3.14 | 3.05 | 3.49 | 3.26 |
That single line lays out the opportunity. Every maturity starting at 6 months offers a yield in excess of 3%. My suggestion is a bond ladder with equal amounts invested at an interval of your choice and extending to a maturity of your choice. It’s not like a stock decision where you are right or wrong, early or late. You can shape the choices you make to your own needs. If you want to bet in the direction of yields going quite a bit higher you can keep your maturities and ladder intervals short. If you think the current yields are likely to be about as good as it gets you may want to buy some longer maturities. The yields aren’t very different from 6 months to 30 years. I bought short maturities mostly within 2 1/2 years along with a bit at 7 years. I also kept some cash.
Here’s the headline: You haven’t had a chance to put together a Treasury ladder like this in over a decade. The Fed seems pretty much locked into a hike of .75% at its next meeting. If you have been sitting in cash wishing bond yields were high enough to contribute meaningfully to your portfolio, this is it. It’s finally giving savers a decent chance. An assured rate of 3% with flexibility to respond to future rate moves feels like a gift. It’s a nice bump up in total portfolio return without adding risk. Think through your options and preferences. You may miss the top in yields, but you can’t go far wrong. It’s a gimme. Take advantage of it.
3. When Will Inflation Peak?
Answer: I don’t know.
Explanation: This question is linked to Question 2 above and is equally hard to calculate. Major inflation has appeared several times in US history for a variety of reasons. It is often linked with specific events including wars, the oil shocks of the 1970s, and the combined monetary and fiscal policies designed to prevent a severe recession stemming from the COVID lock down of the economy. The causes of some past eras of inflation are still debated by economists and historians.
A better question might be to ask where inflation might settle in the long term. The answer would contain helpful insight as to whether the last few years represented a generational turn of the tide toward the long term average of 3% inflation. Or is it just a blip after which we will ultimately settle back to the 1.5-2% level of the decade leading up to 2020?
The US Treasury market provides an estimate of future inflation five days a week. To check it out just subtract the real yield of TIPS from the yield of ordinary Treasuries of the same maturity. The market’s current 5-year inflation expectation is by that calculation is 2.82%. Using 10-year TIPS and ordinary Treasuries the 10-year inflation expectation is 2.62%. That’s more than it was for most of the decade before 2021 but less than the 100-year average. It suggests that inflation will soon decline and continue to slide down gradually going ten years our.
That should provide some comfort to those who fear that inflation will stick to 8-10% for many years. The cumulative weight of all Treasury trading says not to worry about that too much. Of course, the Treasury market shifts its bet continually, sometimes by double digit moves in basis point during a single session. For what it’s worth, the market bet implies that inflation rates will need to begin falling pretty soon.
What would I do differently if I knew the answer?
In terms of action the only action I take specifically to address inflation is buying the max in I Bonds every year. This year I also used the Gift Box to add to the total, and I may do so again in September. We may be nearing the end of a golden moment for I Bonds when it is possible to start with a first year return over 8%, but even at much lower rates I Bonds are the best deal around. I will write more on this sometime in October when we have solid information telling us what I Bonds will provide over one year. Watch for that article. I’ll try to discuss potential actions from many angles.
4. Where Are Oil Prices Headed?
Answer: I don’t know.
Explanation: For a brief moment in 2020 the price for West Texas Intermediate immediate expiration dropped below zero. Earlier this year WTI crude traded between $120 and 130. You can’t exactly say that either price was wrong, but you might guess that those prices bracketed the extremes barring some new and extreme event. If you wanted to estimate what normal times might look like – always risky with energy – you might take a price like $80 per barrel of oil equivalent within a band plus or minus 25%. It’s like the weatherman’s reluctant estimate of weather for the D-Day invasion: useless, he said, but command insisted you had to have one for “planning purposes” (read Kenneth Arrow).
What would I do differently if I knew the answer?
There’s another way of looking at oil prices. Low prices have already produced consolidation in the industry, as in Occidental (OXY) buying Anadarko, and the oil majors have shown discipline so far in refusing to increase production. They have instead improved their balance sheets and rewarded their shareholders. At the low in November 2020 oil stocks were constituted less than 2% of the S&P 500. Oil stocks have doubled this to 4% since then, but they are still dirt cheap by every measure. They will make solid profits if the oil price over the next few years spends most of its time in that large $60-100 band. Most investors should own some.
5. Is Bitcoin A Buy Right Now?
Answer: I don’t know.
Explanation: Bitcoin is worth something between zero and the value of all currencies in circulation. At any given moment it’s worth the price at which bids and offers intersect. There is no way to establish valuation by any of the standard approaches. Bitcoin is like a lottery ticket. When you buy a lottery ticket it’s worth the product of the payoff and the very low probability of holding the winning ticket. The following day it’s worth zero for almost all players. There will be a winner but there’s a high probability it won’t be you.
An Amazon Prime show my wife and I watched for a season (Outlaws) involved a motley group of Brits who get hold of a lot of cash stolen by criminals and launder some of it by gambling in a casino and cashing out after small losses. The hit show Ozark sort of worked that way too and I still haven’t worked out whether the main characters were heroes or villains. Criminals are happy to accept small losses to launder their money. So far that’s probably the primary use for Bitcoin. I do have a suggestion for the Bitcoin big shots. They should cut a deal with state and Federal agencies to accept close supervision in return for paying both governments 2% or so on all Bitcoins mined or changing hands. All current Bitcoin holders would be required to pay these fees on their present holdings or face criminal charges. Oh, and the fees would be before income taxes. The governments would jump at it and defend Bitcoin’s existence as they do with lotteries.
What would I do differently if I knew the answer?
I twice bought a single ticket when the payoff reached the billions. I wanted to see what, if anything, God really thought of me. Not much, I guess.
6. Are We In A Recession? Are We Headed For One?
Answer: I don’t know.
Explanation: Weak housing and some inventory problems for large retailers give a maybe yes answer. Most employment data so far say maybe no. Corporate profits and GDP are open to interpretation. If you are at risk of losing your job you have to keep the possibility on your radar. You should consider your survival alternatives and come up with a plan. If you have a diversified portfolio you should pay less attention to the market on a day to day basis so that you aren’t tempted to do dumb things.
What would I do differently if I knew the answer?
Nothing, or nothing much. I always sell losers in my portfolio for the tax loss. I usually buy them back cheaper in a month or two. Sometimes I buy something I have come to like better. Recessions are often good times to upgrade your portfolio. You might write down a policy for actions you will or will not take in the event of a recessionary bear market. If you own shares in strong and resilient companies you will do fine in the long run.
7. What Non-Obvious Events Are Likely To Have An Impact On Your Life?
Answer: I don’t know.
Explanation:
Anything can happen, even the nuclear war I discouraged my first wife from thinking about. Warren Buffett framed the question this way in 2016: “What’s a small probability in a short period approaches certainty in the longer run. If there is only one chance in 30 of an event occurring in a given year, the likelihood of it occurring at least once in a century is 96.6%.”
There’s a counterintuitive positive aspect to this. The probability doesn’t accumulate but resets every year. Warren and I should both be a little less worried personally about nukes with every passing year. Nukes are running out of time with us. Unfortunately, we have to be more worried every year about all the other things that could do us or our portfolios harm. That’s how you have to think if you work in the financial area.
What would I do differently if I knew the answer?
About thirty years ago my best friend asked me to look over his investments and see if they made sense as a retirement portfolio. His name was Sandy. Our friendship was grounded in tennis, and we played practice matches about four times a week and often went to tournaments together. He owned quite a bit of a utility fund so he wasn’t diversified. It made a certain sense, however, because he ran a growing short haul trucking company which was somewhat sensitive to the economy. He spent his days matching truck drivers swear word for swear word and the two of us generally communicated with each other in a language you might call Low Locker Room. After the 1987 Crash he helped me considerably by telling me that his business was fine and he couldn’t imagine an economic collapse any time in the foreseeable future. I was more than happy to look over his investments.
I gave my pal Sandy an assignment. I told him to take a sheet of paper and write down the important things that had happened in the world since he was old enough to be aware of them. These included the Korean War with the battle line drawn daily on the first TV his family owned, the Cuban Missile Crisis (some of my college classmates hunkered down in the underground tunnels connecting dorms), Vietnam (in which I participated), and the aforementioned 1970s inflation which made a huge number of Americans believe that the world had ceased to work in a way they understood. Mao, Brezhnev, LBJ, Nixon, Carter, and finally Reagan occupied center stage and exited on the right. The Doomsday Clock in the Bulletin of Atomic Scientists bounced around within a few minutes of midnight.
The 1970s’ near-hyper inflation was the major economic event for each of us. We each had one divorce. We both had children. I told him that the past 40 years were not unusual. They were normal. Stuff like that would probably happen in the next 40 years, it just wouldn’t be the same stuff. He made up his list. I suggested a couple of Vanguard funds for new money but suggested he keep his utility fund rather than pay cap gains taxes. Diversifying against your own personal job became one of my chief precepts when I became a financial advisor a few years later.
The most dangerous thing we did turned out to be playing tennis without shirts. We did it mainly to provoke the lady who tried to maintain standards at the local public tennis courts. About a decade after my buddy Sandy made that list he was diagnosed with a melanoma. His doctor told him to go home and make a will. He fought it bravely for several years, was still lifting weights and hitting a couple of my easy tennis lessons for exercise when he suddenly walked up to the net and told me he couldn’t see anything on the right side of his head. The future projected on that list left his widow in a good place financially. She waited a few years and remarried. Nobody was ever going to be quite like Sandy, and I’m pretty sure she knew it.
Non-obvious events are just another set of things about which we must admit we don’t know. OK, keep your shirt on, wear a hat, use strong sunscreen, and with luck if you start today you’ll get away with Moh’s surgery on basal cells and squamous cells. I have so far.
My Best Advice For Readers
Take out a sheet of paper, look back as many years as you think you might still have going forward and draw up your own list. That list contains what your future is most likely to look like as far as external events are concerned. Fit yourself into the equation if you can. Cultivate good habits.
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