Much of our time here at Nottingham is spent working with our clients with an eye to the past, examining what happened to portfolios over the last quarter, last year, or the past 3 to 5 years. While we consider it time well spent, ensuring we stay on the same page with our clients, focusing on the past does often bring into play what behavioral psychologists refer to as hindsight bias. This can be a fairly common phenomenon that causes one to think they can accurately predict market movements before they happen, and can often lead to ill-advised decision making. For instance, when reviewing portfolio returns for 2022 we might hear, “Gosh, I just knew the market was going to fall”, or “This decline is going to continue for some time, I just know it”. The less technical term for what we’re talking about here is the “shoulda, woulda, coulda” syndrome.
While studying the past is indeed valuable, and crucial to understanding how markets can behave, it is the study of the future that equally informs our decision making process here at Nottingham. As we go to press here in Q4, there is little we can do about the dismal returns across asset classes thus far in 2022. It truly is a year for the record books in many ways, few of them positive. And, as much as this year’s results may bias us towards adopting a more conservative outlook, we can’t help but think there are areas of the market that look historically cheap, and many areas that are cheap-er than they have been in some time. Therein lies the challenge for investors today: in the face of disappointing results thus far in 2022, do we have the courage to invest in areas like Europe or the Far East, where valuations are incredibly attractive, but the news is nearly all bad??
Or, should we hunker down, conserve our cash, and wait until the market gives us the “all clear” signal? While safer, the problem with that is there is no “all clear” signal for investors. Successful investing often requires a degree of uncomfortableness while one is putting money to work. Personally, and based upon my 25+ years in the bond business, I think 10-year AA-rated municipal bonds yielding 4% (tax-free remember!) are very attractive. The yield on those securities just a year ago was roughly half that! However, if inflation stays hot, the yield on that bond might rise to 5% over the next 6 to 12 months. How would I feel then if I bought that bond today? Should I wait to find out, only to possibly see the yield fall again to 2%? Damocles should be so fortunate!
Seriously, though, these are the decisions we face and discuss and debate every day here at Nottingham. Only time will tell if our timing was good, but as students of history we can at least make informed and prudent choices. Our mandate as fiduciaries demands it.
So, with that said, we turn our attention to the future and the chart on the accompanying page courtesy of our friend at Research Affiliates. This snapshot, taken from their (very robust) interactive website, looks at expected 10-year return and risk characteristics for multiple asset classes, based on their assumptions and inputs. There are many firms that do this, including Nottingham, but I like their framework and straightforward charting functionality, not to mention their optimistic estimates for future returns from here. As evidenced in the chart, return and risk are most often directionally correlated – the more risk one takes, the higher the return expectation should be. Looking at the chart, notice the possible range of outcomes for investors across various asset classes, as well as multiple diversified portfolios. As expected return increases (y-axis), the volatility associated with that return also increases (x-axis). Despite illusions to the contrary, there is no free lunch.
If we turn our attention to the top right quadrant, we see noted in red EAFE (that’s Developed International), EM Equity (Emerging Markets) and US Small (domestic small-caps), as three asset classes that in Research Affiliates estimation should earn 10%+ nominal returns over the next decade. In the bottom left quadrant, we see “USA”, that’s domestic cash, earning about 2% per annum. In between are diversified portfolios, similar to what we manage here at Nottingham (and in fact, we occasionally overlay our strategies on this chart and they line up as one would expect). Somewhat consistent with the chart, Nottingham has touted US Small cap as our “best idea” over the past few months, and continue to think they’re cheap on a valuation basis.
The takeaway I would like our readers to glean from this is, based upon valuations today, and estimates for future global growth, equities may provide investors with historically solid returns in the years ahead. Secondly, given geopolitical uncertainties, as well as inflationary challenges here in the US, diversification will likely reward investors handsomely over time. All the negative news we read about every day (inflation, war, inequality, pandemic, geopolitics) in theory gets incorporated into stock prices in real-time. Thus, we can assume that all the “bad news” is priced in. What would happen to stock prices if earnings hold up better than expected? What if inflation has peaked and is poised to start falling? What if growth slows to the point where the Fed needs to cut interest rates in 2023? The answers are all unknowable at this point, but also NOT priced into stocks! In other words, a little good news could go a long way.
So, as we review past performance and discuss asset allocation, it’s important to try and keep an eye towards the future. We may not have seen the bottom yet for equities (or maybe we have). Interest rates may not have peaked yet (or maybe they have). Either way, the future prospects for well-diversified portfolios remain far better in our estimation than at any point in the past few years due to the extreme valuation adjustments we’ve experienced. Volatility may not ebb any time soon; however, for the bold long-term investor, we feel both stocks and bonds are offering a more compelling entry point than we’ve seen in recent memory.
We recognize that “hope” is not a very compelling or viable investment strategy. Experience dictates that investors should follow a sound and detail-oriented financial plan in order to increase the odds for success. Courage and acumen are two key components to achieving that success. Nottingham’s investment strategies and financial planning tools are designed to help our clients improve their odds of achieving their long-term goals. Please let us know how we can help you, as we navigate through this volatile time together.
Larry Whistler, CFA
Larry joined Nottingham in 2006 and heads the Investment Policy Committee, along with portfolio and relationship management responsibilities. Prior to joining Nottingham in 2006, Larry worked as an independent RIA for two years, and before that spent a decade as a bond trader for Merrill Lynch Capital Markets in Los Angeles and New York City.
Nottingham Advisors offers both institutional and individual clients experience, sophistication, and professionalism when helping them achieve their goals. With over 40 years of serving Western New York and clients in more than 30 states, Nottingham tailors each solution to fit the specific needs of each client.
For more information about Nottingham’s offerings, visit www.nottinghamadvisors.com or call 716-633-3800.
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