Notes from the CIO - SAM Mark Mowrey, CFA

This session, I ponder the motivations of and position our work against the "do this now!" punditry.

In this podcast, I provide some early glimpses of the power of artificial intelligence in practice. I also discuss some concerns I have for the technologies' broader usage in investment management and allow Microsoft's CoPilot to chime in.

Cash holdings may provide comfort, but inflation diminishes the value of uninvested cash over time. Outside of purchase delays and product substitutes, there is little more consumers can do to directly address inflation. Investors, on the other hand, have a range of options to address that potential drag. The greater the expected return of a portfolio, the potential greater success one may find in achieving financial goals, which may specifically include seeking to beat inflation. The constant caveat applies: the more return we seek the greater the risk we might not achieve that expected return:









* Short-term Treasury securities may offer a reasonable alternative to plain old cash. But generally relatively low expected returns may mean they at times do not keep up with inflation







* Stocks historically have provided among the strongest total returns across all asset classes, normally offering a substantial cushion against inflation. But stocks are volatile, and may see losses even over long periods







* With bond yields now at multi-decade highs, investors need not see relative safety as a zero-gain alternative to risky stocks. Still, with time, stocks may provide relative returns commensurate to their incremental risk









202309 SAM CommentaryDownload







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Inflation: Risk of Doing Nothing







Fair to suggest that a minimal expectation for any investment strategy is to maintain purchasing power over time, implying returns in excess of inflation (a positive “real” return). While that goal might seem straightforward enough, achieving it isn’t always so simple. To wit: for the better part of the last 15 years, U.S. inflation, as measured by the year-over-year change in the Consumer Price Index, ran hotter than the yield one could earn buying 1-month U.S. Treasury bills. With short-term bond yields now comfortably above latest U.S. inflation figures (consumer prices roses 3.2% year-over-year in July, versus a 1-month Treasury Bill yield of 5.3% at the end of June), investors can take on very little risk while seeking to ensure their savings maintain purchasing power. That short-term Treasury yields are higher than concurrent inflation marks a return to a relatively more normal situation: As we show in Figure 1, 1-month Treasury returns were above inflation just under three-fifths (57.8%) of the time since 1949.















Investing: Risk of Doing Something







Over longer periods of time, the rate of success improves. While a “most, but not all the time” success rate might fail to inspire confidence, one must remember that T-bill investors are assuming very little risk. There are various ways to address inflation more directly in portfolios, including the purchase of inflation-protected securities and inflation-targeting hedges. But such strategies may come with their own unique set of considerations and risks and may at best only directly offset inflation, rather than provide meaningful “real” gains.







As is generally the case when one seeks higher returns, “beating” inflation likely requires that investors assume greater risk. Equity investments may offer among the more straightforward options available to outgrow inflation. Looking back to Figure 1, while stocks achieve about the same rate of success over 1-month ...

So long as one did not carry too substantial an amount of interest rate risk in portfolios, markets provided a solid foundation for generally positive returns over the past quarter and year. While fixed income returns have yet to register the now higher yields on offer (recall that yields up = price down in bonds), global stocks took off from the October bottom.







“Despite all that” is a common refrain when discussing stock performance over the past year. Though they fell behind in May, developed-market stocks nearly matched the performance of U.S. stocks. Emerging-market equities languished over the trailing twelve months.







In the States, Large-Cap Growth stocks once again took the lead last quarter, adding to substantially stronger gains for the prior year, during which time Growth generally outperformed Value across all sizes of stocks. Meantime, Value turned in a better quarter abroad, while coming in close to Growth over the prior twelve months.







Turning to fixed income, rates have proved remarkably volatile so far in 2023 as investors on several occasions seem to have been caught wrong-footed relative to evolving macroeconomic data and potential shifts in monetary policy. But the general trend was higher, leaving much of the domestic investment-grade bond market in the red for the trailing 3- and 12-month periods. Nonetheless, generally narrower credit spreads helped offset the impact of rising rates on corporate bond returns.







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2023Q2 SAM Quarter In ReviewDownload

While it’s understandable that investors may get excited about future prospects of new industries and business models, that enthusiasm may need to be tempered when it comes to the associated investment cases. Early investors may see substantial gains from the immense risks they took on when potentially grand success was merely imagined. But even later buyers-in may be arriving when measurably optimistic prospects are still baked into the valuation pie. Past examples of the resulting heartburn may provide reason for caution:









* Market history is strewn with examples of investors rallying around emergent business themes, only to find their return expectations to have proved wildly optimistic. Disappointing outcomes may be especially acute when investments are concentrated across relatively few participants in the new models







* Perhaps better to spread investments across a wider range of potential future winners from yet unforeseen advantages than buy into an already widely priced-in story







* Though it may seem painful in the short-term to have not fully participated in hyperbolic gains, more rationale perspectives may lead to improved longer-term outcomes









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202306 SAM CommentaryDownload







So Top Heavy







One can argue that the outsized gains experienced by its largest stocks over the past few years have seen the domestic equity market become a good bit less diversified. Rising from near a tenth of the U.S. market in early 2016, the five biggest names in terms of market capitalization now account for more than 20% of the broadest market exposure and represent an even higher concentration when one looks at large-cap stocks alone. Definitionally, that heavier concentration may have allowed some investors to benefit from the gains that have led to that declining diversity. One naturally wonders, though, to what undue risks might the ongoing ownership of these now far weightier names expose investors. As with most things in investing, the answer must be a nuanced one. From our perspective, the ongoing risks are less about the size than they are about how that size has come about. Most meaningful: what happens if the optimistic investment themes that have been driving some of what we see as excess returns fail to meet expectations?















Imagine an Ill Wind…







Given the expectations reflected in the current valuations of these large-cap, mostly technology-oriented names, we don’t doubt that investors in any one or all of the current Big-5 U.S. stocks could experience future disappointment. Such are the natures of corporate, industry and macroeconomic cycles. One need only review the jostling about for fifth position on that top-5 list to find a fine example of the consequences of a failure to achieve growth-oriented goals implied by a soaring stock price and accompanying valuations. Then arguably reflecting a “they’ll own the whole car market!” narrative, Tesla (TSLA) shares traded near $410 in November 2021. Investors who piled in on the way from $200 to $400—now that the stock made a round trip from that prior peak—may have learned the lesson that high multiples require lofty goals to be met for the stock just to stay still. Further gains require even loftier goals be set and eventually achieved.

Over the four-plus decades since Americans last braced against a high-inflation environment, investors have seen interest rates sink to fresh lows and rise to lower peaks with each successive economic cycle. Rates are well off recent depths on account of ongoing efforts to ease upward price pressures, bringing positive and negative impacts along with:









* The objective of the “tighter” monetary policy being pursued by the Federal reserve is to pressure the economy in various ways in order to inhibit growth, dampen employment and, thereby, ease inflation







* But higher rates may bring benefits, too. It’s been a long time since we’ve been able to look to bonds as much or more for their expected return as we have for their tendency to suppress overall portfolio volatility







* More generous yields may help investors meet return- and risk- specific targets







* Nonetheless, as ongoing woes within the banking sector demonstrate, the rapid shift higher in interest rates has left some market participants overly exposed to potential losses from the forced sale of bonds now underwater on account of those now higher yields









202304 SAM CommentaryDownload







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Out of the Valley







In each of the three major market crises since the turn of the millennium—the Tech Bubble, the Great Financial Crisis (GFC) and the COVID-19 Pandemic—the Federal Reserve pushed interest rates lower to foster an investment environment more amenable to growth-as-cure remedies. As the sharper impacts of those crises abated, the Fed sought to withdraw its theretofore extraordinary market support. Prior to each subsequent dislocation, though, interest rates never returned to their prior “normal” before realizing new lows on account of even more creative and aggressive attempts by the Fed to maintain proper market function and provide a foundation for macroeconomic stability. By the summer of 2020, rates on U.S. Treasury securities languished at levels not seen in history. Among the consequences of those paltry yields was the increasing inability of savers to look to bonds to generate income.















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Post-GFC, various forces left the Federal Reserve (and other central banks around the globe) concerned about deflation, or insufficient upward pressure in prices, which is thought to hamper macroeconomic growth. We’re collectively still learning about these forces to this day, but the list is thought to include increased regulation of the financial sector and the sobering effects, including heightened fiscal austerity, that tend to come along with financial crises.







Conversely, the path to “normal” interest rates after the pandemic has seen central banks fighting burdensome levels of inflation, or too much upward pressure on prices. We’ll similarly for years be pondering aloud the drivers that have resulted in the highest rates of inflation the U.S. has experienced since the early 1980s, with the list of influences currently thought to include easy-for-too-long Federal Reserve policies and way-too-generous fiscal responses to pandemic-related macroeconomic issues in the form of cash handouts, debt repayment delays and outright forgiveness.