This week we want to touch on two topics: first, the current stock market pullback and second, our recent shift in public fixed income holdings.
The stock market has had a rough couple of days, continuing its recent pullback since the middle of July. As of writing this note, the global stock market has fallen just under 6% since its most recent peak.
While some may be feeling nervous, so far this decline is fairly normal. Since 1980, the stock market has had intra-year drawdowns of between 6-10% almost every year. in all but 8 of those 45 years, the markets delivered positive returns for the year.
Honestly, we’ve been expecting the markets to take a break from their relentless rally this year. For some context, even with the recent decline, the global stock market has returned nearly 12% this year.
We’ve been saying for months that the markets may have gotten ahead of themselves based on elevated investor sentiment, surging inflows into stocks and extremely high growth expectations.
By mid July, sentiment was deep into euphoria territory. This steady increase pulled a lot of money into the market as investors feared missing the next big move.
We think the elevated sentiment and the subsequent buying flows have been driven by pretty high growth assumptions. Hopefully this recent drawdown will inject some reality back into the market growth assumptions.
Moving to topic two. Most of you will have noticed several trades in your accounts this week. The bulk of that activity was due to a shift in our public fixed income holdings.
This year we were positioned to take advantage of declining interest rates. Our public fixed income investments were structured so that our duration (sensitivity to interest rates changes) was more than the broad bond market. Our duration was closer to 7.5 vs the benchmark of 6.0.
Since early May, the 10 Year Treasury Yield has fallen by nearly 1% to 3.8%. We think that this level of yield is too low now and wanted to shift our duration.
With these recent changes, we’ve moved to 5.5 duration with a nice caveat. In certain types of bonds, duration changes based on the direction and level of interest rates. This is due to features in the bond indenture such as callability, prepayment, etc.
We’ve invested in a new fund that has a very unique asymmetric duration profile. We estimate that if interest rates rise our duration will be 5.5 but if interest rates fall, our duration will be closer to 7.1. This allows us to protect the portfolio from rising interest rates but still capture the benefit of falling interest rates. We’ll share more information about this fund in a future note.
