17 Oct 2023
The return of risk: “Higher for longer” disrupting both stocks and bonds
Something important has changed. 2022 may prove to be a year that signifies the end of the easy money era and the beginning of a new reflation era. As we enter the fourth quarter, many may have thought that we would have had inflation licked by now and would be returning to a time of easy money. One year into the Fed’s rate hike campaign in earnest, “higher for longer” appears to be the new mantra. The economy is stronger than expected, and inflation is stickier.
Consequently, interest rates in the marketplace – those controlled by investors – rose last quarter as investors sold high-quality and longer-duration bonds again. So much for extending duration.
THE POPULAR ASSETS OF S&P 500®, NASDAQ, AND AGGREGATE BONDS ARE BELOW 2021 PEAKS.
Source: YCharts. Data as of September 30, 2023.
Stocks don’t like higher interest rates either, as rising borrowing costs negatively impact corporate prospects. And it is the longer-term interest rates that rose last quarter that have the most impact on borrowing costs, as mortgages and business loans tend to be long-term. Thus, the third quarter represented a return to risk, as both stocks and bonds declined in unison again. When interest rates are the problem, stocks and bonds tend to be correlated on the downside.
What has changed?
Unless you live in a cave (sorry to offend any cave dwellers), you are well aware that the Fed has been on a steep campaign of raising the Fed Funds Rate to combat inflation. This has caused the yield curve to become inverted, as rapid Fed tightening pushed the short end of the yield curve higher while longer-dated yields rose to a lesser degree. The inverted yield curve signifies the battle between the Fed and investors. On one side, the Fed claims that inflation is higher for longer, and on the other, investors are implying that the Fed is wrong and that interest rates will soon return to their resting place of yesteryear.
U.S. TREASURY YIELD CURVE: DE-INVERTING
Source: YCharts. Data as of September 30, 2023.
Last quarter, though, a tiny shift in the yield curve occurred, which could be construed as a sign of major consequences. What looks like an inconsequential rise of long-dated interest rates from about 3.9% to 4.6% could signify investors throwing in the towel on the inverted yield curve and, in effect, accepting that higher for longer might be here to stay and that the Fed is not fleeting.
A tectonic shift or a return to easy money policies?
Leading up to 2022, interest rates had been falling for about 40 years and seriously repressed for the prior 13 years. History would imply, though, that the easy money policies post the Great Financial Crisis were anomalous. We are probably not headed back to that era. More often, or more normally, interest rates have been at least 4% for the 10-year treasury. Returning to “normal” likely presents greater risks for the economy and capital markets than we have seen so far. Vast portions of our economy and how people invest are based on a low or stable interest rate environment. Forty years of falling interest rates might prove to be a major and entrenched trend to turn around.
WHAT IS NORMAL? 10-YEAR TREASURY YIELD BELOW 4%, OR GREATER THAN 4%?
Source: Yahoo Finance. Data as of September 30, 2023.
What got you here may not get you there.
The investment industry has become reliant on managing portfolio risk through stock and bond combinations. But what is an investor to do when stocks and bonds become correlated?
Now consider the assets owned the most by investors: large-cap growth stocks and high-quality bonds. Are these assets benefactors of low-interest rates? Not only do low-interest rates help drive the prices of these assets, but they may also impact the relationship between these assets. When interest rates are subdued or falling, stocks perform better if the economy is strong, while bonds perform better if the economy is weak. They work as diversifying assets in a portfolio. However, what happens when inflation and/or rising interest rates are the problem? Inflation and rising interest rates negatively impact both stocks and bonds.
In reality, stocks and bonds have exhibited a positive correlation throughout history. It is just when inflation and interest rates are low or falling that stocks and bonds are uncorrelated.
S&P 500 INDEX AND INTERMEDIATE-TERM TREASURY BOND ROLLING 12-MONTH CORRELATIONS
Source: SBBI. Data as of September 30, 2023.
Going forward, portfolio management – particularly risk management – might require some new thinking.
The longer trends persist, the more entrenched the industry becomes that the past is the only path. At some point, though, capital markets break free of the past and forge a new path. It is at these turning points that portfolio positioning becomes important.
Frontier strategies are managed for the future, not the past – and they’re managed for multiple market environments. Not just the ones we were in and are currently in, but also other possible outcomes.
The breakdown in the inverse correlation of stocks and high-quality bonds specifically leads to Frontier strategies holding differentiated positioning from the “herd.” First off, Frontier strategies are positioned to consider a return to risk. Secondly, we hold differentiated positioning to better combat the changing interest rate and correlation environment. Finally, Frontier strategies are actively managed through time and continually adjusted to extract excess return and maintain risk levels.
Are we in a period of change? Will capital markets return to the trends of yesteryear, or will they forge a new path? Nobody knows for certain the answers to these questions. However, dogmatically holding large-cap growth stocks and high-quality long-dated bonds might have gotten you here, but it may not get you there.
Past performance is no guarantee of future returns. The performance discussed represents total returns that include income, realized and unrealized gains, and losses. Nothing presented herein is or is intended to constitute investment advice or recommendations to buy or sell any type of securities, and no investment decision should be made based solely on the information provided herein. There is a risk of loss from an investment in securities, including the risk of loss of principal. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for an investor’s financial situation or risk tolerance. Diversification and asset allocation do not ensure a profit or protect against a loss. All performance results should be considered in light of the market and economic conditions that prevailed at the time those results were generated. Before investing, consider investment objectives, risks, fees, and expenses. Frontier may modify its process, opinions, and assumptions at any time without notice as data is analyzed.
Envestnet licenses models from Frontier that are used in investment advisory programs sponsored by Registered Investment Advisers. In such programs, Envestnet acts as the discretionary manager for client accounts in the programs. In many cases, Envestnet manages and implements the models as received from the model provider. The performance information included herein is intended to provide you with a general understanding of how the model has performed when managed by Frontier. However, such performance information is likely to be different from the actual performance you would experience should Envestnet make changes to the models or place trades at different times, and also depending on when your account is incepted and when you make contributions and withdrawals.
Information provided herein reflects Frontier’s views as of the date of this newsletter and can change at any time without notice. Frontier obtained some of the information provided herein from third-party sources believed to be reliable, but it is not guaranteed, and Frontier does not warrant or guarantee the accuracy or completeness of such information. The use of such sources does not constitute an endorsement. Frontier’s use of external articles should in no way be considered a validation. The views and opinions of these authors are theirs alone. Readers access the links or websites at their own risk. Frontier is not responsible for any adverse outcomes from references provided and cannot guarantee their safety. Frontier does not have a position on the contents of these articles. Frontier does not have an affiliation with any author, company or security noted within. Frontier reserves the right to remove these links at any time without notice.
Exclusive reliance on the information herein is not advised. This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Assumptions, opinions, and estimates are provided for illustrative purposes only. They should not be relied upon as recommendations to buy or sell any securities, commodities, treasuries, or financial instruments of any kind. This material has been prepared for information purposes only and is not intended to provide, and should not be relied on for, accounting, legal, investment, or tax advice. Frontier does not directly use economic data as a part of its investment process.
Any forward-looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. The estimates, including expected returns and downside risk, throughout are calculated monthly by Frontier and will change from month to month depending upon factors, including market movements, over which Frontier has no control. They are only one factor among many considered in Frontier’s investment process and are provided solely to offer insight into Frontier’s current views on long-term future asset class returns. They are not intended as guarantees of future returns and should not be relied upon in making investment decisions.
Hypothetical expected returns have certain limitations, are discussed for illustrative purposes only and it should not be assumed that actual results will match the hypothetical expected returns referred to. Unlike actual performance, hypothetical expected returns do not represent actual trading and since trades have not been executed, the results shown may have under or overcompensated for the impact, if any, of certain unforeseen market factors. Hypothetical expected returns, whether back tested or forecasted, have many inherent limitations and no representation is being made that any account will or is likely to achieve the results expected. In fact, there are frequently material differences between hypothetical expected results and actual results achieved. One of the limitations of hypothetical expected results is that they do not take into account that material market factors may have impacted the adviser’s decision-making process if the firm were actually trading clients’ accounts. Also, when calculating the hypothetical expected returns, the adviser has the ability to change certain assumptions and criteria in order to reflect better returns. There are numerous other factors related to the markets in general or to the implementation of any specific investment strategy that cannot be fully accounted for in the preparation of hypothetical expected results, all of which can adversely affect actual trading and performance. Importantly, it should not be assumed that investors who actually invest in this strategy will have positive returns or returns that equal either the hypothetical expected results expected. In addition, performance can and does vary between individuals.
In reviewing the performance information presented here, we recommend that you consider both the returns generated and the level of risk that was assumed in generating those results. We believe that performance information cannot be properly assessed without understanding the amount of risk that was taken in delivering that performance.
Frontier provides model strategies to various investment advisory firms and does not manage those models on a discretionary basis. The performance and holdings of model strategies may vary from strategies managed by Frontier.
Inflation is the decline of purchasing power of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. The rise in the general level of prices often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods.
© Morningstar 2023. All rights reserved. Use of this content requires expert knowledge. It is to be used by specialist institutions only. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied, adapted, or distributed; and (3) is not warranted to be accurate, complete, or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information, except where such damages or losses cannot be limited or excluded by law in your jurisdiction. Past financial performance is no guarantee of future results.
It is generally not possible to invest directly in an index. Exposure to an asset class or trading strategy or other category represented by an index is only available through third-party investable instruments (if any) based on that index.
Frontier Asset Management, LLC is a Registered Investment Advisor. Frontier’s ADV Brochure and Form CRS are available at no charge by request at info@frontierasset.com or 307.673.5675 and are available on our website frontierasset.com. They contain important disclosures and should be read carefully.
| ASSET CLASS | INDEX | INDEX DESCRIPTION |
| U.S. Large Cap Equity | S&P 500 / Nasdaq Composite Index | Represents US large company stocks. |
20231017.31356
Past performance is no guarantee of future returns. The performance discussed represents total returns that include income, realized and unrealized gains, and losses. Nothing presented herein is or is intended to constitute investment advice or recommendations to buy or sell any type of securities, and no investment decision should be made based solely on the information provided herein. There is a risk of loss from an investment in securities, including the risk of loss of principal. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for an investor’s financial situation or risk tolerance. Diversification and asset allocation do not ensure a profit or protect against a loss. All performance results should be considered in light of the market and economic conditions that prevailed at the time those results were generated. Before investing, consider investment objectives, risks, fees, and expenses. Frontier may modify its process, opinions, and assumptions at any time without notice as data is analyzed.
Envestnet licenses models from Frontier that are used in investment advisory programs sponsored by Registered Investment Advisers. In such programs, Envestnet acts as the discretionary manager for client accounts in the programs. In many cases, Envestnet manages and implements the models as received from the model provider. The performance information included herein is intended to provide you with a general understanding of how the model has performed when managed by Frontier. However, such performance information is likely to be different from the actual performance you would experience should Envestnet make changes to the models or place trades at different times, and also depending on when your account is incepted and when you make contributions and withdrawals.
Information provided herein reflects Frontier’s views as of the date of this newsletter and can change at any time without notice. Frontier obtained some of the information provided herein from third-party sources believed to be reliable, but it is not guaranteed, and Frontier does not warrant or guarantee the accuracy or completeness of such information. The use of such sources does not constitute an endorsement. Frontier’s use of external articles should in no way be considered a validation. The views and opinions of these authors are theirs alone. Readers access the links or websites at their own risk. Frontier is not responsible for any adverse outcomes from references provided and cannot guarantee their safety. Frontier does not have a position on the contents of these articles. Frontier does not have an affiliation with any author, company or security noted within. Frontier reserves the right to remove these links at any time without notice.
Exclusive reliance on the information herein is not advised. This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Assumptions, opinions, and estimates are provided for illustrative purposes only. They should not be relied upon as recommendations to buy or sell any securities, commodities, treasuries, or financial instruments of any kind. This material has been prepared for information purposes only and is not intended to provide, and should not be relied on for, accounting, legal, investment, or tax advice. Frontier does not directly use economic data as a part of its investment process.
Any forward-looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. The estimates, including expected returns and downside risk, throughout are calculated monthly by Frontier and will change from month to month depending upon factors, including market movements, over which Frontier has no control. They are only one factor among many considered in Frontier’s investment process and are provided solely to offer insight into Frontier’s current views on long-term future asset class returns. They are not intended as guarantees of future returns and should not be relied upon in making investment decisions.
Hypothetical expected returns have certain limitations, are discussed for illustrative purposes only and it should not be assumed that actual results will match the hypothetical expected returns referred to. Unlike actual performance, hypothetical expected returns do not represent actual trading and since trades have not been executed, the results shown may have under or overcompensated for the impact, if any, of certain unforeseen market factors. Hypothetical expected returns, whether back tested or forecasted, have many inherent limitations and no representation is being made that any account will or is likely to achieve the results expected. In fact, there are frequently material differences between hypothetical expected results and actual results achieved. One of the limitations of hypothetical expected results is that they do not take into account that material market factors may have impacted the adviser’s decision-making process if the firm were actually trading clients’ accounts. Also, when calculating the hypothetical expected returns, the adviser has the ability to change certain assumptions and criteria in order to reflect better returns. There are numerous other factors related to the markets in general or to the implementation of any specific investment strategy that cannot be fully accounted for in the preparation of hypothetical expected results, all of which can adversely affect actual trading and performance. Importantly, it should not be assumed that investors who actually invest in this strategy will have positive returns or returns that equal either the hypothetical expected results expected. In addition, performance can and does vary between individuals.
In reviewing the performance information presented here, we recommend that you consider both the returns generated and the level of risk that was assumed in generating those results. We believe that performance information cannot be properly assessed without understanding the amount of risk that was taken in delivering that performance.
Frontier provides model strategies to various investment advisory firms and does not manage those models on a discretionary basis. The performance and holdings of model strategies may vary from strategies managed by Frontier.
Inflation is the decline of purchasing power of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. The rise in the general level of prices often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods.
© Morningstar 2023. All rights reserved. Use of this content requires expert knowledge. It is to be used by specialist institutions only. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied, adapted, or distributed; and (3) is not warranted to be accurate, complete, or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information, except where such damages or losses cannot be limited or excluded by law in your jurisdiction. Past financial performance is no guarantee of future results.
It is generally not possible to invest directly in an index. Exposure to an asset class or trading strategy or other category represented by an index is only available through third-party investable instruments (if any) based on that index.
Frontier Asset Management, LLC is a Registered Investment Advisor. Frontier’s ADV Brochure and Form CRS are available at no charge by request at info@frontierasset.com or 307.673.5675 and are available on our website frontierasset.com. They contain important disclosures and should be read carefully.
| ASSET CLASS | INDEX | INDEX DESCRIPTION |
| U.S. Large Cap Equity | S&P 500 / Nasdaq Composite Index | Represents US large company stocks. |
20231017.31356