Investing for the Good and the Bad

Negativity bias is a very well documented and understood phenomena and yet few of us recognise it in ourselves. It explains why a commentator calling for a property or share market crash will always get airtime and why the call for a rush to fixed rate bonds because the economy is about to crater has such strong effect.

After the Fed pivoted in mid December 23, the US 10 Year bond yield dropped by 0.40% into the end of the year based largely on a hunch that the reduction in rates would be too late for a slowing economy. The US had already had a inverted yield curve for around 18 months, a phenomenon that had almost always occurred before a major slowdown. Of course rates rose pretty aggressively since the market made that early call costing bondholders plenty. Where did the slowdown go and why is the bond market doubling up again despite all evidence to the contrary?  

My favourite ever “textbook” is Daniel Khaneman’s Thinking Fast and Slow. It has unlocked for me what was always in my behaviour set, but now I am better able to recognise subliminal habits. I now try to focus on situations objectively rather than dragging on with the lazy quick response I am famous for. The bond market is still thinking fast and maybe needs some time to reflect on what will actually occur.

When we invest we often look at historical markers which anchor us into a relativity or return paradigm. How many times in the last 10 years have you heard or read someone ironically deriding the idea that “this time it’s different?” The bond versus equity correlation outcome for most of those 10 years should be telling us that maybe this time it is. On the other side of the coin, despite a widespread belief that GDP growth is likely to be systemically lower that we experienced in the 50 years since the end of the Korean War, investors are still keen to allocate 60-80% of their retirement savings to equities.

Many of those investors would be very satisfied with a return of 7-8% from their savings pool over the next decade. In fact if fully reinvested in a low tax environment (superannuation for example) over those 10 years, a 7% investment will double those savings. Equity markets might achieve this but we can be almost certain that there will be a roller coaster ride along the way. If the negative bias bond markets are showing is (eventually) right, there will be a big drawdown on the way to that doubling.

While we talk about the negativity we are attuned to hear most loudly, I am going to take a few items from an article in The Sunday Times entitled “54 good news stories you may have missed in 2023.” I cannot remember a time when the chatter wasn’t that we are in troubled times, it seems a perennial if lazy trope. I will kick off with the news that a baby beaver was seen in London for the first time in 400 years as a programme of rewilding came to fruition. In a similar vein, pilotless drones are dropping eucalypt seeds in difficult locations in order to return burned out koala habitats.

China CO2 emissions are set to drop in 2024 for the first time. In an example of humanity’s ability to remediate the environment, according to a study backed by the UN, the hole in the ozone layer is on track to be largely healed by 2040. In positive news given today is Jane McGrath day at the Sydney Pink Cricket Test, “the number of women who die from breast cancer within a few years of diagnosis has fallen by two thirds since the 1990s. More than 90 per cent of women in England who are diagnosed with early-stage breast cancer now survive for five years or more.” Another positive marker is that global under 5 year old child mortality rates are down by 59% in the space of a single generation. Amongst other positives, the percentage of the world’s population living in extreme poverty is now 8.6% according to the IMF, the lowest proportion in human history.

None of the above absolve us from doing more. It also shouldn’t stop us from recognising that the situation is often not as dire as our brains tell us it is. From an investing point of view thinking slow as well as fast will help us break out of the old paradigm and the 60:40 asset allocation with its volatility in both the risky assets and the so called defensive fixed rate allocation. Investing just for the bad or just for the good is equally fraught, we should be striving for balance in all conditions.

In fact I know of a pretty sensible Bond Income Fund that is expecting a return around 7-8% (at current rates) with significantly lower volatility than either equities or bonds. With floating rate exposure to a portfolio of 80% investment grade assets I am finding it hard to think of an investor type who should not consider that sort of fund for a medium term income allocation.