Capital Markets Update and Outlook: October 2023

Welcome everyone to our Capital Markets Update.

My name is Kara Duckworth. I’m the managing director client experience at Mercer Advisors.

And I’m delighted to be joined as well by Don Calcagney, our chief investment officer today.

We have a lot to get to today, but it’s important for us to tell you as we begin that all of the information that we are presenting today is for information only and it should be general in nature.

None of the information that we are presenting today should be construed as personal investment advice or personal financial plan related to your own situation.

Those questions should be directed to your personal wealth advisor at Mercer Advisors.

We have so much information to get to today, but Donna is we were we were preparing for this and then last night as I was watching television. I, I thought of you as being a Philadelphia area area native and seeing the fillies last night not make it to the world series. So I thought you may you may not be having a good morning today, but I I know that was on your mind last night.

You had you had to bring it up. Right? You had to rub it in. So, for for sure. Yeah. I I was up late and, you know, hollering at the TV quite a bit.

So, yeah, you know, it’s, you know, it’s interesting. Yeah, so on the one hand, I’m very disappointed in my phillies.

On the other hand, and and our our audience probably does not know this. This would only people who are, like, economics, nerds would know this. But there’s a theory, a really bad theory that I think is wrong that argues that when the Philly’s win the world series that we we have an economic recession.

And that is so discredited if you just look at the data. But on the plus side, If indeed there’s any credence to that theory, and I gotta admit I’m at least a little bit superstitious.

On the plus side, tells me that we’re probably not gonna have a recession. And I know many of our audience members had that question. It was probably the most popular question. And, so rest assured we probably won’t have a recession now that my Philly’s law will not be going to the world series. So Good to know. That’s how we’re making decisions.

So people know that’s not how we make decisions.

Right? Let’s make sure there’s no no confusion.

Well, thank you all for submitting your questions. I know that we took a bunch of questions in advance of this presentation and we’re gonna continue to be questions live as well. So if you have questions, please go ahead and submit them to the Q and A function that you’ll see on the bottom of your screen so that we can review. But to start off on, we analyzed all of the questions that came in in advance and perhaps you can kind of talk about the trends that you’re seeing and and your comments there.

For sure. And so thank you everybody again for submitting your questions. We we love it when you do that, by the way. It it gives us some insight into what’s on your mind, and If you, can see the the the slide here on the screen, this is a word cloud.

So all we did is we took all of your questions, dropped them into a Google Word generator, And what this does is this this highlights, you know, what’s on people’s minds, right, interest rates, right, recession, bonds, things like that. No surprises here. These are these are topics that are on the minds of all of the members of our investment committee on the minds of our advisors and Certainly, we’ll we’ll talk about these today. But, again, no surprises that these are the major themes that seem to be rising to the top when we look at questions that you all submitted plus also, you know, what we’re hearing from our advisors as well.

So let’s let’s jump right in. Let’s, you know, Karen, I’m gonna kick it off here with about ten to fifteen minutes of prepared remarks, and then let’s just get into everybody’s questions. This is their time, and make sure they can get as much value out of our out of our time together. So just a few high level data points that I think we should touch on is, you know, inflation.

Right? We’re gonna talk a little bit more about inflation here in a moment, but inflation has been driving what has been happening in the economy for the better part of two years. In March of twenty twenty two, the Fed began raising interest rates quite aggressively. We’ll talk about interest rates some more here in a little bit.

Unemployment still remains at near historic lows, and then GDP growth. In fact, just this morning, we received a new GDP report for the third quarter of this year, and it actually came in at a piping hot four point five percent GDP growth. This is the highest GDP growth in two years. So the US economy by any objective measure continues to grow.

And again, we’ll talk some more about that here in a few moments. Data point here that’s a little bit ironic is the consumer sentiment, you know, how all of us are feeling about the economy. The University of Michigan does a survey to try to gauge how we’re all feeling about our finances and the economy. That is still below average, below its long term average, yet it is consumer spending that is really propelling US economic growth at the moment.

So bit of a contradiction there in the data. By the way, this is not new in economics. It’s always really tough to try to figure out what the heck is happening in the economy because the the data often gives us very conflicting messages.

Just a couple of other high level themes that we’ll touch on today is, you know, the Federal Reserve, of course, has raised interest rates quite dramatically over the past eighteen months. There’s this question around g. Are they gonna continue to raise rates? We’ll talk a little bit more about that here in a few moments.

Whether or not the Fed raises interest rates, what we have observed here in the past month, month and a half, as we have seen the thirty year mortgage rate hit a more recent all time high, not an all time high, but eight percent, very high, probably the highest since about two thousand and two or three. So very, very high. We’ve also seen the thirty year treasury interest rate go up quite dramatically. It’s now at just about five percent.

I wanna highlight what’s happening over here, the Federal Reserve. This is the nation’s central bank they have been, reducing their balance sheet. So what does that mean to combat the global financial crisis back in eight zero nine? And then to support the economy for the past decade.

And then again during COVID, the central bank pumped a lot of cash, new cash. Into the economy, and they do that by buying bonds, treasury bonds. Well, the those bonds have been maturing. And as they mature, the Fed has been removing cash from the financial system.

So that’s also pushing up interest rates. So those are just a couple of themes. The rest here, you know, we can perhaps save for another webinar. But what I wanna highlight here is how dramatically inflation has come down.

We’re not there yet. Let’s be very clear. We are not there yet.

But inflation peaked at nine point one percent in June of twenty two. The Fed began raising interest rates in March of twenty two. And since then, it has been pretty much an obvious trend down. Now it is kind of flat lined a little bit.

It’s leveled out. Right? The easier declines were the ones up in here that Fed has a two percent inflation target. So even at a three point seven percent current inflation rate, it’s too high.

Right? And the Fed continues to highlight this. This is one of the reasons why the Fed might, might, raise interest rates. Again, maybe another quarter point, maybe another two quarter point high in the future.

And, again, we can we can tackle that. What I wanna highlight before I leave this lean this, slide is that we are seeing some deflation Right? So inflation as prices are going up. Disinflation is when the growth in prices is declining.

Deflation is when prices are declining. So in energy, we have seen a decline in energy prices. This is, by the way, is not what anybody has really expected given the war in Ukraine, now given the war in the Middle East. So again, just an interesting contradiction again in the economic data, I think relative to what we would have expected.

So let’s talk interest rates.

Just to remind ourselves, the Fed raised interest rates quite dramatically.

Beginning in March of twenty two. And just recently, I think it was July. It was their most recent rate hike. The fed did not hike rates in September. And there’s a debate around whether or not the Fed will raise interest rates again at at the the meeting, in November. At the moment, the market does not think the Fed is gonna raise interest rates in November. I tend to agree with that, but I do think that there is a chance that the Fed raises interest rates sometime in early twenty twenty four.

I wanna highlight the future here. These these dotted lines represent what the market thinks the Fed is going to do.

Over the next couple of years. And the market is this raspberry colored line, and then this sort of baby blue colored line is what the fed, the central bank themselves, predicts their future path of an interest rates will look like. And you can see that they mostly both align in that we think they’re going to go down sometime in twenty twenty four.

I would just caution. There is no law of finance, no law of economics that would lead us to conclude that interest rates should absolutely go back down. And in fact, given that the economy is doing so well, I think the Fed would be hard pressed to justify future interest rate cuts. I’m not saying that it won’t happen. I’m just cautioning that some of these predictions I think are ultimately, flawed and should always be interpreted with a very healthy degree of humility. Alright? So I’d be careful not to put too much stock in these interest rate predictions.

One of the questions that we were seeing a lot in the, in the questions that you all submitted questions around, g, why are interest rates rising? The fed didn’t raise rates in September. Why is it that the mortgage interest rates continue to go up. Why did the interest rate on the thirty year treasury bonds continue to go up? Well, there’s a lot of reasons I think one of the biggest reasons is that the federal government continues to borrow a significant amount of capital from financial markets.

Like I said a few moments ago, the Federal Reserve is reducing its balance sheet. What that means is they are no longer buying bonds issued by the US treasury. Right?

The US Federal Reserve is the largest buyer of bonds, or at least they were historically. They are no longer buying bonds. So what that means is they’re not financing this one point four trillion dollars, in in deficit in debt spending, deficit spending. And in fact, that number came in at one point seven So this was a projection from the congressional budget office, that was off a little bit.

It actually came in at one point seven trillion, very significant government deficit.

The US treasury is financing that now through borrowings from private investors in the marketplace. That pushes up interest rates because there’s only so much capital available to be lent out at any particular time. So that’s one of the reasons why think rates have gone up. Think there’s other reasons.

I think we have political paralysis, obviously, in the House of Representatives at the moment. So there’s these other issues, you know, the prospect of a government shutdown, federal government shutdown. I know that was punted from, late September to mid November. And I think given the paralysis in Congress at the moment, I think it’s gonna be really challenging.

It’ll be interesting to see. I’m not a political scientist full disclosure. I’m not predicting what Congress is going to do but I do think that that that that weighs on markets. Interest rates are high.

The Fed has told us that they’re gonna be higher for longer. And I think all these reasons taken together continue to push interest rates higher, including interest rates on mortgages. So last slide here, Cara, that, that I’ll review, and then we can perhaps open it up for some questions.

What I wanna draw your attention to is really just you know, how markets have done, both in q three, but also year to date. Markets, and by markets, I mean everything. I mean bonds, I mean, international stocks, the whole nine yards, actually peaked at the end of July.

Since July markets have come down a bit, we’ve seen a sell off, that’s partly in response to the fact that interest rates were going up. So as rates were rising, we started to see this sell off in equity markets, around the world, as well as bond markets when when when interest rates go up bond prices come down. And we see that represented here in these year to date returns. We see these slightly negative returns for, US taxable and municipal bonds.

We can talk some more about that here. I’m sure we have some questions, Kara, about some of that. But US equities continue to steal the show. This isn’t always the case earlier this year.

Non US equities were doing very, very well, relative to US equities, but that has since reversed.

But equities for the most part are positive around the world, emerging markets coming in at third place there, but still positive. Through the end of, of September. So this is a year where we saw a bit of a recovery in stock prices relative to returns that we experienced last year, but we’re still waiting to see, bond prices really recover. And I think they will.

Investors are gonna recapture those losses in the form now of higher interest rates, higher yields. These are some of the highest interest rates that we’ve seen in fifteen years. And, you know, I’m sure we’ve got many questions in the queue coming in from clients like, gee, why should I not put more money in in bonds or CDs or something along those lines. And so happy to happy to talk about that.

So, so, Carol, I’ll stop it here, and and, we’ll we’ll open up for some some questions.

So as I’m reading through all these questions that are being submitted done, lots of them. Thank you all for participating.

The one that I’m seeing just rising to the top here is is certainly about recession. Seems that the predictions are that The OS is either already in a recession or is heading into a recession. Can you comment on that if you think we either are or heading heading towards that?

Well, I think as we saw from this morning’s GDP report, by any measure, the US economy is not in a recession. A recession is defined as, generally. This is a sort of a rule of thumb definition, but it’s defined as two successive quarters in a row of negative GDP growth.

Well, GDP growth is, it’s not negative. It is positive. It just came in at four point five percent for the third quarter. So again, not currently in a recession. If we go back to some of the data that I highlighted with my opening remarks, We have historically low unemployment.

Inflation has come down dramatically, but still running pretty, pretty high relative to the Fed’s target. But again, by any measure, the US economy is not in recession.

And I think this is an interesting an interesting and humbling, lesson that we all have to learn, especially those of us that work on Wall Street or work in economics or finance, And that is this recession has been, by far, the most widely predicted recession. Like, there has been basically total consensus across Wall Street, across economists, that we were heading into recession by the four quarter of twenty twenty three. And it seemed very logical. It’s a very strong case. Interest rates had gone up dramatically.

It seemed obvious that the US consumer was going to pull back and not spend given that prices were rising, given that interest rates were going up. I mean, perfectly logical logical case that we’re heading into recession, and yet here we are. Four point five percent highest GDP growth in two years. And so whether or not we’re going into recession is debatable.

I find it hard to believe that the economy won’t slow down when you have mortgage rates at eight percent.

It just seems logical that consumers should pull back given higher interest rates and higher prices.

We have not seen that. We have not seen that yet. In fact, if you look at the details of the GDP report that came out this morning, it is consumer spending that continues to drive the US economy higher.

So at the moment, we’re not in recession. Whether we go into recession is really hard to say. If we do, it it it probably won’t be till the second half of next year.

Just because the US consumer appears at the moment to be so unbelievably strong. It just seems unlikely that we would go from four point five percent positive g to be GDP growth to something that’s negative overnight. That just does not seem like it’s, possible.

So, Don, we’re also getting a lot of questions related to interest rates. I know you commented on what you kind of thought the action of the Fed might be going forward or into the end of next year. So if you’re if you’re maybe comment a little bit on what you think actually is going to happen with rates in the period of time, but I’m also seeing a lot of about mortgages.

And do we think that those are gonna be correlated to Fed interest rates? When do you think those might might be going back down? What whether you’re looking to buy a home or you’re thinking about selling your home, but don’t wanna have to refinance. I know that mortgages in relation to the interest rates are a big topic of of interest.

Sure. And what what I would say let let let me tackle the second half of that question first. Mortgage interest rates absolutely are related.

To short term interest rates that are set by the Federal Reserve. So they’re absolutely related. Right? It’s not a law of physics, but they are definitely related.

As the Fed raises interest rates, it’s logical that mortgage interest rates would continue to rise. So the question then is, well, do we think the Fed is gonna sit tight, or do we think the Fed’s gonna continue to raise rates or perhaps even cut interest rates? That’s the debate. I personally think the Fed raises rates one more time, probably in early twenty twenty four.

And the reason I say that is three point seven percent inflation is still much higher than their two percent target. That’s number one. And number two, the US economy is clearly clearly still firing on all cylinders. That’s not to say that there probably aren’t, not probably.

There there certainly are some troubling, painful areas in the economy I’m thinking of these young families that are trying to buy homes at the moment, but there’s not a lot of supply on the market. So ironically, home prices have remained elevated despite thirty year, thirty year mortgage rates now, topping eight percent. But a lot of that comes back to the fact that there’s just not a lot of supply of housing on the market. You have a lot of lot of families, a lot of homeowners who I think would like to move, but if you’re locked in at a three, three and a half percent mortgage, I think that’s a barrier for a lot of those families to seriously contemplate putting their home on the market and perhaps moving, you know, maybe downsizing or moving from, you know, up north to somewhere down south of warmer climate.

So I think I think we’re starting to see that that’s that’s the problem in the housing market. There’s just not a lot of supply And a lot of this has been a problem that’s been in the works for ten or fifteen years coming out of the global financial crisis. We had too much housing during the first decade of this century. Now we we have too little.

But I do think the Fed raises interest rates one more time given the economy. I do think that’s gonna probably continue to push mortgage rates a little bit higher for a period of time.

Like I said, there’s really no law, physics that says the Fed has to reduce interest rates. We could be in this new interest rate regime for quite a long time. And so it could be a number of years, one, two, three years before we see interest rates come back. The Fed themselves is forecasting that they would be cutting interest rates or that they expect selves to be cutting interest rates in the second half of next year, but let’s be candid. The Fed has the best economic data in the country And even the Fed has a horrible track record of predicting what the economy is gonna do, what markets are gonna do, and what interest rates are going to do. So again, I would interpret all of this with a high degree of humility.

I wanna shift our focus now, Don.

Not not quite so much on the US domestic, but maybe around the world. So we’ve got wars in Ukraine. We’ve got wars in the Middle East. We’ve got tensions with China and Russia.

What do you think investors should make of all of the situation going on around the world that geopolitical risk? Should they be concerned about that?

And your view on an an investing in non US markets.

Yeah. I mean, I mean, I I I think first and, and foremost, you know, we should acknowledge the human dimension. Right? Wars are, in my view, they’re always a tragedy. Nobody wins.

And, you know, wars are the opposite of economic productivity. Right? Wars destroy productive assets. They destroy lives.

And so I think by any measure, you know, it it’s a real tragedy. What’s happened in Ukraine, what’s happening in the Middle East at the moment.

Now when I look at geopolitical risk through the lens of an investor’s eyes, I think there’s a couple things we need to keep in mind. Number one is that the purpose of markets, what markets do, markets are these giant scales that are always weighing information and incorporating that information into asset prices. That could be stock prices, bond prices, real estate prices, commercial real estate prices, even gold and Bitcoin, I would argue, are not immune to all of this information.

That markets are trying very hard to incorporate into prices. Geo political risk is certainly one of those factors that markets are always trying to incorporate into prices. So markets are not blind to what’s happening in Eastern Europe or the Middle East or the tensions across the Taiwan strait.

But markets are incorporating more than that information. Right? They’re incorporating everything from interest rates. What the Fed is going to do.

Markets are incorporating this four point five percent GDP report that we got this morning. They incorporate earnings reports from Alphabet and Microsoft and all of these other all of these other companies. So I think we need to be careful thinking that somehow that there’s one piece of information to buy itself will move markets dramatically. I would argue that there’s lots of things that move markets.

So how should we think about it as investors?

I think markets are very resilient. If we look at geopolitical risk, we’ve had Joe political risk since the dawn of humanity. Right? For those of us that grew up during the cold war, geopolitical risk was always ever present.

Right, during the Cuban missile crisis. Right? Markets actually were very resilient. Right? You would have thought that given the severity of that crisis, that markets would have absolutely cratered.

Well, they didn’t. Right? And we’ve had many geopolitical crises since. We’ve also had other crises.

You know, we had the COVID crisis. Right? March of twenty twenty, April of twenty twenty.

Again, I think markets are pretty resilient. They incorporate this information. I I I hope I pray that those wars come to an end, as soon as possible.

But the reality is geopolitical risk is a is a is permanent characteristic of the human condition and and markets, I think, know that. Now the second part of your question is what do we think of international markets Well, I think when we look at global markets, when you look at global stocks, for example, they are trading at very, very attractive prices relative to their profits.

Right? So a true investor looks at these things. They look at earnings. They look at profits.

Forget the short term trading, the momentum, all of that. Right? That’s speculation. That’s not investing. But when you look at global companies, European companies, for example, are trading at twelve times earnings.

Just to give you some context, US growth stocks, our technology companies are trading at nosebleed valuations.

Twenty five, twenty six, thirty times earnings. We have some AI related companies that are trading at fifty, sixty, sometimes almost a hundred times earnings. So I think when you look at stocks on a global basis, non US stocks look pretty attractive. We haven’t seen really great returns in non US stocks and in quite some time. But again, I think I think when you look at those prices, I think the forward looking opportunity for those looks pretty attractive at the moment, certainly relative to the forward looking returns for certain types of US companies.

You mentioned a lot of the things with how efficient markets are about absorbing information and taking in all of these details. But in contrast, if we look at the news and the headlines and we see political paralysis in Congress and we see high rate interest rates and high inflation and wars and economic problems in China and we’ve got a challenging real estate market and just seems to go on and on and as an invest or you’re kind of thinking, oh my goodness, these headlines are just, wow, so terrible.

And we’ve got a couple of questions here. Is this reminiscent of what we saw in in two thousand and seven leading up to the global financial crisis. Do what do you think about is a market crash coming?

Yeah. I mean, that’s a Put you on the spot there.

That’s a very heavy question.

So if you think about what a market quote what quote a market crash is, it is when there is a substantial dramatic decline in prices across all asset classes, right, around the world.

And look, we’ve experienced that. Right? O o seven zero eight, you know, the morning after Lehman Brothers for bankruptcy. So Raymond filed for bankruptcy on September fifteenth two thousand eight. That was a that was a tough day for those of us that were in markets. At the time. And we, yeah, we were there.

So, you know, I I I think I think history rhymes I don’t think history repeats itself perfectly.

But again, you know, first off, it’s important to highlight that the only news that sells is bad news. Right? Good news does not sell. Right?

And and think one of the privileges I have in in my role is I evaluate all kinds of news. I probably read three or four newspapers every morning. Podcasts. I sit in as a number of conference calls.

And look, there is good news out there, and I know it’s hard to see. And that that it’s never gonna make the front page. Of the newspapers. Right?

And it’s certainly not gonna make the evening news or or CMBC, fast money episode, but there is good news in markets earnings look really good.

You know, these higher interest rates are good for many of our clients who are, on the cusp of retirement Right? I think higher interest rates are a good thing for those of us that have diversified portfolios that don’t wanna just load up on, portfolios that are, you know, overweight global stocks. So I think there is good news out there. It’s hard to see. I don’t wanna gloss over the fact that, yeah, look, there is bad news out there.

But having done this now for close to thirty years, I can tell you there’s always bad news. Right? Even back in the nineties, during the dot com bubble, there was bad news. Right, for those of us that were round long enough.

You know, Russia defaulted on the ruble in September of, I think it was in September ninety eight. Right? And the whole world went into cardiac arrest. Now the fed rest shoot us at the time.

But there’s always bad news, right, whether it be terror attacks, wars unfortunately seem to be a permanent, condition.

For humanity. Right? We had, you know, after nine eleven, we had the invasion of Afghanistan and Iraq and so on and so forth. So, There’s always bad news. The purpose of markets is to incorporate that news into prices.

Right? Cause when there’s lots of bad news, prices logically should go down. And that’s prices go down because we now have to reward investors with a higher future return for assuming these risks.

Right? So, again, markets are incorporating this information. You mentioned political paralysis in Washington. I I think that is a big risk. Ron, I know we punted the, prospect of a government shutdown from September to, to November. So it’ll be interesting to see what happens in the house. Do they get a speaker so who can that person, you know, mend fences and build bridges to hopefully get a deal to fund government, come come November.

But think all of these things weigh on markets. I think without these things, markets would probably be a lot higher than they are today, but I don’t see a crash coming in the in the traditional sense. And one last thing that I’ll finish on Cara is that I do expect that there’s a reckoning coming for certain types of US stocks.

I mentioned those growth stocks, some of those technology stocks that are trading at nosebleed prices relative to their earnings.

It does not logically make sense that they should be trading at those prices given that interest rates have gone up so dramatically. I know many of our own clients submitted questions along the lines of, like, gee, why not just own more bonds with interest rates being so high? Why do I need to the risk of owning stocks. And that’s a great question. It’s a fair question. And our investment committee, we’re always asking ourselves those types of questions.

And, but it the fact that you’re even asking yourself that question tells me that there’s a reckoning coming for some of these stocks that are priced for absolute perfection.

And I do think we see some declines in those companies, over the next, probably over the next twelve months.

So, Don, you mentioned stocks and bonds and diversified portfolios and starting to think about your your asset allocation and how we construct portfolios. And so if I if I look at The results for both stocks and bonds, they were both negative in twenty twenty two. How should investors be thinking about the relationships between What we think of as kind of the the the critically important asset classes, those stocks or bonds, do bonds still provide the diversification power that they historically have?

You know, again, another another wonderful question and one of one of the things that we’re always analyzing. So the way I would encourage our audience to think about the diversification power of bonds is that it is related to interest rates. When rates are really, really low like they were in twenty twenty two, the diversification power of bonds is relatively less.

Alright? And so I I think that’s an important, an important point. Right? But I also think we gotta be careful.

Not all bonds are created equal. And I’ll come back to that point in a moment. I wanna this thought that I had on on interest rates. Now that interest rates are a lot higher, the diversification power of bonds is likewise a lot higher than it was in twenty twenty two.

And that’s because now that you have, for example, US treasury bonds trading at five and a half percent interest rate, The Federal Reserve, if and when the economy faces challenges again, the Federal Reserve has a lot of dry powder now to deal with the next economic challenge. And if the Fed were to cut interest rates, we would see those bonds go up in price. Right? That’s the That’s that’s the good.

That’s the good side of owning bonds when rates go down. And so if the economy is is dealing with some challenges, if stock prices continue to go down a bit, and the Fed needs to get involved, certainly that is, you know, that’s they have a lot more dry powder now than they did in twenty twenty two.

So, so I think the diversification power has improved markedly over the past, over the past year, year and a half.

Now before I move on, I would just I would just highlight that I think it is important to keep in mind that there’s more in the world than just stocks and bonds. There’s real estate. There’s private assets, private equity, venture capital. And so there’s there’s a lot more out there than investors could and should be doing to diversify their portfolio. And so, again, that’s a that’s a conversation clients, should have with their with their with their advisor.

Before we move off of this, topic. I do think it’s important to highlight that not all bonds are created equal. Longer term bonds were hit hardest over the past year and a half. At Mercer Advisors, we invest mostly in very short term bonds, so the way that you immunize or protect your portfolio on a relative basis from interest rate hikes is you invest in shorter term higher quality bonds, and that’s that’s what we’ve done for quite a long time.

In January of twenty a twenty two when when our investment committee met, we voted to shorten the duration in our bond portfolios. We did that again in April of twenty twenty two. We did that because the Federal Reserve was telling the whole world that they were gonna raise interest rates. And our investment committee, we took them at their word.

We said, okay. Well, if that’s the case, let’s shorten up our duration.

Now did we still lose a little bit on our bonds in twenty two? Yeah. A little bit. But not nearly as much as the bond market.

The bond market was down thirteen percent in twenty twenty two. I think we were down somewhere in the four to five percent range depending on the portfolio and and so on and so forth. So, so there are things you can do. And again, I think it’s important to keep in mind not all bonds are created equal?

Well, building on that and and that discussion of yields and the expectation of of return and and the safety, and thinking about bonds and the duration. Let’s talk about cash.

If I could look at the bank CDs and money market funds and the yields that they’re paying after paying, you know, nothing for many years here in the past. How do you think about should there be more cash in a portfolio for a client? Should we be investing in CDs or money market? Funds? What what’s your outlook there for an overall asset allocation for our clients?

Yeah. I mean, we’re we’re all loving these higher yields now, right, especially for our emergency reserves for our safety bucket, to use a financial planning term that I used to use many years ago.

So look, I mean, these higher interest rates are great. And so I I certainly encourage our clients. Look, take advantage of those. But I think it’s important to draw a distinction between the short term safety or the emergency reserve assets that you hold on to.

Naturally, you can get really nice, attractive interest rates on that cash right now. But I think it’s important to keep in mind that interest rates can and do go up and down. And like I showed you, on the PowerPoint slide a little bit ago, even the Federal Reserve themselves are for Pasting that at some point in the future, we don’t know when, but they themselves are forecasting that they’re gonna cut interest rates. And so I think we need to keep in mind that these are higher interest rates than, even the fed themselves, believes is probably sustainable long term.

So if those rates go back down, then naturally, you’re not gonna get those those higher yields. Right? So you you need to keep that in mind. If you talk to your advisor, I think all of us as advisors of, certified financial planners would agree, that the biggest threat to your financial security, your long term financial security, especially as you enter retirement, is inflation.

It’s not the market. It’s not interest rates. It’s inflation. Inflation will erode your purchasing power over time.

The the the best tried and true approach to outperforming inflation over time is you need those growthier asset classes in your portfolio.

That is stocks. You need stocks in your portfolio to outperform inflation over time. If you bought a bond today, a thirty year US treasury bond to a that’s paying you five percent annually. That five percent is not inflation adjusted. That will not rise. That will not grow. There’s no earnings.

When you buy stock in a company, over the next thirty years, that company is doing its best to grow. It’s looking to expand into new markets, to attract new customers to deliver more profitable products and services. All of that flows to you. Right? If you look at the dividend yield on the S and P five hundred index, you know, for the past thirty years, I mean, it’s gone up quite quite handsomely.

Over that over that particular timeline, you don’t get that with fixed income. Hence, the term fixed. It’s a fixed income. And so, so you do need to invest for growth.

I do think that this balance between stocks and bonds is critically important, though, to constantly be revisiting with your advisor. That’s a function of your need for safety, for liquidity, for cash flow. It’s also a function of your need to grow your assets on an inflation adjusted basis over time. So I would encourage all of our clients revisit that constantly with your advisor.

It’s one of the most critically important decisions that you have to make as an investor is what is the right balance for you of that mix between stocks, bonds, real estate, and cash.

So you mentioned a a few other asset classes. And so I’m gonna call them the quote unquote alternative asset classes. And so we think of those as being real estate, AI stocks, Bitcoin, and more commonly gold, silver, hard assets.

Why or why not should investors own that in your portfolios and your thinking on those?

Wow. This is a big topic. We could spend hours on this one. So so first off, I would just think it’s important to acknowledge that there’s no magic bullet in financial markets.

Right? And I think oftentimes these alternative asset classes are positioned as these silver bullets or magic bullet or whatever you wanna call it, a panacea. Or the gold bullet. Or the gold bullet that’s gonna fix all of our problems.

There is no asset or asset class in the market. That gives you safety, that gives you liquidity, that gives you growth, that gives you inflation hedging properties, There’s nothing that gives you all that at one time. And anyone who tells you otherwise, you should hold on to your wallet, turn around and run. Okay?

There is no such thing.

And so I think that’s an important point to keep in mind. Real Estate AI stocks, I don’t view those as alternative asset classes. We If you just owning an index fund, you have an allocation to real estate. Real estate was added to the S and P five hundred in two thousand sixteen.

So real estate’s very much part of the market. So I don’t view that as alternative e maybe private real estate. That’s certainly an alternative asset class in the sense that it’s not publicly traded. But that’s a different topic for a different day.

AI stocks? Well, what are the AI stocks? It’s Nvidia, it’s Microsoft, it’s companies like that. You already own those in your portfolio.

Just buying an index fund, you already have an allocation to AI stocks, which really gets me to, I think, the most important point, which is there’s nothing against owning perhaps a little bit of gold or commodities or something along those lines, it all comes back to the position side Well, how much the the challenge with these conversations is typically I’m asking these questions through some sort of lens as if this is a binary decision. It’s all or nothing. All my money is going into AI stocks or all my money is going into gold or or even a substantial portion of my money going into say gold versus a more diversified portfolio.

That I think is very dangerous thinking.

Right? If you wanna take a half of a percent of your portfolio and buy some gold because it makes you feel good, then fine. Do that. I don’t see a major problem with that. I think doing something north of that, I think, is problematic. If you look at the long term history of gold, for example, since you brought up gold Cara, between nineteen eighty, and I think two thousand and three, gold over that whole period, twenty three years delivered negative returns.

Negative returns to investors. Right? So if you bought Golden in January of nineteen eighty, you had to wait until two thousand and three just to break even on your investment from two from nineteen eighty. Right? That is an exceptionally long period of time of horrible returns.

That’s a so and and think about it. Inflation was positive over that period, which means gold didn’t hedge inflation. Over that twenty three year period.

Now gold did phenomenally well in the run up to the financial crisis, which is why it’s even a topic today and why we tend to get questions on it. Right? And it’s done really well recently. It didn’t do so well in the immediate aftermath of the financial crisis for the better part of, what, eight years maybe?

Right? So gold I look at gold as, like, one of these, it’s almost like a lottery ticket in terms of its payoff, meaning that you have these really long periods of chronic losses or even flat returns if you’re lucky. And then you’ll have a spectacular payoff We saw some of this last year when the Fed started raising interest rates. So I think we need to be careful.

I would argue that’s that’s not really an investable asset.

Right? When you have to go twenty three years to break even, that’s our view. Right? So I would just I would just caution back to my initial comment There’s no silver bullet.

There’s no gold bullet that’s gonna solve all of these problems that we as investors have to deal with. Right? We need safety. We need liquid liquidity.

We need growth and we need inflation hedging. That’s how you should be thinking about your portfolio. Right? Investing is not some, you know, game to be one.

It’s not a a sport, it’s a means to an end. And that’s how you should be thinking about your portfolio is is my portfolio bringing me closer to achieving these goals or is it pulling me further away? Right? That’s how you should be thinking about, investing.

Not necessarily looking for some magical asset class that’s gonna solve all of our problems.

That’s really great insight, Don. I think in terms of how we think about solving for portfolios and what’s important for each one of our clients individually as we build their portfolios. But I know we’ve got a lot of newer clients on this webinar as well. So could you review kind of how do we make investment decisions at Mercer Advisors, walk us through the investment committee. And and when as you mentioned, we do make some changes kind of how and why we do that.

Yeah. So that that that’s a great question, and we could spend a couple of hours talking about. I’m always happy to talk about how, you know, talk about Mercer and and how we do things.

So but but but to this very specific question, so Mercer Advisors has an investment committee. And I’ll start with the investment committee, and then I’ll explain perhaps the rest of the investment function at Mercer. Our investment committee is fifty one people from across the organization.

Three quarters of those folks are advisors like yourself, Kara, one third of those members are female. It’s a very diverse group to diverse views, which is which is good. And and I’m an academic at heart and I love when we have our investment committee meetings because there’s lots of debate, lots of discussion.

And those fifty one members serve on seven different subcommittees that have very specific focuses. So, for example, we have a sub committee just on venture capital and private equity. We have a sub committee on institutional portfolios, and we have other subcommittees focused on everything from, manager selection. So I think mutual funds ETFs and another committee focused on portfolio design. And so the whole idea there is to get lots of ideas, lots of input You know, we we we believe at Mercer, and I believe this with every fiber of my being, that no single person has a monopoly on good ideas. And so we wanna definitely have that debate. Should always be a data driven debate and always focused on what is it, what we believe to be in clients absolute best interest.

We are fiduciaries. That is critically important. We do not sell financial products. We are a registered investment adviser And that means that by law, we have a a very serious fiduciary duty to our clients. And so the investment committee’s mandate is to uphold and deliver on that fiduciary promise that we make to to all of our clients. So that’s investment committee. Investment Committee makes all the portfolio design and manager selection decisions in our portfolios.

Working with your advisor, your advisor ultimately, custom tailor’s that portfolio. They personalize it to account for your preferences, your restraints, maybe you have capital gains issues, tax issues that you’re trying to manage. So your vis your visor worked with you to select the appropriate asset mix, the appropriate portfolio strategy that our investment committee is managing, on your behalf.

The rest of the organization has close to eighty full time people just in across the what we call the investment function. So that’s trading, that’s portfolio research, portfolio design, portfolio consulting. These are there’s a group of consultants that actually work behind the scenes to support your adviser. Right?

We we, you know, I was an advisor for the first twenty years of my career. We don’t don’t know everything. We need help. Right?

We have attorneys. We have CPA’s. We have investment experts. We have trust experts.

To help give us advice, to help us understand what’s the best solution, for our clients. So it’s a very deep organization, a lot of talent, a lot of lot lot of lot of folks contributing to how we think about the world. We do take a very scientific approach to how we think about portfolio design. Our goal isn’t to try to beat the market every ten minutes or every quarter or even every year. Our goal is to make sure that we are delivering exceptionally well diversified provide risk managed portfolios to our clients and that we are doing that in the in the lowest cost, possible.

So that helps our clients hold on to to to keep the returns that they’re earning in their portfolios.

So lower costs, more tax efficient.

But very scientifically designed. We spend a lot of time, Kara, revisiting the latest academic research, looking at the data, and thinking through what is the absolute best thing to do given what we know about markets and portfolios.

Our our goal here is not to invest in Fads. Right? We’re not gonna invest in popular trends.

Our goals is to help you achieve your goals and to do that in the most responsible, prudent, low cost, and tax efficient way possible. So, that’s how we think about think about those things.

So I got a couple of questions, Don, about diversification.

So we’ve got questions about what is the benefit of building a globally diversified portfolio. Is it possible to be over diversified? Would you contrast that with investing in maybe just fifteen to twenty stocks and picking those as so you speak to why diversification is important and how we think of it in terms of portfolio construction?

Yeah. It’s a great it’s a great question. So first, let me say it is mathematically impossible to be over diversified.

Right? And that’s because diversification is a risk management strategy. Right? I’m not gonna bore our audience with all the financial theory. But anyone who’s taken a graduate level course, and finance or portfolio management knows that you cannot be over diversified. That’s just mathematically not a thing.

So so again, diversification is about risk management.

It’s it’s not about maximizing returns Those are different things. If you wanna try to maximize your return, then there are other things perhaps you could do. But with Any any attempt to maximize returns, by definition, you are really gearing up the risk in your portfolio. So let me take the the example, fifteen to twenty stocks.

Okay. That is not a diversified portfolio. That is an exceptionally risky portfolio. Right, by any measure.

And just to give you a case in point, right? I mean, let’s just say you own twenty stocks and and let’s say a handful of those were in technology last year. Last year, technology as a sector was down forty percent.

Ouch.

Right? So that’s not a good thing. Let’s say some of those companies were perhaps in Enron. Right?

And for those of us who’ve been around long enough, we know that For that. I I can’t tell you when the next enron shoe is gonna fall, but there will probably be another one. Right? It’s it you know, it these things happen.

Divertification is to protect you against those things happening. Now there’s one other point that I wish to make.

If you look at all stocks that have ever been publicly traded since the dawn of humanity, and we actually have that data, right, going back to there’s eighteen ninety six when the Dow Jones was first, formulated. And Jeremy Siegel at Wharton actually took this data back to, like, eighteen o four. I don’t know how he did that, but he went all the way back to eighteen zero four. If you actually look at all the stocks that have ever been publicly traded, the vast majority of them, close to one hundred percent of them, actually underperformed the stock market. And you may be thinking, well, how could that be? How can how can the majority underperform the stock market? Well, that’s because most stock market returns come from a very, very small handful of companies.

About four to five percent of stocks account for almost all of the return on the stock market over long periods of time. The problem, the challenge is identifying those companies in advance. That is exceptionally hard to do.

The very, very, very best asset managers in the market have really been unable to do that. Right, maybe one or two. And even then, most of those folks ultimately have failed over time, given enough time. So the challenge is identifying those companies in advance. So what’s the best thing to do? Well, the best thing to do is to diversify.

Why pick one when you can just pick all of them. Right? That way you hedge your bets. Right?

And that way you can ensure that you’re gonna capture the broad market return and avoid the risks of perhaps stepping on some sort of enron like or it doesn’t have to be enron. Think of Sears. Sears was the Amazon dot com of the twentieth century. For those of us who are old enough, the Sears catalog was, you know, that was Amazon dot com.

Right? Sears bankrupt.

It’s not even around. Right? That I I think that just highlights that the biggest and best companies that you’re in love with today, that you think are gonna be around forever No. They they come and go.

There was a time when Apple was dead. Apple has come back to life, thanks to Steve Jobs, but there was a time when Apple was virtually dead. So, anyway, I think, I think that makes the point. So you definitely wanna diversify and not try to load up on just fifteen to twenty companies.

I would argue that’s not that’s not a prudent approach to managing money. So I hope I hope nobody does that.

Well, I’ve I’ve heard you say many times, and think, historically, it’s been proven that time in the market is more important than trying to time the market.

But we have questions here about does buy and hold still work?

And if we hear clients say maybe in their portfolios, well, come there aren’t a lot of changes if if perhaps they have mutual funds or ETFs in their portfolio?

And, can you talk a little bit about a, how we think about making changes in the portfolio and a bit about what mutual funds ETFs and how that works and and seeing the adjustments that are made. Two portfolios.

So so I think there’s a I think I think the quote buy and hold is really over interpreted and taken far too literally. Right?

I would agree that lower turnover portfolios, meaning you’re constantly buying and selling and playing the hokey pokey with the market where you’re in, you’re out, you’re in, you’re out. That’s not investing. You definitely wanna minimize that. One, because there are transaction charges. Right? When you buy and sell, even if your custodian tells you it’s free, it ain’t free.

Right? There there are costs somewhere along that eye chain that ultimately we as investors are paying. It could be in the form of spreads. It could be a commission.

Could be a lot of different things. Right? So, so transaction costs are not free, which means you wanna minimize that. Right?

You wanna you you you don’t wanna overly trade. At the same time, this whole idea of buying hold, I think, is is is taken to literally. Even an index based portfolio, which would be the epitome. Think of Vanguard, which would be the epitome of a buy and hold strategy.

Even their index funds will have turnover of, say, five percent annually. That’s because the S and P five hundred reconstitutes every year. They kick out some companies and they bring in new ones.

If you look at an ETF port folio here at Mercer Advisors, think of like our multi factor global equity portfolio.

Even if you look at that, and let’s say it it owns all ETFs. Right? And at Mercer, we use ETF use individual stocks. We use individual bonds. We use mutual funds. It just depends on the situation.

But if you look at an ETF portfolio, you optically, as the investor, you maybe you’re getting your statement and you’re like, hey, there’s no changes in the portfolio.

Well, let’s back up for a moment. There actually are a lot of changes. You don’t see it. If you look under the hood inside each of those ETFs and you look at the portfolio as a whole, you’re gonna see probably about twenty percent average turnover.

So what does that mean? Well, if you own ten thousand companies through a basket of ETFs, which is very common, If you own ten thousand global companies with twenty percent turnover, right? Think about that. That’s four thousand trades.

Right? Cause you sell two thousand, you buy two thousand.

That’s a lot of transactions.

You don’t wanna see those individual trades in your account. Why do you not wanna see that? Well, it’s more tax efficient for it to occur inside the ETF. ETFs have some special tax privileges that you and I as individual investors buying individual stocks, we don’t enjoy those tax privileges.

Right? That doesn’t mean that you shouldn’t or or shouldn’t build a portfolio of individual stocks. I’m raising this so that we understand it. That’s in a very important consideration.

So there’s very much turnover things constantly changing in the portfolio. If you look at a value strategy, if you look at a lot of our portfolios, you’ll see an an allocation to value stocks. Could be a DFA value fund, could be an ETF or something along those lines.

If you look at DFA, for example, every day, they are reconstituting the portfolio. They’re selling some buying others. And that’s because the prices of companies are always changing relative to their earnings, right, or relative to some other accounting metric that we use. So there’s constantly trading that’s occurring.

Even if clients don’t always see that, it’s occurring inside of the ETF. Now you asked about when does our investment committee make decisions? Well, let’s just go back to twenty twenty two. In January of twenty twenty two, our investment committee had voted to shorten duration.

Remember I said a little while ago, the fed beginning in October, the fed’s October twenty twenty one, the Fed started telling the whole world, hey, we’re gonna raise interest rates come March.

And so our investment committee, our view, as well, let’s take them at their word. Inflation is really high. It was getting higher, and the Fed says they’re gonna raise interest rates. Seems logical.

At the time, our portfolios had a duration of about six years. And remember what I said earlier, the way that you protect your bond portfolio against rises and interest rates is you wanna shorten that up. We originally shortened that up to around four years in January twenty twenty two. Fed raises rates in in March of twenty two, and it is actually in April, mid April.

That the Fed said, okay, we are not gonna be raising rates only at a quarter point. We’re thinking three quarters of a point, maybe even a full point going forward. That was a shocking moment. We held an emergency investment committee meeting.

We said, we need to do something about this, and we shortened the duration even more. So even though we have a large committee, I like to think that we’re very agile, we’re flexible. We’re definitely not afraid to make changes, and we did that. We also had I think this was earlier this year, Kara.

We had two managers in our portfolio. I won’t mention their names, but we had two ETFs in our Folio that our investment committee was not happy with some of the changes they had made in how they were managing that portfolio.

We sold. That was a half a billion dollars worth of trades that we placed in April and again in June to exit those positions. So we’re certainly not afraid to make decisions. We are data dependent I know that term’s a bit overused, but we look at the data. We look at what the Fed is telling us. And if we think a change is warranted, if it’s justified, if it’s defensible, if it’s in our client’s best interests, then we’re gonna make that change.

Well, Don, what this last question that I’m gonna ask you kind of stuck out in it and it’s actually a personal question. Uh-oh. Our audience would like to know what you what you do for fun?

I don’t have fun.

No. I’m joking. I’m joking. I went to University of Chicago, and they used to say University of Chicago was where fun goes to die.

And in fact, they affect Japanese first, let’s say. And I believe that. No, what do I do for fun? All kidding aside.

You know, I love sports. I love college football. I love baseball. I usually love my fillies, but I don’t love them too much right now.

But, you know, I’m a big sports fan. I’m also a big science fiction geek. If you actually look on my shelf back here, I’ve got baby Yoda. I’ve got, these are all little bobbleheads.

I have Darth Vader, and I got even have Indiana Jones up there. So and and Boba Fett. So, so we love movies and science fiction, and I love reading and and all those things. And love going for long walks in the woods.

We have a farm outside of town where I like to just go for a walk, and you just stare up at the trees, especially this time of the So, so yeah, sports, the outdoors, science fiction. Those are kind of my big three.

I’m away from the office to get a wider perspective. I think that’s really helpful. That is that is true though.

Well, thanks for all the commentary. I’m seeing a lot of questions as well as asking about if this presentation is being recorded. So the answer to that is yes, this presentation is being recorded.

And we will be posting it as we do with all of our, capital market updates to our website mercer advisers dot com If you go to our insights section, you’ll see that all of those are posted. In addition to, these updates that we do on a periodic basis. You’ll also find a lot of Don’s commentary on certain happenings in the market and as things change those also get posted on our insights tab.

Additionally, you can find information about, lots of things that we reference that we aren’t able to cover in detail with the time limitations. We do cover on our podcasts.

In much more detail. So, again, you can find those on our website at merceradvisors dot com. So as we’re coming now here on time, Don. Thank you for all of the insight that you share with all of us and our clients, and thank you to all of our clients for attending for providing these great questions.

If we didn’t have the opportunity to get to your question, as we mentioned, We have been recording those and we will be sharing those with your advisor and they will be able to answer those questions as well for you.

Thank you all for attending. Thank you, Don. Great. Thank you, everybody. Thank you, Kara.

Take care.