Ken Fisher Answers Your Questions – April 2023

Full Episode Transcript

Naj Srinivas

Hello and welcome to the Fisher Investments Market Insights podcast, where we discuss our firm's latest thinking on global capital markets and current events.

I’m Naj Srinivas, senior vice president of corporate communications here at the firm. Today, we’ll hear from founder, Executive Chairman and Co-Chief Investment Officer of Fisher Investments, Ken Fisher.

In this episode of Market Insights, Ken answers some common listener questions to help them better understand the world of finance and investing. 

Before we dive in, I'd like to ask you to rate and recommend our podcast wherever you listen to it. In just a few minutes, you can help make this valuable information available to even more people.

Thanks so much for your help, in advance.

With that, let's dig with this month’s Ken Fisher mailbag.

[TRANSITION MUSIC]

Ken Fisher

So, every month people send in questions and I try to respond to them in this format that allows you to know what I think very quickly about a whole variety of topics.

So here's one that comes in. How would you respond to folks who bring up sequence of returns as a reason to weight your portfolio more heavily toward fixed income once in retirement?

Well, I'd respond to them saying they don't know what they're doing. The fact is the concept of sequence of returns is one that makes perfect sense if you don't really have a long-term view. And let me explain why.

If you buy at 100. And the market falls by 30%. At that moment, you've got 70. And it takes a 50% increase from 70 to get to 105, which means you need a bigger than 30%—almost 50% return—to make up for a 30% drop.

So the theory is that if you have a portfolio that falls markedly first, you’ve got to make up for it with even more later. Now, that's true if those are your points. If that “70” is important to you relative to your cash flow in retirement—and I kind of makes sense a little bit—but most people in retirement. You know, the average 65-year-old man married to a 60-year-old woman, which is about as common a couple as you get. One of the two of them is going to live more than 20 years more. Maybe 30 years more. Maybe longer. And they have a fairly long-term horizon. And over the course of that period, the first and the seconds just keep repeating each other. And if you do what “sequence investors” think you should do, which is make your portfolio more defensive, less volatile because of the risk that you could have a down move first before an up move, which you always could have. You end up with a lower long-term return, because in very long periods, stocks do better than bonds. Stocks do better than cash. Not in the short term necessarily, but in those long time horizons that most retired folks have. The fact is the sequence of return argument leads you to worse returns.

Another question that's sort of parallel to this is, “Is an 80/20 allocation of stocks and bonds or stocks and cash, or a 90/10, sufficient enough to reduce overall portfolio volatility in your portfolio.

Well, some people, as their time horizon they need their investments to work over, gets shorter do need to reduce the volatility in their portfolio. But, it's a little bit like saying if you put your toe in the water, are you very wet? Well, not as well as if you put your foot in the water and not as wet as if you go down to your knee. But it's actually hard to stand on the side of the pool and go down to your knee without falling over sideways and then you get all wet.

What's the right amount? And the answer is—and this is really simple as I explain it to you—if you have a really long time horizon, you don't really need to reduce volatility at all. As you get older, you get to a point where your time horizon will get shorter. Not so much when you're 55 or 60 or 65, but after that. And as it gets shorter and shorter, you can start with 90/10. And that's the right amount of volatility. And then it gets a little shorter and you go to 80/20, and then 70/30 if you want. But the reality is there's not a magic number that's right for all. And when I say that to you, it should make sense to you that there's not a magic number that's right for all. That kind of has to be figured based on your time horizon and your circumstances. But a 90/10 doesn't give you much portfolio volatility reduction, but it gives you a little bit 80/20, a little bit more. You go from your toe to your foot to your knee.

But the reality is for most people with a really long time horizon, you want to be in the water the whole time anyway.

On the next one, why does the market go up and down so much every time the Fed[eral Reserve] speaks when the market should have priced in these moves weeks ago? Should the Fed be stopped from speaking?

I don't know. I've always been a Fed critic. And if you've heard me before, I'm not just a Fed critic, I'm generally a central bank critic. I don't believe central bankers actually are more than mostly—not 100%—as it comes to monetary policy other than reactive.

They're not leading us to something, mostly. They're mostly following what happens, and they react month to month. So you get a period like January, where the inflation numbers come in higher than people expected in February, and people freak out and so does the Fed. And the Fed people start talking about how they got to raise rates more to fight inflation. Well, they weren't saying that the month before. So the inconsistency freaks people out. And then you get a period where things come in better—in terms of the things they worry about—and then they talk otherwise. And you take something like Silicon Valley Bank. Uh, Janet Yellen—not the Fed—Secretary, Treasurer, who used to be head of the Fed, says on the Saturday that after Silicon Valley Bank failed Friday…Saturday., “We will not bail out Silicon Valley Bank.” The next day, Sunday, Treasury, FDIC and the Federal Reserve collectively bail out all the depositors 100%. They don't bail out the shareholders. They don't bail out the creditors. They say it's not a bailout, but it's a bailout. And in that, those kinds of inconsistencies scare the dickens out of the market.

In fact, when governments ever say inconsistencies—first we say this, then we say that, then we say this—You say this—I say that—This member of the board of governors says the one thing—the other member of the board of governors says the other thing—and they conflict two weeks apart, it drives people crazy.

And the reality is they don't know what they're going to do. So what they do is often a surprise at the last minute. Sometimes it's not. Sometimes it is. What they say a lot of the time is because they're talking all the time. I wish they wouldn't talk. The question says, should they be banned from speaking? I wish they wouldn't speak, but there isn't really the authority to stop that. That would take an act of Congress. And, actually, an act of Congress is really hard to do.

And, you know. I'm not Catholic. Maybe you are. Maybe you're not. But traditionally, Catholic people love the pope. And make sense why they would. But once you look at somebody that's head of the Fed, for the most part, most people treat them as nearly as sacred as the pope, as if they had some all knowing power. And members of the board of governors are kind of seen as one step away from the pope of finance. And as that happens, their utterances, as they wiggle around, cause inconsistency and cause uncertainty. And that's what makes markets volatile relative to them.

With that comes the question what consequences of Fed rate hikes are you concerned about?

Really, not so much, because what the Fed does is it raises fed funds rates, which impact the US Treasury bill rates, but don't really have a lot more impact than that. People often think they do, but they don't—in this environment. In other environments, they sometimes can and have often in history, and there have been long periods of time where—long periods of time—where when the Fed has raised rates or lowered rates, it's had huge impact. But right now, it's not having much impact, really, which you could tell by the fact that over the course of the last year, they raised rates more than they pretty much ever have in a year. And meanwhile, the economy keeps going on. And the drops in things like grain prices and oil prices and what-have-you, and the supply chain “unsnarfling” mostly all happened before they ever started making any of their 75-basis-point hikes.

But to that point, that goes to the next question to ask, “Does the historically inverted yield curve not matter this time? Why is this time different?”

Well, anybody that's read me for a long time has probably known that in decades past, I would regularly cite the yield curve. That when it becomes so-called inverted—inverted meaning when short term rates get above long term rates, so short-term rates, intermediate-term rates, longer-term rates, very-long-term rates, slopes downward with short rates above longer term rates—I would have always said that leads to recession and until it ends is probably parallel to a bear market continuing.

Why? Because what I would have said then and did say then is that this is a reflection of future banking system eagerness to lend. Why? Because the core business of banking, whether it was Silicon Valley Bank or any other bank—they do other things, but the core business is taking in short-term deposits—as the basis of making long term loans.

And if they have to pay a lot more for the short-term deposits than they're going to get off the long-term loans, then there's no profit incentive to lending at those lower long-term rates, and they're not going to do it. But, when short-term rates are above long-term rates, they would.

Now most of my life, the Treasury bill rate for 90 day T-bills has been a pretty good proxy—not perfect, but pretty good proxy—for what it has cost banks to get deposits that they would use short-term deposits—that they would use as the basis for making these longer-term loans. I am not going to get into a detailed treatise of how banking works, but those longer-term loans fall into varied pockets in a normal bank handled varied ways. And that's all very well understood. But, the aftermath of what happened with COVID, and the period actually leading up to COVID a little bit, flooded the banking system with deposits. As short-term interest rates were very low. That had the deposits costing the banks almost nothing. And you'll remember short-term rates being low, but what you don't think about is if you go to JP Morgan today or Bank of America or Citigroup and you want to put in a deposit, on average, you get paid about one third of one percent. But mortgage rates, you know where they are. That's a common thing banks lend to. Banks lend longer term to businesses and those rates are higher, mostly higher still with the exception of just a very few kinds of businesses. And banks also buy long-term government bonds in a ten-year bond. Right now, that's just a hair whisker over 3.5%. So if you've got a cost of 35 basis points, a third of 1% , 33 basis points, and you're lending out at ten-year Treasury bill rate a little over three and one half percent. You've got a whopping profit margin on doing that. You've got a lot of incentive to lend. Normally, yield curve inverts—long-term rates are higher than short-term rates, banks stop lending. The lending kills the economy because businesses and people who are dependent on borrowing before are dependent on borrowing to continue, And when the bank says, “Give me back my bullets,” they have to pull in their horns and they can't do the activities that they previously engage in. And that shrinks the economy.

In 2022, as a Fed raised rates steadily, loan growth actually increased. In the beginning of 2022, it was operating at a four-and-one-half-percent annual rate. By the time we got to the end of the year, it was operating at a 12% annual rate. Loan growth accelerated because those deposits stayed the same at low costs to the banks. Regardless of what happened at Treasury-bill rates and long rates went up out of increased fear of inflation. And as that happened, when one long rate goes up, all the rest of them tend to go up in parallel: mortgage rates, corporate bond rates and rates for intermediate term business loans. And so banks make more profit from lending. As they make more profits from lending, they keep going. It's why it's different this time. And until you see lending in aggregate for the banking system—you can see this online from the Federal Reserve of Saint Louis, every two weeks, two weeks after the lending numbers are actually completed—until lending falls below the inflation rate, it's pretty hard to have the economy go bad, which is what the Fed is banking on doing to try to stem inflation, kneecap the economy.

So I think we've covered all of the points. I always enjoy talking to you about these. Keep sending questions in. Hopefully I can answer them. There's a lot of things I can't answer, but I always love talking to you. Thank you so much.

TRANSITION MUSIC

Naj Srinivas

That was Ken Fisher answering listener questions as part of his monthly mailbag. Thanks to Ken for sharing his insights with us.

If you want to learn more about the topics discussed today, you can visit the episode page on our website, Fisher Investments.com. You'll find a link to that in the show description. While you’re on our website, you can also subscribe to our weekly digest, which rounds up our latest commentary and delivers it right to your inbox every week. And if you have questions about investing or capital markets that we can cover in a future episode of Market Insights, email us at marketinsights@fi.com. [3:53]

We'd love to hear from you, and we'll answer as many questions that we receive as we can in a future episode.

Until then, I'm Naj Srinivas. Thanks for tuning in.

Disclosure:

Investing in securities involves the risk of loss. Past performance is no guarantee of future returns. The content of this podcast represents the opinions and viewpoints of Fisher Investments, and should not be regarded as personal investment advice. No assurances are made we will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. Copyright Fisher Investments, 2023.