What will rising rates cause?

I get asked almost every week what will happen when rates finally rise.

This is something that most people think they kind of understand, but almost nobody has actually thought through.

The correct answer is that it depends why the rates are going up. Rates, you see, are pretty much always a dependent variable. They do not simply rise randomly and cause chaos in the world. Now, that doesn’t mean they are predictable, since the factors that affect them may not be predictable.

For example, if rates rise because the economy keeps doing wonderfully, unemployment is minuscule, wages are rising, and inflation is at 3%, then I’d guess you’d look at the correlation between rates and the market, and say what a good thing rising rates are, both lines are up and to the right.

However, as we said before, interest rates are essentially a dependent variable. People get confused about this because the Fed can change a couple of rates (either by setting them directly or with open market operations), but working ideally, the Fed isn’t making those decisions in a vacuum.

If we looked at two worlds going forward, one where rates slowly march up as the economy does well and inflation grows, and one where the Fed decides that “just because” we’re going to raise rates by 3%, you can be pretty confident the stock market and economy are going to react relatively poorly to the 3% raise (think taper tantrum), and that the ‘steady as she goes’ timeline is the better one to live in.

Remember, the next time someone asks you what will happen when rates rise, the smart answer is always “that depends on what is causing the rates to rise.”

Dow 20,000! We did it!

I’m just kidding, nobody cares about arbitrary round numbers that we happen to have passed on an index that kinda sorta measures growth of big companies in America.

And may god help you, if like Business Insider, you post a graph of 100+ years with a linear instead of log y-axis.

djia landmarks COTD

I have to admit, though, if a year ago you told me Trump would be President and we’d be at Dow 20,000, I’d have thought you were totally off your rocker.

By the way, if the Dow goes up by 10% per year, we’ll be at Dow 100K right around the end of 2033. If it goes up by 5% it’ll be right at the beginning of 2050. Compound interest, you crazy.

Giving the People What They Want

When it comes to stock markets, big firms like Goldman know better than anybody to give the people what they want to see. Witness, this slide:

It’s not crazy, it’s a path the market could conceivably follow, but a closer look is instructional.

  • Note how it isn’t simply a line up and to the right, there’s no obvious profitable action to take on a forecast like that. Something like this, well certainly.
  • It has an ‘up’ component built on “hope”, so if it doesn’t materialize, we can chalk it up to the markets being surprisingly rational, not our forecast being wrong.
  • The numbers and timelines are conveniently round, simple to interpret for ever the layest of laymen.
  • If the market goes up (most likely), goes down 5% at some point in the next 12 months (also most likely), and resumes the climb, success can more or less be claimed.

This chart is beautiful, if only for its ability to inspire the average day-trading dentist or pension fund trustees.

Before we leave, let’s take a look at a couple of other ads on the page and appreciate them for what they are, a dazzling ode to confirmation bias:

Like an eclipse, I recommend not viewing these kinds of things directly, they will blind you. However, if you must take a closer look, bring #14 welder’s glass or a pinhole camera.

The Secret of Investing

J.P. Morgan puts out a quarterly ‘Guide to the Markets’, which isn’t really a guide to anything so much as it is a compendium of clever charts.

Like re-reading a good book and finding a new favorite subtlety, one chart in particular stuck out to me.

It stuck out to me because this is the secret that successful investors understand and accept, and underlies the errors that those who always seem to be on the wrong foot are making.

That’s it. That’s it right there. If you’re okay with being down about 10% at some point virtually every year, you can have the market returns. The market returns are quite good.

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Socially Responsible Investing – An Alternative

Larry Swedroe had a wonderful piece a couple of weeks ago on the costs of building a portfolio on a foundation of socially responsible investing.

SRI vs. Impact

I had a conversation with a colleague who is more well versed than most in the subject — it seems that socially responsible investing (SRI) is a bit out of vogue with those in the know. Probably for the reasons Larry gives in his post. The new hotness is “impact investing”, which focuses on positive screening, finding attributes in a company that you like regardless of where they operate. An example would be the oil & gas sector, where I am told the big behemoths (Exxon, Conoco, Chevron, etc.) are actually the companies pushing the hardest toward more sustainable practices, since in the long run their survival depends on it. Standard SRI makes those a big no-buy zone, whereas impact investing might not.

Investing Optimally to Give Optimally

I have a rather different take on the matter, assuming the average Joe Blow with $1 to $1 million dollars is what we’re talking about here, I’m pretty sure the GTO (that’s ‘game theory optimal’ for the non-initiated) move is to invest in whatever you expect will give you the best returns.

Then, either when you die or clearly don’t need the money, giving it to causes that relate to what you care about. Not buying 200 shares of Exxon isn’t going to change anything, especially in the secondary market, because you’re just buying Exxon from a mutual fund or day trading dentist, and none of your money is going to or coming from the company itself. Giving a few extra thousand dollars to a local charity on the other hand, now that might have a real effect.

Real Impact Investing

Now, if you have some real cash, (and I’m going to skip a big group of tweeners here) say, $5 million+, you can start to make a real difference by investing in primary offerings. In other words, a company (usually still very small) takes your money and gives you shares. These are usually not publicly traded, and are extremely risky, which is why people put together funds of these things, to diversify. However, your $50k (along with a few other peoples’) might make the difference between the company being able to make payroll for a few more weeks, keeping the lights on, and making a big discovery that changes the world in a small way.

A Dish Best Served Rich

While I can appreciate the idea of not wanting to be an ‘owner’ of a company that operates in a way you don’t agree with, I think most SRI pitches are just that, a pitch intended to sell a fund. Plus, if something you really don’t agree with is legal and makes a ton of money, is there a better way to fight the power than to funnel the profits to a cause you care about? I can’t think of one.