The performance of bonds and other interest rate-sensitive securities in the second quarter surprised and scared many investors. The downturn and subsequent recovery of these issues during the quarter caused many investors to simply “move to cash” instead of weathering the storm. There were many reasons for the pull back in bonds—some economic, some geopolitical. But, one big reason was how global markets processed one particular piece of public information.
FED TAPERING
The public information in question involved statements made by Ben Bernanke. After the Federal Open Market Committee’s meeting in June, Mr. Bernanke floated the idea that the Fed may begin tapering its bond buying (quantitative easing) program. The remarks surprised many investors and the bond market quickly priced-in an expected rise in long-term interest rates.
As some investors moved out of bonds with low interest rates, others stepped in to buy them and take advantage of the suddenly higher yields they offered (as bond prices go down, the yield goes up). In the days that followed, the market continued to price-in investor expectations for rising rates which caused bonds and other interest rate-sensitive issues to continue their downward trend.
BACK PEDALING
Shortly after the second quarter ended, however, Mr. Bernanke seemed to walk-back his comments and the market recovered its losses and more. In short, global markets dropped sharply and recovered almost as quickly in part because of public information disseminated by the Federal Reserve.
Some might say this demonstrates that public markets are dysfunctional and arbitrary. On the contrary, we believe this demonstrated the market’s ability to take information, form expectations and react in an efficient manner (this holds true for most information whether economic, political or business-related). This efficiency stems from the fact that institutional investors are good at managing their expectations based on the information they receive.
NOTE: Institutional investors are processing the same public information as individual investors (we’re not talking about insider trading here, that’s criminal activity). And, because information is—for the most part—distributed freely and equally, it’s unlikely that individual investors are going to have unique insights that all other global investors don’t.
UNDERSTAND THE MOTIVES
This is one reason we refuse to get caught up in what we see, read or hear from the financial media machine. While providing some good information, the primary focus of television, magazines and newspapers (including The Wall Street Journal), is to sell commercial time, ad space or increase their circulation. This tends to tilt them toward more sensationalized stories. Besides, by the time something appears in the financial media, chances are it’s already been priced into the market.
BE SAVVY ABOUT THE MEDIA
We also advise our clients not to put too much stock (no pun intended) in what they read or hear in the financial media (or constantly watch their portfolios). That’s because investors who do, tend to make rash decisions that end up costing them in the long-run. Like institutional investors, we actively manage our clients’ and our own expectations.
THE KEY TAKEAWAY
The bottom line is that the implications for long-term investors of the volatility in the second quarter should be minimal (the market simply digested Bernanke’s remarks and re-priced bonds and other interest rate-sensitive securities to reflect an expected rise in long-term interest rates). After all, market downturns like the one we experienced in the second quarter are typically followed by a recovery (as was this one).
That’s why we believe that adopting and sticking to a long-term, globally diversified allocation strategy is the best way to ensure you reach your financial goals.
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David L. Blain, CFA, is president and chief investment officer of BlueSky Wealth Advisors, LLC d/b/a D.L. Blain & Co. in New Bern, NC.
