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Monthly Market Dashboard: June

by M. Burke Koonce, III

June 30 2022

“If you are shopping for common stocks, choose them the way you would buy groceries, not the way you would buy perfume.”  — Benjamin Graham

Financial markets just turned in the worst first-half performance in decades, with the S&P 500 now down 20 percent for the year on a total return basis. That’s the worst performance to start the year since 1970. For the month of June, the S&P 500 was down 8.3 percent, the Dow Jones Industrial Average was down 6.5 percent and the growth-heavy NASDAQ fell 8.7 percent.

The six-month report card was grim. Joining the S&P 500 in remedial math this summer will be the Dow, down 14.4 percent, and the NASDAQ, down 29.2 percent. After several flirtations this year, the S&P 500 officially entered a bear market on June 13, closing more than 20 percent down from its January peak, the first time the U.S. stock index closed in bear market territory since the COVID-19 abyss of March 2020.

While markets have long since ceased being fixated by C           OVID-19 cases and death tolls, markets are still very much wrestling with the aftereffects of the pandemic. Supply chains continue to be disrupted by shutdowns in China, while government stimulus around the world, combined with strong employment, has helped keep demand elevated. Finally, the war in Ukraine’s impact on energy prices has been real, contributing to higher price expectations throughout the global economy. Ten-year interest rates in the U.S. have more than doubled since the start of the year.

There’s been a lot of ink spilled about the effect that interest rates have on asset prices, but it’s perhaps worth repeating anyway. As interest rates rise, the biggest price impact is on long duration assets such as long-dated bonds and expensive growth stocks—both are assets that are expected to pay back investors in the distant future. Those future returns are worth relatively less in a higher interest rate environment because they’re discounted back to the present at those higher rates. This is why growth stocks and long bonds have seen such significant price declines in the market this year, far more than short-term bonds and short-duration stocks such as big dividend payers and high earners. (The Russell 2000 Growth Index is now down 29.5 percent year to date, while the Russell 2000 Value is down 17.4 percent.)

However, while market prices continued to slide in June, the nature of the price action seemed to change. Not only had value beaten growth by almost 1600 basis points year to date, but value had outpaced growth every individual month also. That reversed in June, with growth outstripping value by 358 basis points. Of course, one month does not necessarily a trend make, but it did end value’s winning streak. What does this mean? It might be nothing at all, but it might be some evidence that tighter financial conditions are beginning to slow the actual economy, not just the financial markets, which often bodes well for growth stocks, which become more sought-after. Just like that, ten-year yields have come back in from almost 3.5 percent to below 3 percent. Consumer spending actually fell in May, the first time this year, and, according to the Commerce Department, consumer price increases last month were below expectations. Meanwhile, the University of Michigan’s long-running index of consumer sentiment is now at the lowest levels ever recorded. Counterintuitively, these are generally reasons to be bullish.

The market’s decline has been so swift and severe so far this year that one could be forgiven for overlooking how favorable some measures have become. After several years of gaudy valuations, the markets are not even historically expensive anymore. The S&P 500’s price/earnings ratio has fallen below 16.3x—that’s below the 25-year average of 16.9x and a far cry from the low 20s the market was sporting late last year. Granted, earnings numbers could come down as inflation eats away at corporate profits, but the market generally does a pretty good job at discounting information such as that.

We all know the market is quite efficient over the long-term. What’s less obvious sometimes during a period of elevated volatility such as this one is the opportunity it represents to rebalance portfolios to take advantage of favorable short-term price changes. For long-term investors, developments such as rising interest rates are a godsend—as long as one’s time horizon exceeds the duration of a given portfolio, higher rates are going to add to investment returns. That’s because higher rates mean better yields on bonds and lower multiples to pay for stocks.

The market is already pricing in lower rates by the end of 2024 than 2023. In other words, all else equal for long-term investors, these grocery prices might not last.

Mark Twain and the 60/40 Portfolio

by M. Burke Koonce, III

One doesn’t have to be a professional investor to know that markets have been under pressure so far this year. Rising interest rates and troublingly persistent inflation have contributed to a significant re-pricing across both the equity and fixed income markets, and with the S&P 500 in a bear market, bedrock assumptions about investment strategy tend to get called into question. Among the questions percolating through the investment zeitgeist now is the future of the venerated 60/40 portfolio, which has just suffered through its worst first-half performance in 34 years. Is the standard portfolio of 60 percent equities and 40 percent bonds, considered the classic allocation for decades, still an important idea? Or is it, as it seems half the internet would like to proclaim, dead?

For decades, a 60/40 portfolio has been considered if not the cornerstone of diversified investing then certainly a major component. The 60/40 conversation is perhaps the most common starting point for any investor evaluating his or her goals, risk tolerance, and income needs. The portfolio’s usage is perhaps even more common as a baseline for endowments and foundations than it is for individuals, and it is extremely common for individuals.

The attractiveness of 60/40 was that it would capture the majority of equity returns but with the lower volatility and higher income associated with fixed income returns. While an allocation of 100 percent toward equities is theoretically the better way to build long-term wealth, not every investor is positioned to handle the volatility, especially those with shorter time horizons or with income requirements.

Unfortunately, many investors in 60/40 portfolios this year have experienced plenty of volatility in their equity allocations but with minimal protection coming from the fixed income allocation. That’s because rising rates have caused significant price declines not just in the stock market but in the bond market as well. So is now the time to make big changes?

Almost certainly not. It’s not like this is the first time the 60/40 model has come under criticism.

Those of us who are old enough to remember the 2000s recall a decade of disappointing equity returns. “The Lost Decade” in stocks started with the dot-com bust and then as an encore gave us the Great Financial Crisis. The 60/40 portfolio returned just 2.3 percent annual during that time, and market mavens proclaimed that the portfolio was going the way of the dodo. Then, as if on cue, 60/40 proceeded to return 11.1 percent annually from 2011 to 2021.

So this year, as returns are negative across the board, 60/40s critics have returned en masse. This time, it’s not because of equity underperformance but because of either the paltry yields offered up by fixed income or because of fixed income underperformance.

That’s why we think that reports of 60/40’s death are, to paraphrase Mark Twain, greatly exaggerated. First, it’s fair to point out low yields in the bond market, and it’s fair to note that bond returns have been negative this year, but it’s not entirely fair to point to both. That’s because as yields rise, bond prices fall but future returns improve. Barring default, the mark-to-market losses showing up in bond portfolios will reverse over time as bonds accrete and mature and as proceeds get reinvested at higher rates. It’s essential to remember that as long as a bond investor’s time horizon is greater than the duration of the portfolio, rising rates boost returns.

Managing duration is also an important component of equity investing, and it’s mainly accomplished by maintaining a value tilt—avoiding overexposure to stocks with exorbitant earnings multiples that require years of earnings and dividend growth to achieve adequate returns, not just on capital but of capital. Stocks normally have much higher duration than bonds, which is why it’s essential to play the long game and moreover, it’s why having an allocation to bonds, say, a 40 percent allocation, is often so desirable.

There have been many articles written this year about the growing place for alternatives in portfolios. While alternatives such as private equity and private credit are theoretically desirable for well-heeled investors, it’s not really realistic to think that converting a 60/40 portfolio to something like 33/33/33 could have been responsibly allocated within six months’ time, not to mention that moving from public equity and public credit to private equity and private credit is not going to provide a completely different risk/return profile. One of the benefits of alternatives is the forced discipline that comes with a longer time horizon, but alts investing is still going to be, at its core, equity and credit.

Again, as long as one’s time horizon is longer than one’s portfolio duration, rising rates are a godsend—allowing the investor to reinvest at higher rates in the bond market and at lower multiples in the stock market.

Lastly, another significant benefit to a balanced portfolio, it’s 60/40, 70/30 or 80/20, is that it gives the investor two important weapons to use during a significant drawdown. The first is the capability to rebalance in favor of equities during a downturn. The second is that during truly adverse conditions either in the market or during one of life’s emergencies such as a loss of employment, it is generally preferable to liquidate bonds instead of stocks and avoid either losing future gains or paying taxes on capital gains.

So, is 60/40 dead? That sounds like an exaggeration.

A Job Well Done

by William Smith, CFP®

Honoring Two Special Colleagues

Years ago, at least before the Great Resignation, prospective new hires would often comment “I hope this is my last job.”  With the labor market in disarray, such a bold claim rarely comes to pass these days.  However, at Trust Company in the past several months, we’ve had two special colleagues honor that very commitment and finish their distinguished careers with us.

Many Trust Company clients have had the pleasure of working with Lou Nunn during the past five years.  Having held previous posts in client service with regional commercial banks, Lou joined our firm in 2017.  While our role offered a slight departure from her prior commercial bank positions, she confidently embraced the challenge and made an immediate impact.

A consummate player/coach with an ever-positive attitude and servant’s heart, Lou excelled in her role as our client services manager.  Training new hires, implementing new policies and procedures, consolidating our client services function into our Greensboro headquarters, and overcoming obstacles associated with the pandemic, Lou completed each and every assignment with professionalism and grace.  Having stepped down at the end of January, Lou is now busy taking care of her family, especially her two lovely granddaughters!

After an impressive career in financial services of increasing responsibilities with a Big Eight accounting firm, a regional executive benefits organization and a national wealth manager, Mitchell Paul joined Trust Company in 2009 during the depths of the Great Financial Crisis.  In an especially volatile period, Mitchell brought a steady hand and a depth of experience which propelled our firm to new heights.  Whether it was tackling complex systems-related problems, delivering responsive, thoughtful planning advice to our clients, or mentoring younger team members, Mitchell embraced challenges and opportunities with a high attention to detail and established himself as the very essence of what it meant to be a team-player.  With plans to pass the baton at the end of May, Mitchell and his family are excited to have more time to spend with their children and grandchildren.

On behalf of our colleagues and clients, I would like to thank both of these remarkable professionals for their contributions to our organization and wish them many years of joy and happiness in their next adventure!  Both Lou and Mitchell made valuable, lasting marks on our firm, we’re grateful for their service and friendship, and our team at Trust Company is proud to have you as a part of our family.

Monthly Market Dashboard: May

by M. Burke Koonce, III

25 May 2022

Current Conditions

“Rough winds do shake the darling buds of May” — William Shakespeare, Sonnet 18

Shakespeare could have just as well been describing financial markets this month when he wrote his most famous sonnet more than four centuries ago. A more apt description does not readily present itself, let alone one less laden with financial jargon. But alas, Bards are hard to come by these days, so here we are. Elevated volatility, rising interest rates, persistent inflation, and economic uncertainty do shake the darling buds of May… Miss him yet?

The market declines that began almost immediately back in January continue as we near Memorial Day. Through yesterday, the S&P 500 Index was down about 17 percent YTD on a total return basis, while the NASDAQ was down about 28 percent. The Dow Jones Industrial Average has held up somewhat better, off about 11 percent. For the month, the S&P 500 was down about 4.5 percent, the NASDAQ about 8.5 percent and the DJIA about 3 percent. The tech-heavy NASDAQ is well into a bear market (defined by a 20 percent decline from its peak), while the S&P 500 has flirted with bear market territory on numerous occasions.

Interestingly, for all the sturm and drang surrounding markets this year, the DJIA, with its less tech-heavy constituency, has held up remarkably well. That’s because it’s the technology sector that has so far been the primary target of the market’s “slings and arrows of outrageous fortune.” Value has beaten growth in every month this year, and to date, May’s value outperformance is the largest since January. Using the Russell 2000 Value Index and the Russell 2000 Growth Index as proxies, value is now outperforming growth by more than 1600 basis points for the year. Moreover, value is now well ahead of the growth for the trailing one-year period and is now poised to overtake growth on a five-year basis also. It’s a stunning reversal in both scale and speed for financial markets, which have been led higher by technology and growth-oriented issues for years, only to have 100 percent of that outperformance “vanish into air.”

Since the COVID-19 panic and recovery of March 2020, market valuations, particularly in the US, had been elevated, buoyed by oceans of fiscal support, ultra-low interest rates, and of course, an economy that proved far more robust than many thought possible amid the global pandemic. Fully all of that premium valuation has been extinguished during the last five months. As of now, the forward price/earnings ratio of the S&P 500, at 16.7x, has fallen below its 25-year average of 16.9x. Of course, this measure could continue to fall, and as earnings estimates come down due to persistent inflation, the index could continue to drop even if this ratio stabilizes, but this is no longer an expensive market, at least by this one closely-watched yardstick.

The terrible war in Ukraine and COVID-19’s continued burden on the global economy through supply chain disruptions and labor scarcity have dominated headlines, but the true ghost on the platform in Elsinore Castle this year has been rising interest rates. Of course, rates are rising in response to inflationary forces unleashed and exacerbated by Ukraine, COVID-19 and the world’s responses to them, but the receding liquidity that accompanies rising rates is what we are seeing play out in changes in market prices. Ten-year Treasury yields more than doubled between year-end and May 6th, creating a huge repricing in fixed income markets in addition to the equity markets. To the dismay of 60/40 portfolio holders everywhere, bonds did not provide the desired protection from equity market volatility.

“Oh fortune, fortune! All men call thee fickle!” Romeo and Juliet

Then again, if this market has taught us anything this year, it is that circumstances change quickly. On December 31, the market was pricing in just three 25-basis-point rate increases for the year. Fast forward to April 30 and the market was expecting 10 such rate hikes, plus another in February 2023. It is worth noting then that markets have in recent weeks taken on a slightly but distinctly more dovish view, with the current curve pricing in just seven hikes in 2022. Bond markets have stabilized. Five-year inflation expectations, which had jumped to 3.5 percent back in March, are back down to 2.9 percent—not far from where we were at the start of the year. Consumer sentiment is shockingly low, housing starts and building permits have crept lower, and jobless claims have recently been slightly higher than expected. If the economy is cooling a bit, inflation will eventually follow, and interest rates are starting to react.

None of this means we are advocating buying growth stocks with both hands; we never have and almost certainly never will. Markets are fickle, after all. But what we think all of this means is that the areas of the market where the historical evidence suggests that premium returns exist—value, small cap, and international, is where the future premiums do in fact exist.

For the vast majority of investors, bear markets are no fun. Growth is in a bear market at this moment, and it is during bear markets when people rediscover the meaning of margin of safety—the ability to point to an estimated stream of future cash flows generated by a company and say something other than “we are such stuff as dreams are made on.” In a bull market, it’s easy to find someone whose dreams are even more optimistic than your own who will pay you a premium for what you own. In a bear market, stocks return to their rightful owners. And it wasn’t Shakespeare who said that—it was J.P. Morgan.

Not the Same, But Better

by Leah Jane Barnwell, CRPC®

It has been a truly extraordinary couple of years. In the world, in this country, and right here at home in North Carolina. As Americans, we are deeply rooted in the belief that we should always be moving forward – toward progress, toward “more,” toward better.

Two years ago, largely without warning, a global pandemic stopped the world in its tracks, confined whole populations of cities to their homes, and forced us all to sit still for a while. We stayed away from friends and family, masked up, and wondered if life as we knew it would ever be the same.

The idea of going “forward” was now a question of how and when, when it had always seemed to be such a sure thing. Many suffered hardship and loss, some found silver linings; no matter your experience, it’s safe to say we’re all emerging from this time changed.

During a particularly challenging time early in my career, I called a college friend who had recently moved to New York to pursue her dreams in the fashion industry. She listened as I shared all the troubles of my day and expressed doubts about the path I had chosen, and at the end of it all, she offered advice that has stuck with me for many years since that conversation. “Adversity is good for you,” she said, “It forces you to grow in ways you might not have, if there wasn’t something in your way.”

Those words are as true today as they were then. As a firm and like so many other businesses, Trust Company has experienced many challenges in the last two years, and out of that experience, we’ve realized we had the capacity to grow even while others stood still.

We grew as players on a team, seamlessly picking up the slack when a teammate needed to take time for family or experienced illness. We grew as professionals, quickly adopting remote work technologies and developing new communication protocols to keep the matters of daily business on track. We grew as a community, finding creative ways to maintain meaningful communication with our colleagues and clients from afar.

When faced with adversity, we confirmed that we can and will rise to the occasion for clients who depend on us, even if it means getting through one day at a time and wearing as many hats as it takes to “get it done.”

Thanks to the tireless efforts of leadership and our HR department, we came to know and appreciate our coworkers in new ways. Through one of many initiatives (dubbed “TCTS Cribs”, a reboot of the MTV classic), we got a tour of the favorite features of their homes and met their pets, through another we learned about the charitable causes close to their hearts, and we found ways to work better together by understanding the personality types that make each of us tick. A most unexpected silver lining, indeed — our firm culture deepened during our time at home and apart.

As we put the worst of the Covid-19 pandemic behind us, we find new ways to move forward together.

We learned that while there’s no substitute for face-to-face interaction, we can come pretty close to that experience with a great webcam – shortening the distance between us and our clients, between staff from different offices, and giving us the ability to work with vendors across the country as if we are sitting on two sides of the same table.

Out of necessity and under pressure, our successful adoption of innovative technologies allowed us to streamline many of our day-to-day procedures and reduce our dependence on manual and paper-based processes. We’ll use this newfound tech momentum to onboard and adopt two significant new platforms this year – both of which will further enhance our client experience. Pre-pandemic, we may have split these initiatives across multiple years to avoid over-taxing staff – we now understand that our team is ready and willing to tackle whatever comes.

We’ve enjoyed substantial growth in our relationships, welcoming new employees and new clients, and expanding into new spaces in Greensboro, Raleigh and Charlotte. In 2022, Trust Company will celebrate 30 years of exemplary wealth management and fiduciary service to our clients and communities in the southeast and beyond. We go into this next chapter not the same as we were, but better – more nimble, more appreciative, more committed to our shared mission than ever before.

As Trust Company’s Project Manager, Leah Jane works across the firm to support strategic goals through the implementation of marketing, technology and process development initiatives.

Market Quarterly: Q1 2022

by M. Burke Koonce, III

There’s Lots of Bad News. That’s Good News.

After seven consecutive quarters of positive returns, the S&P 500 finally turned in a clunker in the first quarter of 2022, posting a negative total return of 4.6 percent. The other major domestic indices were negative also, with the Dow Jones down 4.1 percent, and the tech-oriented NASDAQ down 8.9 percent on a total return basis.

There was no shortage of gloom and doom on which to blame the market’s downturn. From the first week of the year, just as the Omicron variant was entering a hopefully final blow-off stage, markets turned their collective concern away from COVID-19 and onto inflation, the byproduct of massive fiscal and monetary stimulus, supply chain disruptions, and a post-pandemic hiring bonanza. While a certain amount of inflation was to be expected, these historically large year-over-year price increases have proven stickier than many economists predicted. Then of course, the coup de grace was the horrific Russian invasion of Ukraine, which served to not only exacerbate surging energy prices but to cast a pall over global growth projections as well. Rising inflation was already poised to erode strong annual real economic gains—but war in Ukraine threatens to dampen those gains further and cause the economy to teeter into a recession next year.

The U.S Treasury yield curve, a generally reliable predictor of future recessions, went negative on the first day of the second quarter and financial markets took notice, with broad market indices continuing their decline. While the move was brief and the curve has since steepened again, rising interest rates have had a severe impact on financial markets this year, especially on the more speculative areas.

Markets are now pricing in 50-basis-point interest rate increases at each of the next three Fed meetings, expectations that in January would have seemed completely fantastical. During the teeth of the Covid lockdown, the Federal Reserve abandoned its primary mandate of price stability in favor of promoting maximum employment, indicating it would allow inflation to “run a little hot.” Well, it would appear the Fed achieved that objective, with the U.S. unemployment rate at 3.5 percent, a level last seen in 1969, and the highest headline inflation since 1981. Now the Fed finds itself in the unenviable position of having to quash inflation without choking off the U.S. economy, and there is increasing momentum behind a plan to “front-end load” the interest rate increases it will use to tighten monetary conditions. There’s little doubt the Fed will eventually douse the flames of inflation, but the prices of financial assets will react in perhaps some unpleasant ways in the near term, especially in the more speculative areas of the market.

Rising interest rates tend to make for volatile markets, and these rate increases have differing effects on different assets. Broadly speaking, the rising price of money has the greatest impact on assets with the longest duration—assets that require the longest “payback” period, often called “long duration” assets, see their prices change the most when rates are changing. Examples of these assets are long -dated bonds and expensive growth stocks—stocks that investors have bid up in hopes of a substantial payback in the distant future. The problem is that when rates are at rock-bottom, it’s a lot easier to make the case to wait years to get paid back than it is when rates are shooting up and investors can earn money elsewhere instead of waiting.

This is being borne out in real time in markets right now. During the first quarter, as rates were rising, the Russell 2000 Value Index lost about 2.5 percent while the Russell 2000 Growth Index fell 12.7 percent. So far in April, the trend has continued, with value outperforming growth by about 1300 basis points for the year at the time of this writing. Some of the best performing stocks over the last several years have been caught in brutal sell-offs, with names such as Facebook (now known as Meta) and Netflix down 46 percent and 67 percent, respectively.

Value strongholds such as energy and materials have not been completely immune either. With recent reports of new Covid lockdowns in China and lower global growth expectations, these sectors have tumbled also.

Rising interest rates and inflation also tend to have an outsized impact on small cap stocks. Intuitively, this makes sense, with smaller companies more likely to feel the impact of these factors in the real world, but there’s also the reality that as interest rates rise and liquidity recedes from financial markets, small cap stocks react more negatively, just as they react more positively when liquidity increases at the margin.

Market volatility has spiked, which is unsettling, but it’s also worth maintaining a little perspective. The S&P 500 is now down about 10 percent for the year on a total return basis. Going back to 1980, the market averages a 14 percent intra-year drawdown every year, despite an average annual return of 9.4 percent and positive returns for more than 75 percent of those years. What the broad market is experiencing may seem extreme, but it’s only extreme in comparison to extremely recent experience. It’s also worth pointing out that for the two years ending with the first quarter, the S&P 500 returned more than 89 percent. The Dow Jones returned almost 75 percent and the NASDAQ almost doubled.

So while the bears are having their day, our contrarian impulses are quickening a little. Market volatility is well-above long-term averages, which suggests better times might not be too far ahead. Lastly, consumer confidence is as low as it has been in more than a decade, understandably driven down by stubbornly high inflation. This, counterintuitively, is also good news, as such dismal expectations are often followed by powerful rallies.

While we are not managing client portfolios by trading in and out of every market spike or downturn, you can be assured we continue to monitor markets with a gimlet eye. Moreover, while we are not attempting to predict the future, we can confidently say that equity portfolios are performing as we might expect in this environment, with our value tilt providing a significant tailwind to performance along with our international tilt while our small-cap tilt is a headwind. In a nutshell, diversification is paying dividends, as it does over the long term.

We thank you for you continued trust in our stewardship.

Burke Koonce

On The Eve of the Apocalypse

by M. Burke Koonce, III

It was inevitable, I suppose, the same way good dogs get old, Polaroids fade and rock drummers spontaneously combust. For decades, it looked like the ultimate clash of civilizations might never actually occur. The basketball gods seemed to have deigned that the world was just not ready; that the earth’s crust might crack, freeing some kind of noxious gas or that the atmosphere would be blown away into space. The world was just not ready, and would likely never be ready, for a Final Four matchup between Duke University and the University of North Carolina at Chapel Hill.

But sometime prior to last weekend, the gods changed their minds, or at least the NCAA selection committee and the good people in the advertising department at CBS. For years, the committee was careful never to place Duke and Carolina where they might play each other before the final game. This year, with the Twelve Month Parade of Coach K’s Farewell Tour coming to a close, I assume somebody did the math and determined that manipulating the brackets so that the two schools could face each other in the semi-finals was a maneuver worth taking. It would raise the odds of the apocalypse from extraordinarily low to just plain low. And like they say, a butterfly flaps its wings in Indianapolis and soon enough Roy Williams spits in the Mississippi River.

Of course, Roy Williams is no longer the coach at North Carolina. Neither is Matt Doherty, Bill Guthridge, or the legendary Dean Smith. It’s first-year coach Hubert Davis, a former UNC player and assistant coach (and, full disclosure, my classmate at Carolina). Duke’s coach, as has been the case since March 18, 1980, is Mike Krzyzewski, now the winningest men’s basketball coach of all time, as much as it pains me to say. For perspective, Dean would coach almost exactly half his 36-year career at UNC against Krzyzewski, who has now gone on to coach Duke for another 25 years since Smith retired in 1997.

I suppose over the course of 41 years, during which time Duke vs. Carolina became one of the greatest, if not the greatest rivalry in sports, this could have been expected to happen. And now, on the eve of K’s retirement, which will either be tomorrow night, inshallah, or Monday night at the latest, it has come to pass.

By midnight tomorrow night, as many have written, one side will have eternal bragging rights, and the other will be forced to walk the earth like Jacob Marley’s ghost.

It’s a wager that few of us here on Tobacco Road would ever make; it’s a bit like Russian Roulette. The risk/reward payoff is highly asymmetric and skews sharply negative. For those of us who grew up or attended school between the Haw River to the west and the Neuse River to the east, this is the basketball equivalent of the Ghostbusters crossing the beams, or putting Mentos in Coca-Cola, or making an alopecia joke in front of Will Smith.

But as renowned social psychologist and North Carolina product Ric Flair used to say, “whether you like it or not, learn to love it.” We must summon the wisdom of the ages to come to terms with this.

But how?

This rivalry covers more ground than the taproot of a Carolina pine and is woven into the fabric of my own family’s history like perhaps no other strand. My mother went to Duke and was a passionate basketball fan and my father went to UNC and played football there. So we had the incredible good fortune to have season basketball tickets in both Cameron Indoor Stadium and Carmichael Auditorium, and, later, the Dean Dome. I was on hand with my mom and dad, sitting in Section 16 in Cameron, when Coach K won for the first time against the Tar Heels. He has since won 49 more against Carolina.

As a Carolina graduate and fan, I suppose I should feel pretty good that despite Duke’s (and Coach K’s) wild success that the Blue Devils have only averaged 1.2 wins per year against the Heels in the four decades since, but then again each one felt like someone kicked my dog, some more than others. There was the Austin Rivers shot, the Duhon layup, a half dozen doses of J.J. Reddick, and then of course, Laettner. Duke finally reached the apex of the sport when they knocked off UNLV in the national semi-final in Indianapolis in 1991, the last time Duke and Carolina were both in the Final Four. Duke went on to beat Roy Williams’ Kansas team to win its first national championship. I even pulled for Duke—I was there in Indianapolis sitting next to my mom, of course, but that was the last time. As soon as Duke won, the “Go To Hell Carolina” cheer went up, and I abandoned my dual citizenship on the spot. After all, I was a UNC student at the time.

Fortunately for me, the gods would soon again look favorably on Chapel Hill. Duke would win it again in 1992, but Carolina would win it again for Dean Smith in 1993, in New Orleans, where Michael had given Dean his first championship in 1982, and would go to the Final Four five times in the 1990s. I mean, the Stackhouse/Wallace/Jamison/Carter era was an embarrassment of riches.

Since the famous Jordan shot in 1982, Carolina has won five national championships, and so has Duke. Twice, the two programs have won the title in succession, which exemplifies what has made this rivalry so great—it’s obvious the two programs have made each other better. When K arrived, Dean Smith ran the ACC. It was up to Coach K and the late great Jim Valvano to challenge him. Then the crown went to K. Even though Carolina was neck and neck with Duke, the game was changing in Duke’s favor.

Dean Smith famously lobbied for Krzyzewski to take the reins of USA Basketball, and K did a masterful job with the Olympic team. Unfortunately for the Tar Heels, this, and an academic scandal in Chapel Hill, led to a slight but definite recruiting edge that made Duke perhaps the top collegiate launching pad for future NBA superstars. Ironically, Carolina’s inability to attract the “diaper dandies” helped Roy Williams build veteran teams that could make deep tournament runs for years, but K’s talent edge was persistent.

Unfortunately for Duke and for college basketball in general, the Duke teams, among others, became something of a revolving door for NBA talent, and soon enough, the only Blue Devil I could identify well enough to scream at was Coach K himself.
Which brings us back to the apocalypse. After his year-long farewell tour, K will be exorcised one way or another within about 72 hours. There is another young coach in the league, on the trail of the undisputed king. Will the old lion roar once more, or will the young lion have his own day?

In a sense, this is a game we have seen before. No matter who wins, we are witnessing the changing of the guard in a tradition that has forged the finest that college basketball has had to offer for four decades. And whether you’re a Duke fan or a Carolina fan or just a college basketball fan, your life has been enriched by it. Think of the countless hours of joy and anguish and passion we’ve all felt over the years, and then consider how many hours of practice and preparation the coaches and players put into it. It’s astonishing and humbling.

I hope like hell that Hubert Davis, my old geology lab partner, leads the Heels to victory tomorrow. But no matter what, I am grateful to have been able to watch this extraordinary geyser of human achievement and competition-fueled passion that has erupted virtually every year since I was a child. I thank Mike Krzyzewski for continuing to make both Duke and Carolina better.

For making my life better.

Now, please, Hubert, make him go away! And Go Heels!

A Long March

by M. Burke Koonce, III

True to the proverb, March came in like a lion. As oil prices, interest rates, and geopolitical tensions each climbed higher, market volatility soared and asset prices fell. Fear was so ascendant that it caused the Fed to back away from plans to raise interest rates by 50 basis points and instead settle for just a quarter percentage point. And so, here we are at March’s end, and while the lions can still be heard roaring in the distance, there are some lambs stumbling around.

Amid all the tumult, major U.S. market indices finished the month higher. The S&P 500 finished March up 3.7 percent, while the Dow Jones finished up 2.5 percent and the tech-heavy NASDAQ closed up 3.5 percent (each on a total return basis). This rebound, in the face of perhaps the scariest geopolitical backdrop in more than a decade, is remarkable. After some indices flirted with bear market levels in February, defined by a decline of more than 20 percent, equity asset prices have rebounded strongly off the lows. While the first quarter of 2022 will go down as the first quarter of negative returns since the pandemic bear market, it felt a lot worse a few weeks ago than when it finished.

Curious Cross Currents

While the human tragedy in Ukraine is unspeakable, markets react to geopolitical events in curious ways. On February 24, news reports emerged that Russian forces had begun a “special military operation” in Eastern Ukraine. Immediately, global asset prices first fell, but then rallied hard by the close of that first day. After two additional weeks of market declines on frightening news and chilling forecasts about what had become an all-out war in Ukraine, and with oil having approached $124 per barrel, markets began to behave as if this conflict would have a more nuanced impact on the global economy, and accordingly, asset prices. There is an emerging view that some degree of higher energy costs will help prevent the economy from overheating and could convince central banks not to raise interest rates too rapidly. The yield on the 10-year Treasury, which had widened out to almost 2.5 percent (up almost 100 basis points YTD) has come back in slightly. After all, the cure for high prices is… high prices. The more bearish view is that high energy prices will further fuel inflationary forces even while the economy cools, bringing about a bout of stagflation, for which there is no easy monetary policy cure.

Speaking of monetary policy, it was just two months ago when Fed Chairman Jay Powell indicated that the Fed might be forced to raise rates more quickly to ensure inflation did not begin to impede employment. Fast forward to Powell’s remarks after the most recent Fed decision, and the tune has changed; the employment market is so hot that wage increases are increasingly seen as a bigger threat to price stability than higher prices stemming from supply chain issues. That’s another reason why baseline inflation expectations for the year have continued to creep higher. Just a month ago, the consensus forecast for U.S. CPI increase was about 5 percent—today it is above 6 percent, and the 5-year breakeven inflation rate has jumped from 2.8 percent to 3.4 percent. Yes, inflation is still widely expected to subside, but due to higher wages and higher energy costs, inflation seems likely to fall more gradually than was previously expected.

The trouble with easing inflation is that it feels like monetary tightening. Real interest rates are now at negative 4.0 percent (10-year treasury yields of 2.4% less core inflation of 6.4%). As inflation eventually subsides, the effect on real interest rates will be similar to what happens when the Fed raises rates. The market has been reacting to this tightening with volatility, especially among riskier, long-duration assets. Volatility peaked in early March, with growth stocks suffering significant losses. However, after the Fed slightly softened its stance in response to Ukraine, rates still moved higher but more gradually, and growth stocks staged a bit of a comeback. This is why we tend to view volatility spikes, all else equal, as bullish.

What’s Next?

While we have been keeping a close eye on events in Ukraine and on the broader markets in general, we have not made wholesale changes to portfolios. We believe that should the trend toward higher interest rates and higher inflation continue, value-tilted will be positioned well to outperform. That’s because portfolios with a value-tilt tend to perform relatively well in this kind of environment. Sectors such as financials and energy, which tend to be well-represented in value-oriented portfolios, benefit from these trends. Also, when earnings growth becomes more abundant, investors are less likely to chase pricey growth stocks in favor of value stocks that are also experiencing solid growth. Finally, higher rates tend to have an outsized impact on long-duration assets such as long-dated bonds and expensive growth stocks, because those future cash flows must be discounted back to the present at those higher interest rates.

Even though growth (Russell 2000 Growth Index) rallied in the latter half of March, bouncing more than 7 percent off its lows, value (Russell 2000 Value Index) did even better for the month and has outperformed growth by more than 1000 basis points so far this year.

While geopolitical turmoil is unsettling, it is a risk that has already been incorporated in our allocation models. While these specific risks are unpredictable, we know these events happen from time to time in the aggregate and accordingly they are already baked into longer-term expectations regarding overall risk and return.

While we will continue to monitor events in Ukraine and beyond, we do not anticipate much “trading” around the situation. We will maintain an eye toward rebalancing should circumstances warrant.

As always, we will continue to vigilantly monitor inflation, interest rates, geopolitical events and other market factors, and we thank you for your trust.

Burke is Trust Company’s Investment Strategist. Based in the Raleigh office, Burke works closely with the firm’s Chief Investment Officer helping develop investment strategy and communicating with clients.

Will the Next Domino Fall?

by Dan Tolomay, CFA

My sons like to play with dominoes. Specifically, they like to stand them up in rows, push the first one over, and then watch them fall one by one. The design, which is entertaining to devise and laborious to build, is satisfying to watch as it unfolds as planned. Things don’t always go as concocted, though. Sometimes a shaky hand sets the process off prematurely leading to an incomplete sequence. A fully deployed set of tiles may fail to deploy as was imagined. It’s an interesting analogy in today’s bond market. What seems like a clear sequence of events leads to assumptions about the future and how to react.

The pandemic has resulted in product shortages. The scarcity has pushed up prices. A lack of labor supply has caused employers to raise wages to entice workers to join their teams. These inflationary pressures have nudged up interest rates. Bond investors, who receive fixed payments, see the value of those payments eroded when prices rise. To adjust, they demand higher yields, which is achieved by paying lower bond prices.

At the same time, inflation forces the Federal Reserve into action to stabilize prices. The primary tool the Fed uses for this purpose is interest rate hikes. Increasing short-term rates provides an incentive to save and a disincentive to borrow and spend. The desired impact is to cool the economy down so that it doesn’t overheat.

For the three months ended February 2022, the 2-year US Treasury yield has increased 0.92% and the 10-year US Treasury has increased 0.40%. The bond market (as measured by Vanguard’s Total Bond Market Index fund) fell -4.26% during that time. With inflation still in the headlines and more potential increases in interest rates looming, what are prudent steps to take with a bond portfolio?

First, don’t just focus on the dominoes that failed. Look at what worked. The -4.26% return referenced above is only the price move. When income is included, the return improves to -2.48%.

Next, remember the dominoes don’t always fall as planned. The consensus view is that interest rates will continue to rise. This was the case on March 1, 2018, too. The market’s expectation was that rates would increase from the blue line to the red line in 3 years. What actually transpired can be seen in the gold line.

As the chart below demonstrates, sometimes the dominoes are the victim of a false start; the plan for the grand launch fizzles out abruptly. Looking back 15 years to the Financial Crisis, there are multiple examples of what was perceived at the time to surely be the bottom for interest rates. Yields rose some, then fell again – in some cases even lower.

The argument is not that rates won’t rise. They likely will; however, it’s impossible to know how much, how quickly, and exactly how different maturities will be impacted. Additionally, with the risk of further coronavirus variants, escalating geopolitical tensions in Ukraine, or some other unknown crisis, there remains the chance of a “flight to quality” event. Such an event would see flows into bonds, a rise in bond prices, and a drop in yields. Or, inflation could end up being transitory, which would reduce inflation expectations and allow the Fed to be less aggressive. This would cap yields and support bond prices.

A domino cascade may go awry but it’s still fun; there’s a silver lining. Assuming rates do rise, what does it mean for bonds? That too is a mixed bag. The bad news is that the principal value of a bond will fall. The good news is income will rise.

The extent of the price decline is determined by the bond’s duration, a measure of the timing of a bond’s cash flows and its sensitivity to interest rates. As a rule of thumb, a bond’s value will fall by its duration multiplied by the size of the rate increase. For example, a bond with a duration of 5 will decline by 5.0% for a 100 basis point (bp) or 1.00% jump in yields. (It’s important to note that – absent a default – the bond’s price will ultimately move to par at maturity.) Cash flows from interest payments and bond maturities can be reinvested at higher yields.

These forces can be seen at work in the examples below, which assume a 6.6 duration and a 1.4% beginning yield. The first set of illustrations assumes one-time jumps of 0.50% and 1.00% in yields. The second set shows annual hikes of 0.30% and 0.50%. As the price change rows show in the +1 year columns, there is a negative price change. The yield rows reflect the higher income starting at the same time, though.

One Time Shock to Rates

Annual Rate Shocks

As the tables and graphic above show, rising rates are not catastrophic for bonds. The higher income that comes with rate increases helps offset damage down by principal hits. Down bond markets and down stock markets vary widely in magnitude and frequency.

Don’t let fear of the tiles not falling your way lead to bad decisions or avoidance of the game altogether. As with the stock market, investors must resist the urge to try to sidestep danger via market timing. The temptation with bonds and rising rates is to get out, “wait until it’s over,” and get back in. This could mean going to cash or concentrating exposure in short-duration bonds. Doing so may protect principal but could lower income if rates stay low.

Whether managing dominoes or duration, a strategy is critical. How is Trust Company of the South managing the risk to bond values from higher rates?

(1)    Ensure that holdings match the time horizon – portfolios with short-term liquidity needs (< 6 months) are encouraged to utilize money market funds. These funds will hold their value and see yields increase as the Fed raises rates. Short-term bond funds, by contrast, will suffer price declines and have a deferred uptick in yield.

(2)    Shorten duration – as noted above, there is risk in consolidating all bond holdings into short-term bonds. Acknowledging the low level of rates and their likely move upward, our portfolio’s duration is marginally shorter than the benchmark.

(3)    Add credit exposure – bonds with higher yields are less sensitive to rate increases. Interest rate risk is exchanged for credit risk. Care is taken to keep the portfolio investment grade, which provides a ballast when the equity markets decline.

(4)    Diversify within markets – holding bonds with maturities across the yield curve mitigates the risk of a rate increase in a particular maturity.

(5)    Diversify across markets – international bond markets are influenced by local interest rate moves and inflation expectations. Such moves are not perfectly coordinated with the U.S. bond market. As a result, holding foreign bonds serves to hedge domestic interest rate risk.

The role that bonds play in a portfolio is to dampen volatility. For clients without the ability or willingness to tolerate volatility of an all-stock portfolio, bonds have a place in a long-term portfolio.

The best-designed waterfall of dominoes plays out perfectly in the creator’s mind. It seems so obvious that things will go exactly as planned and lead to an outcome where reality matches expectations. A mistake can quickly shatter that idyllic scenario. Similarly, making portfolio decisions based on perceived sure-things or consensus views feels comfortable at the time. It is only with perfect hindsight that it becomes clear what was off and why. Inflation, interest rates, and bond prices may all act as imagined. But, I wouldn’t count on it nor would I make a large wager on it. I’d get out the box of dominoes.

As Chief Investment Officer, Dan is responsible for developing Trust Company’s investment strategy and managing client portfolios.

When the Ride Gets Bumpy

by M. Burke Koonce, III

Last spring, my wife and I took our daughter to Disney World. We had been recently vaccinated and we were feeling empowered and brave. It helped that Disney was operating at 50 percent capacity—it was a luxury I will require for future visits. Anyway, as my daughter and I were exiting Space Mountain, my Apple watch started to vibrate and I saw I had a call coming in from 911. Startled, and a little out of breath, I answered, not really knowing what to expect. Turned out that our technological overlords had determined that based on the violent maneuvers and abrupt stopping, I might have been in a car accident, and they were calling to ask if I required assistance. I thanked them and told them I was just a middle-aged guy on a roller coaster and we all had a chuckle.

After January’s ride, I half expected my watch to start buzzing again today.

While the history books will show that the major market averages were lower for the month based on month-end pricing, they will not capture the mileage. Yes, January concluded with the Dow down 3.3 percent and S&P 500 down 5.3 percent, but those figures obscure the intra-month declines that landed the other major US index, the tech-heavy NASDAQ, well into correction territory, even though a furious rally these last two days enabled it to post just a 9 percent decline for the month.

For the majority of the overall market’s near two-year trip out of the COVID-19 crash of March 2020, the experience has been more akin to the Seven Dwarfs Mine Train than anything that would require a height minimum. That has changed. It was only three days ago that the Russell 2000 Growth Index had fallen 19 percent since year-end, a single percentage point from a bear market.

Almost right out of the gate, the markets had begun to behave differently than they had in months. Ironically, as COVID-19 finally appeared to be losing its grip on the U.S. economy, markets began to focus not on the virus, but on the side effects of the cure—not the vaccine, but the enormous fiscal and monetary stimulus intended to keep the economy afloat during the dark days of 2020 and early 2021.

Those treatments, coupled with persistent supply chain problems and an extraordinarily tight labor market, have resulted in price inflation not seen in this country since 1982. The Federal Reserve, having successfully achieved its stated goal of strengthening the job market, and then some, will now turn its focus to dampening inflation through a combination of reducing its ownership of financial assets and raising interest rates. Accordingly, the yield on the ten-year Treasury has jumped from 1.51 percent on New Year’s Eve to about 1.77 percent as of the end of January.

While markets had been expecting two rate increases in 2022, the markets are now anticipating five rate hikes before the end of the year. That’s a big difference, especially given how low rates have been, and markets quickly began to reprice assets based on that big difference.
Now, as a general rule, markets do not really like rising interest rates, especially markets for expensive assets such as “growth” stocks—you know, the kind of stocks that have been doing well for years. Investors pay more for “growth” stocks because of the promise of earnings growth that will yield big future profits for those companies. The trouble is, in an environment where we have rising interest rates (because of rising inflation) those future profits aren’t going to be worth as much. As a result, other less expensive stocks, of companies that already have strong earnings even if they’re not promising future trips to Mars, look that much more attractive. Intuitively, this makes sense, right? In an economy such as ours that’s chugging along quite nicely in which lots of companies are generating strong earnings, who wants to pay nosebleed multiples for discounted future earnings when we’re swimming in strong earnings today?

What happened in January was a giant rotation out of “growth” stocks and into “value” stocks. At one point, the Russell 2000 Value Index was outperforming the Russell 2000 Growth Index by more than 1000 basis points, or ten full percentage points in just 19 trading days.
Growth made up considerable ground during the last two trading days of the month to trail by slightly less than 8 percentage points, but that’s still a huge move.

Of course, while we as investors have had the luxury of enjoying a relatively smooth ride recently, it is actually perfectly normal for there to be a 10 percent drawdown; in fact, there’s one just about every year.

But what if this really is something more serious? What if this is an extended drawdown? That would be rare indeed—we’ve only had 12 drawdowns of more than 20 percent since 1946. They usually accompany recessions and yet American corporate balance sheets have perhaps never been stronger, but let’s just say for argument’s sake that this might be serious. What might it look like? Well, if monetary conditions tighten significantly, that’s almost certainly going to be harder on the more speculative areas of the market than the less speculative. The reality is that the Fed is going to beat down inflation, sooner or later. The trouble is, falling inflation feels a lot like rising interest rates, whether nominal rates rise or not. With the 10-year where it is and core CPI at 5.5 percent, that translates into a current real interest rate of negative 3.7 percent. As inflation subsides, it’s just hard to see how we even get back to a real interest rate of zero without some price volatility, particularly for long duration, pricier assets.

All that said, we are not in the market-predicting business. We are in the optimal long-term allocation business, with a tilt toward value (and small caps, and international, and profitable companies). Naturally, this positioning is unlikely to outperform markets when speculation and accommodative monetary policy is ascendant. However, the existence of markets such as this one, characterized by heightened volatility, is incorporated into our long-term view, and, so far anyway, the value-tilt is performing as one might expect.

One of my favorite Warren Buffett observations is that in the near-term the market is a voting machine, but in the long-term it is a weighing machine. Sooner or later, all companies must demonstrate the ability to generate earnings, not just promise it.

Because when the ride gets so bumpy that your watch starts to buzz, it will be the weight of the portfolio that counts, not the number of “likes” it has.

Burke is Trust Company’s Investment Strategist. Based in the Raleigh office, Burke works closely with the firm’s Chief Investment Officer helping develop investment strategy and communicating with clients.

A Toast To Mr. Scrooge

by M. Burke Koonce, III

For the past seven years, my daughter has played a role in a local production of Charles Dickens’ A Christmas Carol, the 1843 novella that to a striking degree laid the foundation for how Christmas is celebrated today. This particular production amplifies the comic undertones of the original and is highly contemporary, which is one reason it just celebrated its 48th year. I first saw it when I was in elementary school. For reference, my older child just returned home from his first semester in college. The one constant in the play, which is performed as a musical, is Ebenezer Scrooge, played by the show’s creator.

Scrooge, of course, is a mean-spirited miser, a misanthrope whose hard-heartedness and self-absorption take a terrible toll not just on himself, but on his community, beginning with his long-suffering employee Bob Cratchit and by extension, Mr. Cratchit’s family, which includes the disabled child Tiny Tim.

When I first saw the play, I was perhaps just slightly older than Tiny Tim. I remember fearing Scrooge but also laughing at his obvious flaws. As a daydreaming kid, I really didn’t need to be told not to waste my life working in pursuit of money and riches (how ridiculous!). I needed no encouragement to celebrate holidays, most especially one in which I stood to receive an abundance of toys and candy in exchange for vague promises of decent behavior. But I was shocked by the vision of Tiny Tim’s death. It truly left an impression. Children weren’t supposed to die.

Well, they weren’t supposed to die in Raleigh in the 1970s, but in London in the 1840s, well, there was no such implicit guarantee. As the agrarian economy of Great Britain gave way to the Industrial Revolution and the Victorian era, urban children living in horrific conditions was becoming increasingly common.  Dickens himself was forced into labor as a child after his father was imprisoned for indebtedness. But A Christmas Carol is not a mere harangue against child labor; instead, it poses bigger questions to Victorian England, and really, of course, to all of us: what kind of society are we? Who are we as a people? Are we, as my economics professors described us using an x and y axis, nothing more than labor and capital?

After all, when I returned to A Christmas Carol as an adult, I must admit that old Mr. Scrooge seemed a lot more sympathetic, perhaps even prophetic. Why, who among us truly enjoys the mad scramble up to Christmas Day? The overspending, overindulging, brazen commercialization, and creeping cynicism all seem to suggest Scrooge might have been onto something. Bah, humbug, indeed! Even the tendrils of Scrooge’s most contemptible notion, that society ought to seek to “decrease the world’s surplus population” seeks to take dark root.

However, the horror of Tiny Tim’s fate had not diminished. As a younger adult, with my own small children, watching this scene hit me harder than before. Every child fears death, but parents fear nothing more than the death of their children. I can hardly bring myself to write about it. Thus for me, the meaning of A Christmas Carol began to change, as all our lives do, from the story of my own dreams, to the story of my dreams for someone else.

Scrooge’s path to redemption begins with the Ghost of Christmas Past reminding him of the younger version of himself, one who loved and was loved, before he was hardened by time and allowed himself to be slowly consumed by ambition and avarice.

The ghost conjures a vision of Scrooge’s mentor, jolly Mr. Fezziwig, a successful merchant who might be English literature’s first example of someone who had achieved the optimum “work/life balance.” Victorian readers would have recognized Fezziwig as a character from a vanishing era, one in which wealthy landowners would open their houses to their tenant farmers for a lengthy Christmastime feast (sometimes even lasting, wait for it, twelve days).

After all, it turns out Scrooge wasn’t born a monster. We learn he was sent off to boarding school at a young age by a distant father and not allowed to return home during the holidays. Little by little, he deviated from the model of the happily married and generous Fezziwig toward something wretched, but not until the Ghost of Christmas Present shows Scrooge the projected fate of Tiny Tim does the scope of his error begin to dawn on him. By the time the Ghost of Christmas Future delivers the vision of Scrooge’s own lonely, miserable death, we already know someone is about to have a change of heart.

This year, my children are much older than Tiny Tim was in that terrible vision. I even made it through that terrible scene without a tear, which for me is an extraordinary achievement. But I did not make it through the whole play. The one that finally got me (spoiler alert) was after Scrooge’s Christmas morning conversion when he becomes as a “second father” to Tiny Tim, promising to cure Tim’s lameness. These were tears of joy and hope, mixed with a few of salty resolve, because this was the recognition that we will all eventually die, that we must each contemplate our own legacy and that we can only hope that our worldly works will leave a positive mark.

Yes, somewhere between elementary school and AARP eligibility, the Scrooge miracle occurred for me just as it occurred for him. Call it humility, self-awareness, the Golden Rule, or a Commandment, the meaning of Christmas managed to penetrate my brain, even if just for a few days. Truly, what matters more than the ducats we accumulate is what we do with them, how we spend our time, and how we treat each other.

As Scrooge’s nephew said, “I always thought of Christmas time as a good time; a kind, forgiving, charitable, pleasant time; when men and women seem by consent to open their shut-up hearts freely, and to think of people below them as if they were really fellow-passengers to the grave, and not another race of creatures bound on other journeys.”

So, just as Bob Cratchit proposed, even before Scrooge was redeemed, here’s to Mr. Scrooge, the founder of our feast. For he is us, and we are him, and we will always be in each other’s company until we leave this earth.

And of course, as Tiny Tim said:

God bless us, every one!

October Surprise

by M. Burke Koonce, III

October. The name of the month conjures particularly vivid imagery. Autumn leaves whispering in the trees and crunching underfoot. Clear, cool nights with spectacular sunsets. Playoff baseball. And of course, fears not just of goblins but of financial market mischief.

More than any other month, investors associate October with spectacular market sell-offs, as evidenced in the wave of concerned emails and phone calls financial advisors begin receiving shortly after Labor Day. Of course, this is not without reason. Some of the biggest drawdowns in history have occurred beneath the Hunter’s Moon. In 2008, the market fell 17 percent. In 1987, it swooned 22 percent. The market declined 20 percent in 1929. But as my colleague Dan Tolomay pointed out last month, October is actually not a particularly scary month in terms of historical returns. Going back to 1928, October has delivered positive returns more often than not. While October does have a higher-than-average standard deviation, it is not the highest (August!). In terms of range of returns, October doesn’t even crack the top half. Finally, of all the “black swan” market returns that have occurred since 1928, October brings just slightly more than random chance would predict.

Now, markets are made up of human beings, and human beings experience fear, so the market isn’t always going to be a fun place. But last month was a perfect example of why trying to time the market is more difficult than bobbing for apples, and perhaps an even less profitable exercise. Markets soared in October. The S&P 500 was up almost 7 percent. The Dow Jones climbed almost 6 percent, and the NASDAQ rose slightly more than 7 percent. Those numbers are closer to historical annual average returns than monthly returns. If you had gotten spooked out of the market last month, you would have missed the best monthly return since last November, when the world was reacting to news of COVID-19 vaccines and the beginning of the end of the pandemic.

This is not to say there aren’t real problems with the U.S. and global economies. Inflation is beginning to look persistently high, fed by labor shortages and supply chain problems. The delta variant of COVID-19 continues to circulate, and wealth inequities are fostering growing social unrest around the world. But fear is the fuel that drives markets higher, not lower. After all, if there were no fear in the marketplace, there would be nowhere to go but down.

Over time, liquid markets are brutally efficient, and fear gets priced in quickly; the result is that market returns tend to run away from consensus not towards consensus—after all, that’s what makes returns possible. As Dan said last month, ‘rather than panic or prepare for an autumn decline, enjoy the beautiful weather.” I would only offer that while the weather outside won’t always be beautiful, and returns will rarely be as pleasing as they were last month, the key is to not get distracted by your emotions or short-term thinking and let the magic of compounding continue to work in your favor. No witch’s spell is more powerful than that.