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  • Writer's pictureBen TeSelle

Dorato News - July 2024

Portfolio Issues - Cash Fever


We have had several conversations recently about money market funds and whether moving money into them is a good option. We think it is important to differentiate between short-term needs versus long-term goals.


A sharp rise in short-term interest rates makes switching to cash an alluring choice. Investors shifted large amounts into money market funds over the past few years as rates on these funds steadily climbed to 5%. That is a stark contrast to the previous decade where money market rates were essentially 0%. For savings that will be used in the next few years, this presents a great opportunity. But if you have a longer time horizon, leaving money in those

funds is not ideal.


There are several downsides to money markets worth mentioning. They do not keep up with inflation long-term, income from them is taxed at ordinary rates and the return will go down if the Federal Reserve cuts rates. These traits make them a poor choice compared to stocks. 

Bonds are the more obvious candidate for substitution. Their role as a stabilizer for investors is being questioned due to their poor performance since long-term rates (which the fed does not control) started to rise in 2021. However, since 1926, bonds have returned close to 5% annually including the recent downturn. We think they will continue to be an integral part of portfolios going forward.


There is a use for money market funds in many portfolios, but they should not replace stocks and bonds to meet long-term investing goals.


“Everest is kind of passé. I want to climb the US debt mountain.”

 

 

Market View - Bumpy

 

The similarities between the US stock market of 1999 and today are eerie. Back then, technology stocks comprised 42% of the index, more than twice the weighting of any other  economic sector. Today, the top ten stocks comprise 38% of the index, and most of those stocks are in the technology sector. The S&P 500 didn’t provide quite the diversification that people hoped for then, and it doesn’t now.

 

Back then, investors became enamored with the internet and the potential profits to be had. Cisco became the most valuable company in the index, and investors thought they were being quite rational, because Cisco’s profits had doubled in 1999. Today, investors are starry-eyed about artificial intelligence, and recently, Nvidia became the most valuable company in the index. Investors think they are being quite rational, because Nvidia’s profits have doubled in the past year.

 

Back then, the US Department of Justice initiated legal proceedings against Microsoft under the anti-trust provisions of US law. Today, the Federal Trade Commission and the US Department of Justice have initiated anti-trust legal proceedings against Apple, Alphabet, Meta, and Amazon. Regardless of the merits of past and current cases, they are an indication that the technology industry has lost political support.

 

All that eeriness makes us wary of what happens next. Back then, the S&P 500 fell 25% over the next two years, and technology stocks got clobbered. Cisco dropped 80%. But just because there are some striking similarities between 1999 and 2024 doesn't mean that 2000 and 2025 will look exactly the same. The world is a different place. But we do think it’s prudent to be skeptical of the current stock market darlings, and to think more about preserving capital than about how to make millions from artificial intelligence.

 

In the bond market, short-term rates, at 5%, are still above the 10-year rate, at about 4.3%. You used to hear how this inversion always predicts a recession. You don’t hear that so much anymore, and is a reminder not to get too awfully hot and bothered about any one prediction or another.

 

Inflation has come down, from 8-9% two years ago to a bit above 3% now. But the Federal Reserve has said their target is 2%, which is why they’re in no hurry to lower short-term rates. Also, the federal government is running enormous annual deficits, which keeps the economy chugging along and keeps inflation elevated. The US is essentially pressing on the gas pedal (federal government) and the brake (Federal Reserve) at the same time. Even if and when the Federal Reserve lowers short-term rates, long term rates are likely to remain where they are or move higher, as investors wake up to the large US debt pile and questionable budget management of our federal government.

 

Internationally, the news is unsettling. War in the Middle East and Europe, angry voters in Europe, and a tense US-China relationship seem to presage change, and not necessarily for the better.

 

So as we write this Market View section, we realize that we are not exactly brimming with confidence. We think the next several years are likely to be bumpy. The problem is that we don’t know when those bumps will hit. As Yogi Berra said, predictions are hard, especially about the future. So the best strategy is to stay invested. Trying to time the bumps is impossible.

 

Sources: Economist, Wall Street Journal, Value Line, Vanguard, Applied Finance Group, Schwab

 

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