Carnage in the bond sector; Bill Ackman covers bet against Treasurys; How I cost my client his job; McKinsey: Last Week Tonight With John Oliver
1) While I'm almost exclusively a stock investor, I follow the bond market as well...
Many people might be surprised to learn that the bond market is actually larger than the stock market, both in the U.S. and globally.
According to the Securities Industry and Financial Markets Association, "the U.S. fixed income markets are the largest in the world, comprising 40.0% of the $130 trillion securities outstanding"... while "U.S. equity markets represent 42.9% of the $106.0 trillion global equity market cap in 2023, or $45.5 trillion."
The primary reason almost all investors put their money in bonds is because they're supposed to be a safe, conservative asset class – while returns might not be exciting, at least you won't lose any money, right?
Not so fast...
There are two primary ways to lose money investing in bonds. The first is obvious: the company defaults and fails to pay interest and/or principal.
But many investors forget the second way: rising interest rates. Consider, for instance, one of the world's safest investments, the 30-year U.S. Treasury.
As you can see in this five-year chart, when the pandemic hit in early 2020 and markets around the world crashed, investors fled to the "safety" of U.S. Treasurys – driving the interest rate paid on the 30-year to barely above 1%:
But look what has happened since then... As the world recovered, inflation reared its ugly head – leading the Fed to raise rates faster than any time in history – and the interest rate soared to today's level of 5%.
So today, three and a half years later, investors who bought a 30-year Treasury yielding a mere 1.2% have lost a staggering 50% of their money. That's not because they won't get repaid (they will), but because who wants to own a bond for the next 26.5 years yielding a piddly 1.2% when you can buy one that will pay you 5% annually for the next 30 years? (The answer is: plenty of people – but only if they can buy it for half of the face value.)
I'm truly amazed at the carnage that has taken place in the bond market, especially among of longer-duration bonds, whose price is affected the most by rising interest rates. As you can see in this 100-year chart of the maximum declines in the 30-year Treasury, the current 50% loss is twice anything prior:
Similarly, here's a table from Charlie Bilello showing the annual performance of the 10-year Treasury, which, like the 30-year, has never experienced anything like the current decline:
Not surprisingly, the classic, conservative 60/40 strategy has failed recently – as this Wall Street Journal article notes: The Trusted 60-40 Investing Strategy Just Had Its Worst Year in Generations. Excerpt:
For generations, financial advisers touted the 60-40 strategy as the single best way for ordinary people to invest. The idea is simple: owning stocks in good times helps grow your wealth. When stocks have a bad year, bonds typically perform better, cushioning the blow.
Not anymore.
Some analysts say the crux of the portfolio's success – bonds' tendency to rise when stocks fall – generally happens when inflation and interest rates are relatively low. They argue that expectations for a prolonged period of higher rates and lingering inflation will weigh on both stocks and bonds, fostering a market environment that looks much different than in recent decades.
Wall Street's biggest asset managers now focus on the pitfalls of what volatile markets can do to an unprepared portfolio in their marketing materials. Financial advisers are fielding an onslaught of calls from their clients to dump stocks and pile into cash – while some advisers are recommending assets not typically sold to individuals like commodities and private asset markets.
The tried-and-true 60-40 portfolio lost 17% last year, its worst performance since at least 1937, according to Leuthold Group analysis. Even with a 14% gain in the S&P 500 helping the strategy recover in 2023, stocks and bonds have moved in tandem, more over the past three years than any time since 1997, Standpoint Asset Management analysis shows.
2) So what does the future hold?
Well, at least one smart investor, my college buddy Bill Ackman, thinks the bond sell-off has peaked and covered Pershing Square's bond short, which undoubtedly was extremely profitable:
Here's a CNBC article about it: Bill Ackman covers bet against Treasurys, says 'too much risk in the world' to bet against bonds.
So what does all this mean for average investors? It's mostly good news. Just a few years ago, investors felt like they could only buy stocks – the so-called TINA ("there is no alternative") problem – because bonds, to quote Jim Grant, offered nothing but "return-free risk."
But today, the world's safest investments, U.S. Treasurys, are yielding 4.8% to 5.6%, depending on duration, as you can see in this chart:
That's why, just two months ago, for the first time I bought Treasurys of various short-term durations, as I described in my August 21 e-mail, earning more than 5% annually.
Additionally, looking ahead for what investors should be doing, my good friend Porter Stansberry is going on camera on Thursday to hold a special briefing on what he sees coming in the markets.
No one else is covering the story Porter will reveal on Thursday. If you've read his work or seen any of his presentations before, you'll know he's no stranger to controversy... And this could be another in the long string of predictions he gets right. They're always well-researched and reliable.
Porter's briefing is completely free to attend – you just need to reserve your spot in advance. You can do so here.
3) The only "real" job I've ever had was two years as an associate at management consulting firm Boston Consulting Group ("BCG") from 1990 to 1992, in between college and business school.
It was a great learning experience for me and during this time I met both my wife and best friend to this day – two of the world's most patient and forgiving people! Here's a picture of us from back then:
And more recently:
But while BCG was a great place to work, I have to confess that, looking back, I'm not sure we added much value.
In fact, in one case, we got our client (and ourselves) fired! He was the CEO of a local health management organization ("HMO") called Harvard Community Health Plan ("HCHP") and hired BCG to figure out a way to improve doctor productivity.
By every measure, the in-house doctors at HCHP were less productive, working shorter hours, and seeing many fewer patients per day than independent doctors in private practice. (This was an early lesson for me in the massive difference in human behavior between people working for themselves versus getting a salary from a big company.)
So we came up with a carefully crafted plan of carrots and sticks to "encourage" the doctors to be more productive, with financial incentives for top performers and the possibility of job loss for laggards.
It was all very logical – but we missed one important thing: the doctors hated it.
The reason they chose to work at HCHP and make a lot less money than their peers in private practice was so they could work 40-hour weeks with low stress. As many folks reasonably do, they were trading money for quality of life. So when the CEO tried to change the deal (with our help), they rose up and threw him (and us) out!
Another friend of mine – who worked for a similar firm, Bain & Company – once visited a meat-processing plant where he was part of a team advising management on cost cutting (i.e., layoffs). As he was walking through the plant, all of a sudden a severed pig's head hit him in the leg – thrown by an angry employee (who was never identified). He was never able to shake the nickname "Pig Head" at Bain...
I was reminded of these stories, which I've never told before, when I watched John Oliver's scathing takedown of the world's most prestigious management consulting firm, McKinsey & Company: McKinsey: Last Week Tonight With John Oliver. Here's a Guardian article about it: John Oliver on management consulting firms: 'They shouldn't get to be invisible'. Excerpt:
John Oliver tore into management consulting firms on Sunday's Last Week Tonight, and in particular the track record of McKinsey & Company, the "massive" and "ubiquitous" firm with offices in more than 65 countries and over $15bn in annual revenue.
McKinsey frames its work as a force for good in the world, though its reputation has taken a knock in recent years for taking on a number of questionable clients, including several oil companies, Purdue Pharma, and the Saudi government.
The company, founded in 1926, keeps a purposefully low profile – no published client lists, no signs on its offices – and has a notoriously rigorous interview process for ambitious new hires. But much of the time, its bespoke advice is pretty straightforward; the firm reorganizes sales forces or designs by-the-numbers downsizing to reduce overhead costs. "Essentially, McKinsey is a firm that projects a huge amount of confidence to sell a frequently unremarkable product at sky-high prices, making them truly the Salt Bae of companies," said Oliver. "You've had salt before, but have you ever had it from a douche?"
McKinsey advice is associated with mass layoffs, disguised with euphemisms such as "finding efficiencies" or "organizational streamlining," and with the expansion of executive pay. "Layoffs are sometimes necessary, but they're always painful," said Oliver. "And much more painful than some mid-20s Ivy Leaguer who fancies himself a business genius might realize."
Oliver then started in on McKinsey's shadowy client list with Purdue Pharma, the makers of OxyContin, which paid McKinsey about $84m in fees to "turbocharge" sales of opioids.
McKinsey also advises public entities, such as New York City, which paid the company $27.5m to help reduce violence at Rikers Island. Advice provided by the consultants included the expanded use of Tasers, shotguns, and aggressive dogs. "It's some really outside-the-box thinking for people who are literally trapped inside boxes," Oliver deadpanned.
McKinsey reminds me of Goldman Sachs (GS): great firms filled with smart, high-grade people doing valuable work for clients – places I would be happy to have one of my daughters work.
But sometimes they go astray in pursuit of lucrative fees, so this kind of scrutiny by the media is very healthy...
Best regards,
Whitney
P.S. I welcome your feedback at WTDfeedback@empirefinancialresearch.com.