Interest Rates Rise, Market Does Not Blink - August Allocation

August 01, 2023

Welcome to August!  We had a very successful month across all stock funds.  The laggard F Fund continues to drag down the Lifecycle funds that are invested in it. I’ve always been a proponent of staying away from the G Fund as it will always return negative returns when adjust for inflation, but the F Fund seems to be worse in recent years.

The last few months have seen the S Fund and the small caps continue to thrive with very strong returns. I recognize my performance would be higher if I were to have invested in the S Fund in recent months, but in my opinion, the risk right now is still too high compared to the expected returns.  The YTD risk of the S Fund is hovering around 5% while the C Fund and the I Fund are at ~3% and ~4%, respectively. Combining this with the YTD returns yields YTD risk to reward ratios of ~0.14 for the C Fund and 0.28 and 0.25 for the S Fund and I Fund, respectively.  I take many other factors into consideration when adjusting my allocation percentages, and my system sets different time horizons than YTD, but from these basic numbers, one can clearly see the risk for the S Fund is currently very high for the expected returns. 

I predicted back in my April allocation newsletter, “I am of the belief that rates will be hiked twice this year, given current economic indicators-inflation, unemployment, and GDP. The one-time hike is priced in; the second is not.”  We got our second rate hike this year, and I think it is our last.  Back in April the market had not priced in the hike, but as the job market continued to show strong gains, month after month, the market got the point and when the rate hike did come, the impact was minimal.

Some investment advisors are saying we have positioned the US economy for a recession as we have had 10 interest rate hikes in 16 months.  They argue, interest rates are now high enough to cause the job market to stumble. However, Federal Reserve has raised interest rates to 5.25% - 5.5% with a healthy job market, and Inflation is mostly back under control.  I argue the Federal Reserve has positioned us well for any looming recession as they now how maneuver room should a recession occur.  Recessions will always occur, but the impact depends on how well one has prepared, and right now I think the US economy, as a whole, has improved to the point where any recession will be short and not as deep as previous ones given the return to a 5%+ interest rate.

In Europe, inflation has settled down a bit as well and their economies are also looking decent. The one question mark is China and its internal troubles around its property / banking crises and its aging workforce.

Overall, I’m still very strong on the C Fund and the I Fund.  Keep investing!