Today we’ll pause from our usual market analysis and talk a bit about perspective.

 

Many times, investors find themselves focusing on what the press puts before them instead of concentrating on issues relevant to their goals.

 

Let’s discuss why investment time horizon should be a key focus of portfolio thinking.

 

Most investors have an instinctive understanding of their individual risk tolerance and a robust filter to ignore news stories that are outside their universe.

 

When it comes to investment time horizon, though, the situation is reversed.

 

With investors overly focused on issues that are largely irrelevant to their portfolio goals when measured over the appropriate time span.

 

The Long Road

Most investors say they have a long-term perspective. This is a view that makes sense.

 

Individuals tend to save for major life events such as children’s college tuition or retirement that are frequently years in the future. Many even take an intergenerational approach, looking to provide for grandchildren or more distant heirs. That mindset is very different from active institutional traders, who tend to think in terms of quarterly earnings reports and annual bonus payments.

 

Institutional traders cannot really determine their own holding period. They tend to rely significantly on borrowed money—in some cases, positions are funded with as much as 90 % debt.

 

This forces traders to take a short-term outlook; if they cannot meet the margin call from their lenders, they are forced to liquidate positions. Irrespective if their long-term view was correct—they still end up losing money. This is a factor in short-term market volatility.

 

The financial press tends to reflect the short-term perspective of more active traders - partly because it makes for better headline fodder. It also helps news outlets to explain daily market moves; short-term predictions let reporters and the press get a jump on the news cycle. For instance, an article headlined “Quarterly portfolio rebalance comes off without a hitch” is not likely to draw a lot of clicks.

 

The Noise Filter

This difference in time horizon has significant implications for how investors should approach their consumption of financial data.

 

Take, for instance, all the discussion about the timing of Fed rate cuts. Rather than getting sucked into a discussion of will they, won’t they, or when they move, investors should start by asking if the outcome really matters to them. For many, if not most, individual investors, the answer is likely no.

Let’s start with bond prices.

 

If the Fed delayed rate cuts by a year, the impact on 5-year Treasury rates would be approximately 20 basis points, assuming the central bank then implemented the policy path embedded in interest rate futures pricing. That’s less than the yield change from Feb. 7 to Feb. 13 of this year.

 

So, all of the analysis, all of the discussion, and all of the forecasting on the Fed boils down to the equivalent of some random week in February ? This hardly anything worth losing any sleep over.

 

Equity price moves are also sensitive to interest rates, and Fed policy could have a meaningful impact on where stocks go in the short term.

 

However - it’s important to put interest rate policy into context.

 

If rates are staying high, but corporate earnings and economic growth are solid, then there is little reason to expect a sustained loss of value to stock prices.

 

In its recent rate hike campaign, the Fed took interests rates up by 5.25 %, and equity markets are at or near record highs. Do we really think a small delay in rate cuts is a meaningful threat over a multiyear time horizon?

 

It’s very clear why short-term traders care about the timing and number of cuts—they’re playing with borrowed money and need to make sure that margin calls don’t push them into forced sales.

 

For a cash investor, or one who uses moderate leverage, the likely impacts of May versus June versus September for the first cut are blips in performance that will likely be long forgotten when retirement rolls around.

 

The Proper Perspective

The informational bias toward short-term results can even turn perceived outcomes from negative to positive.

 

Most regular readers of the financial press, for instance, probably worry about a potential market selloff caused by the Fed’s failure to cut when expected. That may be a bad outcome for a hedge fund, but the economics look very different for a retirement saver.

 

Higher interest rates also mean better reinvestment rates on upcoming portfolio cash flows; coupons and dividends will earn more, boosting realized yields.

 

Additionally, lower security prices allow investors to optimize their tax profile, swapping losing positions into new securities to delay or even eliminate taxes.

 

The bottom line is that there’s only one account valuation that really matters—the valuation on the day the investment is sold. Intermediate readings are potentially important markers, but focusing on those data points is letting the tail wag the dog.

 

Interest Rates Are Important…But Not The Only Factor

This is not to say that monetary policy is irrelevant or that macroeconomic conditions don’t matter.

 

The ideal blend of equities and fixed income will vary with prospects for a recession, and for investors with shorter time horizons— such as those in retirement or with a high emphasis on money market investments—rate cut timing may be important to their portfolios.

 

Individuals may also have significant exposure to interest rate policy through their employment or personal business.

 

The point isn’t to ignore the Fed. Instead, the degree and type of attention paid to particular inputs varies with the individual.

 

Just as a moderate risk investor is probably not going to be looking too deeply into exotic option pricing, a long-term investor can likely look past the first rate cut debate.

 

History Does Repeat Itself

John Maynard Keynes famously observed that “in the long run, we’re all dead,” while Burton Malkiel and other economists have told us that short-term asset price moves are random.

 

Knowing where you sit on the spectrum from quantum uncertainty to the inevitable future is a first step toward knowing what to focus on when thinking about markets.

 

If you have any questions or comments, please feel free to let me know.