December 2024 Monthly Commentary

The Weighing Machine – A Year in Review · Stay Diversified – Bond Outlook Improves · Always Be 

Portfolio Advice, Talking Points, and Useful Resources

• A Year in Review: In 2024, the weekly Weighing Machine podcast delivered engaging conversations with industry leaders, innovative thinkers, and investment experts, offering diverse perspectives on market trends, portfolio strategies, and the evolving financial landscape. We list a few highlights. 
• Bond Outlook Improves: Following another challenging year for fixed income, the bond outlook appears more promising with higher starting yields and inflation retreating from its peak.
• The Power of Gratitude, Humility, and Strength: Embracing gratitude, humility, and strength can empower long-term investors to navigate challenges and achieve lasting success.
   

Happy New Year!

As we enter a new year, it is a good time to reflect on the current market environment. Despite the challenges we have faced this year, from stubborn inflationary pressures to geopolitical uncertainties, there are reasons to feel cautiously optimistic about what lies ahead. 

While market volatility can sometimes test investor patience, it is important to remember that periods of stress and volatility are part of the investment journey. As investment manager Phillip Toews has said: “There is no ‘likelihood’ of down markets or recessions — there is a certainty.” Historically, staying disciplined and focusing on long-term goals has been a winning strategy. 

Uncertainty is a constant, which is why diversification is crucial to building a resilient portfolio that investors can stick with through different economic regimes and emotional narratives in the financial press. However, diversification is not just about spreading investments across asset classes. It is about thoughtfully balancing risk and reward. 

Currently, one area we are closely monitoring is fixed income. With higher yields available, bonds have become more attractive, offering both income and a hedge against equity market volatility. In this month’s report, research investment analyst Nolan Mauk provides a compelling argument to maintain fixed-income exposure, despite its overall performance in recent years. 

Ultimately, we believe that staying invested, diversified, and disciplined is the key for investors to navigate market and economic uncertainty with confidence and stay on course toward their financial goals. 

The Weighing Machine Podcast: Top Highlights from the Past Year

By Rusty Vanneman, CFA, CMT, BFA, Chief Investment Strategist

We just wrapped up our seventh full year of Orion's The Weighing Machine weekly podcasts, and it was another fantastic year! We launched the podcast with the goal of helping financial advisors and investors achieve their long-term financial goals.

The title of the show — The Weighing Machine — was inspired by the classic investing saying often attributed to Benjamin Graham (or Warren Buffett): “The stock market is a voting machine in the short term and a weighing machine over the long run.” In other words, while emotions and expectations drive short-term market movements, fundamentals and valuations determine long-term returns.

Our mission at The Weighing Machine is to provide financial advisors and investors with thoughtful, actionable insights that foster confidence in understanding and navigating the wealth management landscape. The value proposition lies in delivering engaging conversations with industry leaders, innovative thinkers, and investment experts. We aim to offer diverse perspectives on market trends, portfolio strategies, and the evolving financial landscape with the goal of inspiring better financial outcomes and strengthening professional relationships.

On our first podcast of 2025, my co-host, Robyn Murray, and I reflect on some of our favorite highlights from the past year. We also turned The Weighing Machine’s signature closing questions on ourselves! It wasn’t easy to narrow down our top three moments, given the incredible guests and topics we covered, but here are the three I picked.

Cliff Asness of AQR – Balancing Risks and Rewards for a Quantitative Approach

"Diversification always works. It just works for different people at different times." – Cliff Asness

Cliff Asness is a living legend in the industry. He is not only a well-known and successful money manager, but he is also a thought leader and an award-winning researcher. He is the founder, managing principal, and chief investment officer at AQR Capital Management. Throughout his career, he has received multiple awards, including five Bernstein Fabozzi/Jacobs Levy Awards from The Journal of Portfolio Management in 2002, 2004, 2005, 2014, and 2015. The Financial Analysts Journal has honored him with the Graham and Dodd Award for the year's best paper twice, as well as a Graham and Dodd Excellence Award, the award for the best perspectives piece, and the Graham and Dodd Readers’ Choice Award.

In this episode, Robyn and I had the honor of talking to Cliff for nearly two hours (more than twice as long as the average Weighing Machine podcast), but it did not feel like it was long enough. I described the experience as watching your favorite jam band for a three-hour show. Cliff is eminently quotable. The podcast was titled “Balancing Risks and Rewards for a Quantitative Approach," but it covered a lot of ground for investors. Some highlights included:

• Behavioral Finance: Cliff emphasized the role of behavioral finance in overcoming psychological biases. He also stressed that educating clients about these biases can help them make more informed investment decisions.
• Quantitative Investing Evolution: Reflecting on the past decade, Cliff noted significant changes in quantitative investing, highlighting the importance of adapting to market changes and client needs.
• Value Investing: Cliff shared his thoughts on the long-term prospects of value investing (he is optimistic) and about the factors influencing value investing's performance and its relevance in current markets.

Jerry Parker of Chesapeake Capital – The Most Successful Turtle Trader: Lessons From a Career of Systematic Investing

(On trend following and discipline): "I think if you are willing to submit yourself to rules and not be upset or jealous when people are doing better, seemingly, by not using rules ... I think over time this type of strategy will work out, and win out, eventually, but not on a day-to-day basis." – Jerry Parker

Jerry Parker, CEO of Chesapeake Capital, is the chair and chief executive officer of Chesapeake and Chesapeake Holding Company. Jerry started his trading career in 1983 for the also-legendary Richard Dennis in his “Turtle” training program. As a portfolio manager, Jerry has overseen Chesapeake’s operations and its trading since its inception in February 1988. Key highlights of the episode included:

• Discipline: Jerry emphasized the importance of a rules-based, systematic approach to investing, which promotes discipline and consistency. He noted that adhering to established rules can provide confidence, as these strategies have demonstrated success in the past.
• Selecting Investment Managers: Prioritize those with a clear, disciplined approach to trend following and a record of success in systematic investing.
• Client Education: Jerry acknowledged the challenges investors face in sticking with systematic strategies, especially during periods of underperformance. He suggested that educating clients about the long-term benefits of such approaches can help in maintaining discipline.
   

Alex Fink – Leadership Advice from a U.S. Army General

(On cultivating organizational culture): "You can’t just say, 'hey ... this is our culture, this is what we are going to be about' [and] put it on a bunch of cards and pass them out and think it’s just going to last. It’s something that has to be constantly nurtured and reinforced ... with examples.” – Alex Fink

Alex Fink is a recently retired U.S. Army Major General and former chief marketing officer for the U.S. Army. General Fink is credited with reinventing the classic “Be All You Can Be” campaign. He served for more than 33 years in a variety of domestic and overseas operational and strategic leadership positions. He also serves on USO’s Midwest Region Advisory Board and as an executive board member for the Boy Scouts of America’s Pathway to Adventure Council.

In this episode, General Fink shared valuable insights on leadership, team building, and innovation. The following highlights include what I thought were useful action items for financial advisors and all leaders:

• Develop a Consistent Leadership Approach: Establish a personal leadership style that sets clear standards and expectations, promoting trust and enabling team members to make informed decisions independently.
• Cultivate and Maintain Organizational Culture: Actively nurture your organization's culture by embodying and reinforcing its values, ensuring that team members understand and align with the collective mission.
• Encourage Innovation: Create a supportive environment that encourages team members to propose new ideas and approaches, fostering a culture of continuous improvement and adaptability.

It was a fantastic year for The Weighing Machine, and we have an exciting lineup of guests scheduled for 2025. We would love to hear your thoughts on any episodes and welcome your suggestions for future guests. If you enjoy the podcast, don’t forget to subscribe!

Stay Diversified – Bond Outlook Improves

By Nolan Mauk, BFA, Investment Research Analyst

The last few years have been challenging for bond markets. The rapid rise in global inflation and subsequent aggressive rate hikes eroded bond values and have certainly tested the resolve of fixed-income investors. The Bloomberg U.S. Aggregate Bond index remains in a three-plus-year-long drawdown, which has seen a peak-to-trough decline of 18.3%. In 2022, when the S&P 500 was down 18%, bonds were down 13%, delivering one of the most severe blows to the 60/40 portfolio in history. Simply put, bonds have not fulfilled their role as a ballast for portfolios in times of turmoil and volatility. This is in part why our September, October, and November monthly commentaries all included some discussion about how alternatives and real assets fit into diversified portfolios alongside stocks and bonds. While those asset classes remain key elements of our investment philosophy here at Orion, it is important not to bail on bonds when planning for all market cycles, and current data may show a more attractive landscape than what we have seen in recent years.

Higher Starting Yields May Be a Tailwind for Bonds

As of this writing, the U.S. 10-year Treasury bond is yielding 4.5% and in recent months has been producing its highest yield since 2007. While yields may feel unusually lofty, a broader historical lens shows this as more of a return to normalcy than an anomaly. In fact, the 10-year has yielded more than 4% more than 70% of the time since 1970. It was not until the unprecedented quantitative easing from the Federal Reserve in response to the global financial crisis that interest rates fell to the sub-3% levels that we have become accustomed to in the last decade. As the chart below from PIMCO suggests, those lower starting yields were a massive headwind for bonds, as starting yields happen to be a strong historical predictor of forward five-year returns. The higher starting point we are seeing today could provide a long-awaited tailwind to bonds in the intermediate term. 

Source: PIMCO Advisor Playbook, page 17

The Inflation Headwind is Fading, and Low Correlations May Return

Poor performance is not the only reason inflation is detrimental to fixed income. Arguably the biggest problem from a portfolio perspective is that inflation shocks affect both stocks and bonds similarly (as they did in 2022), which raises the correlation between the two assets. Over the last 40 years, the correlation between stocks and bonds has been just 0.21. This low correlation has historically provided robust diversification benefits, reducing portfolio volatility. However, investors have not felt those benefits recently, as that correlation has spiked to 0.72 over the last three years. Investors have had to look to other diversifying asset classes to lower portfolio correlations.

However, according to researchers at PIMCO, inflation is slowly creeping back into the ideal range for low stock/bond correlation, and they believe that as the Fed continues to reel in inflation toward its target rate of 2%, correlations will drop toward low positive or even negative coefficients. Bonds may be poised to reclaim their place as the ballast in a long-term, all-weather portfolio.

Source: PIMCO Advisor Playbook, page 76

Relative Performance: Bonds Have Outperformed Stocks Following Extreme Equity Valuations

The U.S. stock market is as expensive as it has ever been except for the buildup to the dot-com bubble pop. The current Shiller cyclically adjusted price-to-earnings (CAPE) ratio of the S&P 500 is 38, which falls in the 98th percentile of valuations dating back to 1881. Historically, valuations have had strong explanatory power for forward 10-year returns in the stock market, and a current CAPE ratio of 38 suggests below-average equity returns over the next decade if that remains the case.

Given this unappetizing outlook for U.S. stocks, we reviewed how bonds have performed over different time horizons following periods of extremely high equity valuations. Looking back over nearly a century of data, we broke the CAPE ratio into quintiles and measured the subsequent performances of stocks and bonds following these different valuation levels. As expected, investors are rewarded for the extra risk premium of stocks with higher returns over most time horizons and at most valuation levels. However, when stocks are highly valued (quintile five), they have historically underperformed bonds over the next three, five and 10 years by not insignificant margins. Remember, we are currently at the very top of the most expensive quintile. Quintile five begins at CAPE ratios above 25.7, and we are at 38.

S&P 500 Forward Performance in Excess of Bonds by Valuation Quintile

Source: Valuation and S&P 500 return data is from Yale Professor of Economics Robert Shiller. Bonds return data is from Morningstar Direct. Index used: IA SBBI US IT Govt TR USD. As of 11/30/2024.

The data in this article points to the importance of staying diversified across asset classes when building portfolios. Market cycle stages affect asset classes differently, and abandoning an asset class because it has been out of favor recently can be detrimental in the long term. Core bonds have struggled in recent years, but as headwinds subside, they are poised to play a stabilizing role in portfolios once again.

Always Be

By Rusty Vanneman, CFA, CMT, BFA, Chief Investment Strategist

Years ago, alongside Robyn Murray, I co-wrote a book called “Higher Calling: A Guide to Helping Investors Achieve their Goals." In the conclusion of the book, I shared a personal story about the “Vanneman Boys Club,” a club my son, Ethan, and I started when he was a little kid. The club was full of fun traditions — like secret handshakes (which we still do today!) and guiding principles. One of our mottos, which we called the “VBC Code,” was: “Always be grateful. Always be humble. Always be strong.”

I told Ethan this code could be applied to nearly every part of life. When he was about 11 years old, he asked me how I applied it to investing.

Always Be Grateful

• Be grateful for the world we live in, a world full of opportunities, growth, and innovation.
• Take advantage of these opportunities through thoughtful, growth-oriented risk-taking in the financial markets.

To seize these opportunities, we need to take risks. This requires a growth-oriented mindset in managing our portfolios.

Always Be Humble

• We do not know exactly how the future will unfold. We may have informed views, but we cannot predict everything.
• There will always be volatility, surprises, roller-coaster rides, and Black Swan events.

That is why we diversify and stay balanced. Balanced portfolios are built for resilience.

Always Be Strong

• To achieve our goals, we need strength to stay the course.
• There is power in purpose, power in planning, power in discipline, and power in patience.

Patience is the ultimate strength in the investment process.

Thank You for Letting Us Serve You

Thank you for your time and trust. If you have any questions or feedback, please let us know. As always:

Stay invested, stay diversified, and stay disciplined.

Invest well and be well. Happy New Year! We extend our heartfelt wishes for a joyful and prosperous 2025.

Rusty Vanneman, CFA, CMT, BFA
Chief Investment Strategist
rusty@orion.com
strategists@brinkercapital.com