Large cap stocks, traded in both international and domestic markets, were up in April; emerging market stocks and stocks of small companies, on the other hand, were down. Year-to-date stocks produce positive returns that range from 1% in small cap stocks to almost 12% for developed international markets. Year-to-date stocks have performed reasonably well with a globally diversified stock portfolio, earning 4%.


Since the beginning of the year bond yields were up at the short end, but down across maturities beyond 90 days, resulting in positive bond returns (bond prices move inversely with yields). The pattern of yields across various maturities peaks at three-months and falls off steadily before beginning to move up at about ten years. This shape is consistent with expected lower interest rates, which might be explained by the Fed “taking its foot off the gas,” lower expected inflation, or an expected economic slowdown – take your pick. The spread between nominal and inflation-adjusted five-year yields, a reasonably good indication of expected inflation over that period, stayed at about 2.5%.


The trajectory of inflation, the path of interest rates, expectations for a “soft landing,” the banking system and a looming debt ceiling are some of the sources of uncertainty today. While we can be concerned about what inflation has been, current numbers tell an improving story – the Consumer Price Index (CPI) was flat for the month and under 1% year-to-date. The Fed seems to be committed to keeping interest rates high. However, keeping them there too long and triggering a recession is a worry. While there could be surprises ahead, markets seem to be taking today’s unknowns in stride. We’ll see.

The Wonders of Compound Interest

Einstein referred to compound interest as the eighth wonder of the world! He went on to say: “he who understands it – earns it, he who doesn’t – pays it.” To profit from compound interest investors must establish and maintain commitments to risky markets through thick and thin. It is especially important to avoid the common urge to move into the asset class with the best recent results. While diversification means always looking back with regret from commitments to some markets, the fruits of compound interest come from enduring this short-term regret and looking ahead.

The wonder of compound interest lies in its ability to turn small amounts into significant sums over time (playing golf for $1.00 that doubles every hole means playing the 18th hole for more $260,000!). It is the process of earning interest on both the principal amount and reinvested interest that accumulate over time. It means that the longer the portfolio is left untouched, the more it will grow due to this compounding. It is a powerful tool to leverage time to achieve investment goals and weather market volatility.

Investors seeking to build wealth know they must endure risk to achieve growth. Maintaining a diversified portfolio throughout the inevitable market ups and downs is the best way to navigate an uncertain path to growth and realize the wonder of compound interest.


After enduring ups and downs due to the uncertainty in the financial system and the Fed’s response triggered by the collapse of Silicon Valley and Signature banks, stocks ended the first quarter in positive territory. Domestic large cap stocks, International developed markets and emerging markets were up between 4% and 8%, small cap stocks and REITs up just under 3%. Over the trailing twelve months, on the other hand, except for International developed markets, stocks were down significantly because of rising interest rates and inflation uncertainty.

While the past year was not kind to stocks, the story has been mostly positive over longer periods. The past three years saw a portfolio diversified among several markets earning about 15%. Although with considerable variability among individual markets, a diversified stock portfolio earned about 4% and 7% over the last five and ten years, respectively.


Recent turmoil in the banking system drove bond yields down, especially for longer maturities. Since prices move inversely to yields, this downward trajectory in yields pushed first quarter bond returns up between 1.5% and 2.8% depending on maturity. The Yield Curves below show the extent to which yields have climbed since March 2022. The primary culprit is the Fed increasing its Federal Funds rate to dampen inflation. While yields fell back a little this quarter, with the recent 0.25% increase in the Federal Funds rate, the Fed seems committed to keeping rates high for the immediate future.

The spread between nominal- and inflation-adjusted five- and ten-year yields, which is a reasonable measure of the market’s expectation for inflation over these periods, is close to the Fed’s inflation target. The shape of the yield curve can be a harbinger of future interest rates – today’s downward sloping shape implies reduced rates ahead. These signals are positive for future inflation.

Failure of Silicon Valley and Signature Banks

The turmoil in banking brought on by the collapse of Silicon Valley and Signature Banks has not only unsettled markets, but also increased uncertainty in the financial system associated with rapidly rising interest rates and the fight to dampen inflation. These two banks failed because after being accustomed to low interest rates, management lost track of the impact of rising interest rates on bond values. It was surprised by the prices at which its bonds had to be liquidated to meet unanticipated depositor withdrawals, causing sharp losses and eventual failure.

Further exacerbating this interest rate risk, these banks had a concentrated base of large depositors. In response, the Fed has stepped in to protect all depositors. While this intervention has lessened the impact of this crisis, the extent to which it creates a moral hazard that distorts future economic decisions is a downside.

While the implications of the failure of these two banks appear to be well-known and somewhat manageable, it brings heightened uncertainty, not only in the banking system, but also with the Fed’s continued resolve to squeeze out inflation, the availability of credit and economic activity going forward. While the market has absorbed this uncertainty reasonably well so far, we can anticipate continued market volatility.


All stock markets were down In February no doubt reflecting the ongoing uncertainty of rising interest rates, inflation and an economic slowdown.  With its 0.25% increase in its Federal Funds Target Rate, the Fed continues to signal its commitment to rein in inflation.  While Consumer Price Index (CPI) increases are looking better recently, no one is declaring victory.  How far the Fed will go with increasing rates and whether it will trigger a recession remains uncertain.  Not only does this uncertainty impact stocks negatively, but also Increased interest rates reduce the present value of future cash flow and stock prices generally.

This ongoing uncertainty helps to explain losses in domestic large cap (S&P 500), small cap (Russell 2000) and international developed markets of about 2% this month.  Emerging markets were off nearly 4%. After a pretty good January, these February results brought the quarter-to-date returns in a global stock portfolio to under 5%.  While short-term stock returns are unpredictable, continued volatility remains a safe bet.


Yields for Treasuries maturing beyond a year, yields were up 0.05% in February pushing prices down. An index of 3-to-5-year Treasury securities was off 2% in February.  An index of shorter maturing Treasures was off a little less than 0.1% while those maturing in 7-to-10 years were down over 3%.

While the future path of inflation is far from clear, market predictions over 5- and 10-year periods obtained from the spread between nominal and inflation adjusted yields has remained relatively constant at about 2.5%, which provides some comfort that inflation may be short-lived.  We’ll see.

The Value Premium

After trading at significant discounts in recent years, over the most recent twelve months an index of domestic large cap value stocks traded at a premium of 8% to the S&P 500.  These results prompt an examination of the persistence of value premiums.

Stocks are often divided into two categories – “growth” and “value”.  Expected cash flows from growth stocks reflect future investment opportunities and a steeper trajectory, expected cash flow from value stocks, on the other hand, are from assets in place, and consequently the slope is flatter and more immediate. Growth stocks are distinguished by higher price to earnings (P/E) ratios, value stocks by lower PE’s and higher book to market ratios.  Value investing goes back to 1934 with the publication of Benjamin Graham’s “Security Analysis – Warren Buffett is a disciple.  Metrics that distinguish growth and value stocks are used to build indices and allow us to measure value premiums in past data.

Using indices published by Russell and MSCI we observe an average 1% premium in domestic small cap and international market indices.  We don’t see an average premium in domestic large cap market in Russell indices.  However, an annual average value premium that exceeds 2% with greater volatility is present using the so-called “pure value index” published by Standard & Poor’s. While there is evidence of a value premium over the long run, taking advantage means accepting volatility.


Stocks continued to climb in January, with small company and non-domestic stocks earning between 8% and 10% leading the way.  Domestic large cap stocks (S&P 500) returned 6% for the month somewhat less than other markets, which is a change from recent history. A globally diversified stock portfolio was up 8% for the month and 14% over the trailing quarter. International developed markets and emerging markets were up 8% this month and 19% over the trailing quarter reflecting to some extent the decline in the value of the dollar.  These recent numbers demonstrate the benefits of diversification to non-domestic markets.


Except for an up-tick in one-month maturities, short-term bond yields did not move much in January.  Yields on longer maturing bonds (beyond two-years), on the other hand, fell a bit resulting in positive returns.  An index of U.S. Treasury securities maturing in 1 – 3 years returned 0.7% in January; the 3 – 5-year index earned 1.7%. Over the trailing 90 days, the shorter-term index posted a 1.8% return; longer-term index returned 3.6%.  These results are significantly better than what we experience the past twelve months.

Inflation as measured by changes in the Consumer Price Index was flat for the month and trailing quarter.  Over the training twelve months the change was 5.7%, well below 8.7% we saw in March 2022.  The spread between 5-year nominal and inflation-adjust yields, a reasonable measure expected inflation over the period, is 2.3% – not far from the Fed’s goal.

A “Soft Landing”?

Since January 2022 the Fed Funds rate increased from 0.25% to 4.5% reflecting the Fed’s effort to dampen inflation.  The goal is to do this without a significant economic slowdown that often accompanies interest rate hikes.  Markets are forward looking.  While surprises could be lurking, generally market signals anticipate a “soft landing” – stocks are up, bond yields look reasonable, and labor markets are robust for now.

Signals from stock markets are positive.  Last quarter and this month stock returns are up with relatively low volatility.  While these markets can change quickly, current prices do not reflect a significant downturn.

Bond market signals are mixed. Current bond yields are constant at 4.7% over the next year but decline to 3.7% at five years. This downward shape of the Yield Curve can be a predictor of recessions as it suggests a future need for the Fed to reduce interest rates to spur growth.  Yet, expected future interest rates (roughly 3%) implied by today’s pattern of yields do not anticipate a need for massive changes in monetary policy.

Current signals from the labor market are positive.  Unemployment levels and rates are about where they were prior to the Pandemic and much anecdotal evidence suggests difficulty in hiring. While the current spate of announced layoffs in large Tech companies is unsettling, labor markets do not seem poised for a sharp recession.

While there is always room for uncertainty, current signals from stock markets, bond markets and labor markets point to any future recession being reasonably mild – a “soft landing”.

2022 in the Rear View Mirror
Inflation, the Fed’s response and rising interest rates, a sharp falloff in stock and bond prices, uncertainty of a looming recession and Cryptocurrency implosion were all part of the investment landscape in 2022. Although we don’t know what’s ahead, glad this year is behind us.

Inflation and Interest Rates
Inflation and the Fed’s response dominated the investment environment. 2022 saw the inflationary effects of prior years’ stimulus payments, supply chain disruptions, war in Ukraine, and an accommodative Fed – too much money chasing too few goods. The pattern of inflation, measured by prior year changes in the CPI, is shown in the accompanying chart. Throughout the past year, the Fed worked to bring inflation in check without triggering a recession. While some would argue a little late, the Fed ratcheted up the Federal Funds Target rate continuously from 0.75% to 4.50%. While it is too early to declare victory, a quick look at its recent trajectory shows the pattern of our measure of inflation bending in the right direction.

The rising interest rates in 2022 are seen in changing Yield Curves. (Yield Curves show the pattern of returns for holding various Treasury securities to maturity. Generally short-term yields respond to monetary policy; longer-term yields reflect market expectation for future interest rates.) The upward push in yields moved bond prices and returns lower – an index of long-term bonds was down over 14% in 2022. The December 2022 curve showing an upward slope for shorter intervals, then falling off is especially noteworthy. The short run pattern is consistent with the Fed’s continued tightening. The downward slope beyond a year projects interest rates to fall. Often this shape is explained by an anticipated need for an accommodative monetary policy down the road to spur economic growth in a recessionary environment. A more optimistic reason might be an expected reduction in inflation. We’ll see.

Although the recent quarter was positive, 2022 was a down year for stocks, reflecting emerging inflation, increasing economic uncertainty and rising interest rates. A globally diversified stock portfolio finished the year down 18% – a sharp and unsettling change from recent market trajectories.

Stock price reflects the present value of expected future cash flows – as interest rates increase present values (prices) fall. The farther away are the cash flows, the greater the impact of interest rate changes on prices. Consequently, growth stocks lagged value stocks in 2022. Domestic tech stocks were especially hard hit – an equally weighted portfolio of Apple, Microsoft, Amazon, Google and Meta (Facebook) was down nearly 40%.

Inflation and the Fed’s response produced surprises and market volatility in 2022. No doubt we are in store for surprises going forward, some may even be positive.

The Cryptocurrency phenomenon seems to be unwinding. Bitcoin, the most popular of the lot, fell by almost 70%. The Cryptocurrency exchange, FTX, blew up. While it appears the cause of FTX is simple fraud, greed and embezzlement, it prompted a discussion of the Cryptocurrency technology and its expected role going forward. There are two technologies involved – Cryptocurrency as money and “blockchain” to keep track of transactions. It is hard to imagine Bitcoin, or any other Cryptocurrency as money. After 14 years, Bitcoin is nowhere near a meaningful medium of exchange. Its volatility precludes Cryptocurrency as a store of value or unit of account. Blockchain technology was developed to keep track of Cryptocurrency transactions and holdings. While blockchain technology may eventually prove to be useful in certain roles, keeping track of Cryptocurrencies will not be one.



After this week’s ups and downs, stocks ended November up nicely – international and emerging market stocks leading the way earning 11% and 15%, respectively. While not as robust, domestic large cap markets were up 6% and small-company markets returned 2%. These results bring the quarter-to-date returns to 14% for domestic markets, 17% for developed international markets and 11% for emerging markets – a welcome improvement over the first three quarters and consistent with a generally improving economic outlook.

Value markets – both domestic and international – are trading at premiums to broad markets. Year-to-date, the value premium in domestic markets was nearly 12%, in international markets just under 8%. Prices of value stocks reflect earnings from assets in place and less from future investments. These stocks are generally identified by relatively low price earning ratios. Because earnings are not as far off, increasing interest rates have a smaller impact on prices of value stocks and help to explain recent premiums.

Stock prices reflect the future, which is always unknown. The recent upswing is surely positive, but uncertainty remains. No doubt there will be surprises ahead.


Yields on bonds at the short end moved up the last month, reflecting the push by the Fed to increase Federal Funds rates. Yields at the longer end were down a bit as well. Yields peak at one-year maturity and fall off to 3.8% at five years. This sharp inversion indicates lower interest rates ahead and often predicts a recession. The spread between real (inflation-adjusted) and nominal yields at both five- and ten-year maturities (about 2.3%) is consistent with the Fed’s long-term inflation objectives.

A Perspective on Inflation

Inflation can often be explained by too much money chasing too few goods. This description is consistent with the recent economic environment. One source of too much money is the massive stimulus payments made in 2021 to counteract the impact of Covid. These payments become inflationary if they exceed what is necessary to bring the economy to full capacity. The disruptions in the supply chain throughout the pandemic, and constraints in energy supplies from the invasion of Ukraine, meant too few goods. Additionally, throughout this period the Fed was especially accommodative. That inflation resulted should not be a surprise.

The landscape looks different today. Stimulus payments are beginning to work through the economy; supplies are more readily available; embargos seem to have reached a “steady-state,” and; the Fed is committed to being more restrictive. All of which should dampen inflation pressures. The bond market continues to signal benign inflation expectations. Stock markets appear to anticipate a more relaxed interest rate environment, which helps to explain recent positive stock markets.Yet, there are risks with this improving outlook: fiscal and monetary policies can overshoot the mark and either trigger a serious recession or reignite inflation; inflation becomes expected, and consequently, embedded in future transactions and self-fulfilling; and labor markets continue to tighten, driving up wages. Uncertainty remains, and it is reasonable to expect market ups and downs as this future unfolds. Yet, the current inflation and interest rate environment appears to be improving.


Rockbridge Institutional serves the unique needs of institutions, foundations, and endowments by applying a disciplined, proven and responsible investment philosophy. We are intimately familiar with the challenges boards face as we serve on boards and finance committees ourselves.

We are committed to investment ideas that are grounded in academic research. The essence of our investment philosophy is that capital markets work in the long run; a portfolio’s risk is defined by its allocation among asset classes; and that security selection is a matter of constructing portfolios with specific expected return/risk characteristics at the lowest cost.



Except for emerging markets, stocks were up in October. Domestic markets led the way – large cap (S&P 500) up 9%; small cap (Russell 2000) up 11%. International developed markets (EAFE Index) were up 5%, while emerging markets (MSCI Index) were off 3% due to sharply negative results in China. While uncertainty remains, October is a welcome change.


Bond yields were up, especially at the short end. Yields at 1-year maturity are 4.5%, up 0.4%; 1- month and 3-month yields are up 1.0% and 0.8%, respectively. Yields on the 10-year are up just 0.2%-4.0%. Returns move inversely with yield changes, which explains losses in October. The Yield curve stayed inverted (1-year yields exceeding 10-year yields by 0.5%), which is often associated with a recession down the road. The spread between nominal and real yields (inflation adjusted) – a reasonable measure of the market’s expectation for future inflation – remains at 2.5% for 5-year maturities.


Over the last 10 years the largest companies traded in international stock markets (EAFE) earned a real return (inflation adjusted) of just 3%, while domestic stocks (S&P 500) earned 11%. An international allocation has been a drag and raises the question of the title. Yet, if the goal is to build an efficient global portfolio – one with the best expected long-term trade-off of risk and expected return – then international stocks belong.

To begin to look at international stocks, we need measures of how markets are expected to behave. Unfortunately, neither we nor anyone else can reliably predict future markets – the best we can do is come up with a reasonable description that includes not only an expected payoff, but also a range of possible outcomes. Past market behavior provides a clue. Over the past 42 years there are 168 rolling 10-year periods. While I think recent periods distort the picture, and making no adjustments, the average 10-year returns are 7%; the standard deviation is 3%. This picture provides context for the most recent 10 years in international markets. If these statistics describe what we can expect from international markets, then the most recent 10 years is rare (5% probability).

Individual markets don’t all act together – when one is up, the other is apt to be down, and vice versa (e.g., over the same period domestic market returns were well above long-term averages). Because of this lack of perfect correlation, combining market results in the same expected return but with less volatility, the optimum portfolio will include an allocation to international markets, the recent past notwithstanding.

Unfortunately, the benefits of diversification are not always apparent. However, some comfort can be found in the idea of “regression to the mean.” This idea suggests that after a below-average period, to realize the average, future returns must be above the average and justifies sticking to an established strategy in the face of below-average results.

Investing risky assets is hard. It is a long-term process throughout which there will be a lot of short-term volatility. Success requires commitment and patience.


Rockbridge Institutional serves the unique needs of institutions, foundations, and endowments by applying a disciplined, proven and responsible investment philosophy. We are intimately familiar with challenges boards face as we serve on boards and finance committees ourselves.

We are committed to investment ideas that are grounded in academic research. The essence of our investment philosophy is that capital markets work in the long run; a portfolio’s risk is defined by its allocation among asset classes; and that security selection is a matter of constructing portfolios with specific expected return/risk characteristics at the lowest cost.