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.