Big Cats and Best-laid Plans: 3rd Quarter 2023 Commentary

Big Cats and Best-laid Plans

National park officials closed part of Olympic National Park near Seattle, Washington, in late July of this year to protect the public from a dangerous wild cougar. The cougar scare and park closure coincided with my family’s visit to the park. More on our adventure below. Olympic National Park, one of the crown jewels of our national park system, is just a few hours from Seattle. It spans almost one million acres and offers remarkable diversity, including 70 miles of pristine coastline, glacier-capped mountain peaks and old-growth temperate rain forests.

Sounds spectacular, doesn’t it? My wife, Alice and I decided Olympic would be the perfect place for the Bragg family to go hiking this past summer, and thus we dove in and began planning in earnest for an August visit. With full disclosure, Alice planned the entire trip; I had intended to share in the effort, but from my perspective, she seemed to have it well in hand. She didn’t complain. Not much, anyway.

She spent many late evenings working on the trip. Flights, rental cars, hotels, Airbnbs, dinner reservations, hikes, kayaks, guides…you know the drill if you plan your own trips. A complicating factor was that three of our four children were in different states, working summer jobs or permanent jobs (yes, one is off the payroll!). Alice had to reel them all in and land them safely in Seattle to begin our adventure.

One week prior to our departure she was checking on a few last details, probably reading reviews about some cabin somewhere or the best restaurants for families in Port Angeles, Washington (my goodness, the woman never tires of reading reviews, insisting on knowing what every single person has to say about every single thing). I digress and will likely take some heat for including that comment.

Anyway, it was then that I learned about the cougar. Her shouting from the kitchen was heard throughout our house. “A darn cougar is ruining our family vacation!” In her research she had stumbled across a park service bulletin describing a cougar attack the previous day on an eight-year-old boy near an Olympic Park campground. Cougars, also known as mountain lions, pumas or panthers, are common in the American West but are rarely seen by humans. In this case, the boy’s mother yelled loudly and aggressively at the big cat, scaring him away and leaving the boy, miraculously, with no serious injuries. Park officials described the attack on a human as “extraordinarily rare” and “worrisome” to the degree that closing a major section of the park was warranted while officials attempted to locate and euthanize the cougar.

The cougar closure area happened to include the trailhead of the signature hike Alice had planned for our visit. According to the earthtrekkers.com website, the Klahhane Ridge Trail is “a can’t-miss experience which includes breathtaking 360-degree views from the peak of Mt. Angeles.”

Alice was quite bummed and concerned that we would need to re-work the whole itinerary. I discouraged that and tried to reassure her that the cougar would surely be quickly located, and the area reopened. She wouldn’t be satisfied, insisting, “I invested a lot of time in this, the whole family is coming and it’s going to be a bust.” I pointed out that bad weather could just as easily ruin a good day of hiking and that we’d have fun, cougar closure or not. That seemed to calm her down, but she later confessed that she had begun checking the news three or four times per day to learn if they had located the cougar. Our nightly conversations over the next week revealed that her research had gone beyond checking park service updates. Indeed, she had become somewhat of an expert on cougars. She admitted that her Google searches, which included, “How to track a cougar?” and “How likely is it to catch a cougar?” weren’t encouraging or productive.

I’ll spare you the details. We stuck with our original plan and we had an outstanding trip! Hikes, transportation, lodging, meals, flights and fishing all got five stars. The cougar closure caused us to miss that signature hike but we found a different one that was also spectacular. We had wonderful family time together and even the weather was perfect. Alice deserves all the credit. As our family often says when asking the blessing, “God, thank you for Mama who makes everything happen around here.”

Benton, Charlie, Alice, Carlton, and Ben Bragg on the lookout for cougars in Olympic National Park, WA

Speaking of disrupted plans, investors have certainly had their expectations upended this year. The hoped-for peak in interest rates has remained elusive, even as inflation has declined sharply. Just as we hadn’t counted on a cougar attack interrupting our visit to Olympic Park, investors didn’t expect interest rates to still be moving higher at this point in the economic cycle. During the last 18 months, in an effort to squelch inflation, the Fed has raised the Fed Funds rate (short-term interest rates) eleven times for a cumulative increase of 5.25 percentage points. The Fed Funds rate is now higher than it has been since 2001. Real interest rates (after adjusting for inflation), across the spectrum of maturity, are at levels not seen since 2008. Borrowing costs have soared and the market is gradually coming to terms with the idea that these interest rates may be with us for some time. As Matt DeVries explains in his market commentary, we have entered a new economic era. I encourage you to read his article to learn about the far-reaching effects of higher borrowing costs.

Let’s talk about the portfolio we should own in this new economic era.

Bonds: It has been a long time since we have seen opportunity like we now see in the bond market. In short, real return is available in bonds. Nominal yields (before inflation) on government and investment-grade (highly rated) corporate bonds range from 4% to 7% depending on the issuer. Riskier fare (high-yield or “junk” bonds) sport even higher yields to compensate investors for default risk. Municipal bond yields are also significantly higher than just 18 months ago.

Bragg Financial is taking advantage of this environment—our portfolios own these higher-yielding instruments. Importantly, owning these more attractive bonds did not require us to sell the bonds or bond funds our portfolios owned two years ago to replace them with “new higher-yielding bonds.” I hope you will read that sentence again. We have had a number of calls from clients wondering if we should “sell our old bonds to buy new bonds with better yields.” Here is the way I answered that very question for a particular client:

Dear Client,
“One man’s trash is another man’s treasure,” is a good way to describe what is going on in the bond market. No one wants to hold his own beleaguered, beat-up bond portfolio that lost value during the bond rout of 2022 and has done very little in 2023. Instead he wants to sell his existing bond portfolio and buy that beautifully cheap, high-yielding Treasury bond or corporate bond the other guy owns or that is being talked about on CNBC. In reality, both the bond portfolio he owns and the bonds he is hearing about have the same characteristics—the same lower price and the same higher yield. Likewise, both have poor past performance and both offer significantly better potential for future performance.

It is important to realize that every fixed-income instrument, whether an existing bond or a newly issued bond, has a significantly higher yield today. Every instrument is priced by market forces; bonds trade daily, and buyers and sellers set the prices. Current yield is a function of the bond’s current price and its coupon (interest payment). The price of every fixed income instrument fell in 2022 but the coupon (interest payment) did not change. Hence the higher yield. I hope that is helpful.

Stocks: Warren Buffett famously said, “Only when the tide goes out, do you learn who’s been swimming naked.” Extremely low borrowing costs kept a lot of underperforming companies afloat over the last ten years. We’ll likely see more companies in distress. Corporate projects that made sense with low-cost financing will look far less attractive with higher interest costs. Interest costs are like any other expense; they’ve now gone up dramatically and weaker companies will struggle. Companies with higher-quality balance sheets tend to have more staying power and we think they’ll have significant opportunities to strengthen their positions during this period of adjustment.

At Bragg, we’ve often written about our tilt to value within our equity portfolio. On balance, we have emphasized larger, more stable companies with diversified businesses and higher-quality earnings. We have significant exposure to growth sectors like technology but even within growth sectors, we seek to own companies that are well established, are profitable, and which generate plenty of cash to fund operations. Historically, our portfolio has tended to trail the market when things get frothy but hold up better during periods of distress. Over time, our goal is to keep pace with the market while enduring less volatility. This is probably a good time to say that past performance is no indication of future performance.

In the long run, stock prices are driven by earnings. We are seeing volatility in stock and bond markets right now as investors deal with higher interest rates, but according to FactSet, analysts project that S&P earnings may hit an all-time high in the third quarter. These forthcoming earnings reports coupled with strong economic releases (the Atlanta Fed projects third quarter GDP to be between 4% and 5%) may bring some better headlines in the weeks ahead.

In summary, in this new era of higher interest rates, we’re not “reworking the entire itinerary,” as Alice was tempted to do when our vacation plans were disrupted. We’ll continue to own a bond portfolio that is diversified by issuer (government, corporate), that has an intermediate maturity, that is heavy on quality and that today offers attractive yields. We’ll continue to own a stock portfolio that is diversified by asset class (large cap, small cap, foreign), by sector (technology, healthcare, consumer, etc.), by company (no concentrated positions), and that tilts toward companies with higher-quality balance sheets. We think this approach has a greater likelihood of success than other alternatives.

If you’re still reading, it’s probably because you are wondering if they ever found that cougar. They did not. That big cat is still out there.

From all of us at Bragg Financial, thank you for trusting us with your planning and investing.

This information is believed to be accurate at the time of publication but should not be used as specific investment or tax advice as opinions and legislation are subject to change. You should always consult your tax professional or other advisors before acting on the ideas presented here.