Ping Pong: 1st Quarter 2022 Commentary

Ping Pong

A little-known fact about yours truly is that I once held the title of Ping Pong Grand Champion. In the Bragg household, anyway. Narrowing that a bit further, I was grand champion only in reference to the long-running contest with my youngest child, Charlie, age 14. That’s right. For at least four years running, I beat Charlie at ping pong every time we played. I never bought into the idea of letting your child win in order to build his confidence. Nope, I smoked him in every game. Now don’t get me wrong. I wasn’t condescending, smug or sanctimonious like one might describe the fans of certain ACC basketball teams. No, in my victories over Charlie, I was humble and sportsmanlike as I put him in his place game after game. A good sport, yes, but clearly the undisputed champ.

Fortunately, despite my competitiveness, Charlie never grew discouraged and ALWAYS wanted to play another game. He is competitive too! He customized his favorite paddle, stripping off the rubber, taking it down to bare wood on which he wrote cruel messages with a black Sharpie; one side of the paddle read, “Ha, Ha, Fail” and the other simply read, “You’re Bad.” He would hold up his paddle to flash those messages at me whenever I lost a point.

Our ping pong matches started out as a weekend thing when he was 10 or 11 years old but soon became an almost every-night ordeal. As soon as we got the dishes cleaned up after dinner, his taunts would begin. “Ready for a beating, old man? You’re going down tonight.” He would drag me up to the playroom where we would play best two-out-of-three. Did I mention that I always won? I did. For three or four years running, those predictions of his never seemed to work out. I finally grew complacent, thinking he would never replace me as champ. I even convinced myself that he had accepted this as well.

Then one night Charlie beat me. It was about six months ago. It was a heated match. I took the first game, Charlie, the second. Both were tight. The friendly banter had stopped. We were breathing hard, sweating. Charlie tossed his shirt and I kicked off my slippers as we prepared for game three. Ignoring the shouts of my wife Alice from downstairs about Charlie’s bedtime, we settled in for the tie-breaker: first player to 21 wins, winner must win by two, no playing off the ceiling or the nearby wall.

The final game went to the wire, with multiple lead changes and several hotly disputed calls. Finally, it was game point and Charlie had the lead, 20-19. I had the serve. As I started my serving motion, Charlie looked me straight in the eye and held up his paddle so I could clearly read the “You’re Bad” message scrawled on the paddle face, and then he slammed his return past me so fast I never saw it. The Champ was beaten! The endless run was over. To Charlie’s credit, he didn’t hold up his “Ha, Ha, Fail” paddle.

Ping Pong Grand Champion Charlie Bragg

Was that the end? Did everything change? Actually, it didn’t. On subsequent nights for the next month or so, I went back to winning every night. I convinced myself that his victory had been a fluke.

But over the next few months, Charlie started winning more than he lost. After many years of being off the mark, his bold predictions were coming true. As things now stand, I dread going up to the playroom for what surely will be another drubbing. Sure, I take a game here and there, but it has been over a month since I beat him two-out-of-three. I’m starting to accept that things really have changed. My long reign has truly ended; I’m no longer the undisputed ping pong grand champion. Charlie is.

Speaking of long reigns finally ending, the market seems to be telling us that the seemingly endless “reign” of ultra-low interest rates is finally coming to an end. Evidence abounds for this, but I’ll suggest the most compelling evidence is found on your quarterly investment performance report where you can’t miss the negative return of your bond portfolio for the first quarter. The Barclays Aggregate Bond Index was down 5.9% in the first quarter while municipal bonds, as measured by the Barclay‘s Municipal Index, were down 6.2%. As bond returns go, this was a terrible quarter, the third-worst quarter for bonds in the last forty years (the worst quarter in the last forty years was the first quarter of 1980 when the Barclays Aggregate was down 8.7%).

Recall that bond prices and interest rates have an inverse relationship. When rates rise, bond values fall. The decline in bond prices reflects market expectations that we face a higher interest rate environment in the future. Indeed, rates have moved up and the market is signaling they’ll move even higher. In addition to the market signaling higher rates ahead, Federal Reserve Chair Jerome Powell has made it clear through his speeches that the Fed will continue to take action to raise interest rates with the goal of cooling a hot economy and slowing inflation.
It may seem that I am stating the obvious. Over the last year, we’ve all read articles or listened to news stories about surging inflation and the potential for higher interest rates. Shouldn’t we have known that rates would move higher and that bonds would lose value? And looking ahead, shouldn’t we expect rates to continue to move higher and for bonds to continue to suffer? I’ll suggest that it isn’t that straightforward. I’ll suggest that we have been in this situation before. Finally I will suggest that this is a good time to stick with a long-term investment plan.

We’ve talked about, written about, and worried about interest rates for years and years. Like Charlie and his ping pong predictions, expert after expert has incorrectly predicted that inflation would surge and that interest rates would move higher over the last ten years. Going even further back, recall that interest rates peaked in 1981 when a 10-year Treasury bond yielded 15.82%. Rates have gone up and down on their way down over the last thirty years. From the peak back in 1981 to a recent trough in 2020, expectations were that rates “couldn’t go any lower.” But boy, did they! The 10-year Treasury reached an all-time low yield of 0.50% in March 2020 as investors feared a pandemic-driven recession or even depression. Maybe that was the bottom. After starting the year with a yield of 1.50%, a 10-year Treasury yielded 2.32% at the end of the first quarter. Will rates go higher from here? They certainly could.

Should we now assume that we are permanently in a rising rate environment? Further should we accept the arguments that inflation is here to stay, that the far-above-normal growth rate of the economy of the last eighteen months will continue, that we have entered a new era of nationalism marked by the breakdown of global trade agreements, that we are entering a Cold War with China, that the Russia/Ukraine war is the beginning of a more dangerous phase of geopolitics after the thirty-year period of relative peace we have enjoyed since the end of the Cold War? Those are the narratives being bandied about these days. Should we make significant changes to our portfolio to prepare for these eventualities, all of which are most unappealing? Should we build a more defensive portfolio?

Our answer might sound familiar. The short answer is that this is a time for maintaining discipline. The portfolio Bragg constructs is defensive by nature. Our portfolio is designed to be a portfolio for all seasons. First and foremost, our emphasis is client liquidity. We want to be sure a client can make it through a very difficult market. Liquidity can be in the form of income from employment or from other sources as long as the income is highly certain. Beyond that, we create liquidity in the portfolio by owning cash and bonds. Once we are very comfortable that a client has adequate liquidity to get through an extended bear market, we build a diversified portfolio of stocks and we plan to stay the course. Our portfolio has exposure to technology, communications, financials, consumer stocks and every other sector in the S&P 500. Yes, we own oil and commodities, too. These sectors held us back in recent years but they have served us extremely well recently.

I want to point out that this mentality and philosophy is in stark contrast to what one might hear on CNBC. The media fan the flames with stories of fear and trepidation, giving viewers the impression that one must take action now. One must own this type of security or that type of asset class. “These are the sectors you should hold during times of war or during bouts of inflation.” In our opinion, this type of media coverage doesn’t serve investors well. Nor did it serve investors well late in 2021 when the media fanned the flames of stay-at-home stocks, meme investing and cryptocurrency. Gushing commentators leave investors feeling like they are missing out on something. In most cases they are gushing about what has already done well. By the time the gushing starts, the gains have been made. As we like to say, if it is in the headline, it is in the stock price.

Is now the time to load up on oil when the price is up 300% in the last two years? Recall that in April 2020, the price of oil futures went negative and a barrel of crude traded for $11.26. That would’ve been a great time to load up on oil. Brent Crude finished the quarter at $104 per barrel. While some investors play this game, we think there is far more certainty of success in our diversified approach. As someone smarter than I put it, “While one can chase after performance, one can never catch it.”

Going back to interest rates and owning bonds. As painful as it is to see the “safe” part of our portfolio decline by 5–6%, we think it makes sense to stay the course with bonds if your financial plan calls for your having liquidity. As difficult as it is to see the bonds decline, they offer far more stability than stocks. With bonds, at any given time we are worried about a decline of 5–7% (like the one we just suffered), whereas with stocks, at any given time we are concerned about a decline of 30–40%, especially an extended decline like that of 2007–2009 or 2000–2002. We own the bonds for stability. As for long-term wealth creation, we think stocks are the preferred investment.

Despite the awful headlines about the Russian invasion of Ukraine, inflation and higher interest rates, stocks have actually done well of late. After declining 12.4% from the beginning of the year through March 14, the S&P 500 rallied 8.6% through quarter end. It is also worth noting that since Russia invaded Ukraine on February 24, the S&P is up 5.6%. We’ve been surprised by the market’s resilience and continue to think it makes sense to be prepared for continuing volatility as we move forward.

As we go to print, our thoughts are with the people of Ukraine. The images of the suffering of fellow human beings, especially the innocent, are striking and distressing. They remind us that we are very fortunate even as they remind us of the evil in our world. The tragedy of Ukraine, following closely on the ravages of COVID-19, reminds us as we go about our lives, whether working or playing ping pong, that civilization as we know it is fragile, and that we as individuals, as a community and as a country have a responsibility to be engaged and to lead.

As the dogwood, cherry and red bud bloom, we wish you the best this spring. As always, thank you for trusting Bragg with your investing and planning.