Macro Minute: Week of May 5, 2025

I want to set my framework for my readers because the narratives being thrown around are hyperbolic and can lead people astray. To begin, at the very foundational level, I believe people should invest with a long-term horizon and in a way that provides returns over inflation. Over long-term series, the short-term treasury rate has provided a return basically in line with inflation. This is the risk-free rate. I am not going to debate whether this is truly risk free or not, just know that is what it is called. Over time, our investments should seek to provide a return that is above the risk-free rate (which can be had for little to no cost). This is the starting point of all portfolio construction decisions. This means that any position in your portfolio should provide a return above short-term treasury (the risk-free rate). In addition to looking at returns, we need to consider how stable those returns are over time. We measure this as volatility. A third thing that needs to be considered is how different holdings interact with one another. We measure this as correlations. Over short-term intervals both volatility and correlations change, and they tend to trend over different market regimes. Taken as a whole, when putting a portfolio together, the goal is to invest in a mix of assets that have an expected return over the risk-free rate and creates a less volatile return when combined. In my opinion, the goal of portfolio construction should be to create a mix of assets that provide the highest level of return at an individual’s desired level of risk. To do this well, a manager needs to be well versed on market history and asset class interactions and be mindful of significant drawdowns.  

With this as a baseline of understanding, I want to cover a plethora of mistakes I am seeing highly respected market participants making. I am hearing people take extreme stances on what is transpiring in markets right now. Investors over the last 15 years have gotten very comfortable having high concentrations of U.S. assets in their portfolio. When I began investing in the early 2000’s it was common to have a balanced mix of U.S., international, and emerging markets as part of an equity allocation. Some years international would perform best and sometimes the U.S. would perform better. Since the great financial crisis in 2008, the U.S. asset market has outperformed to such a degree that investors have started using 100% U.S. for their equity exposure. From January 2009 to March 2025 the S&P 500 has returned 674% according to Morningstar versus only 203% for the MSCI EAFE. This has created a generation of investors that have only known U.S. outperformance. This year, we are seeing a breakdown of some of the factors that have contributed to this outperformance and the returns have reversed. According to Morningstar, through the first quarter the MSCI EAFE is up 6.86% versus the S&P 500 being down -4.37%. This in and of itself is not earth shattering, but it is noteworthy. I think people are having a hard time reconciling the underlining reason for this. 

For a plethora of reasons, the world has tended to work like this for decades. The U.S. equity market outperforms. When the U.S. equity market wobbles, treasury bonds support equities. This allowed people to build a portfolio of two main assets, U.S. stocks and U.S. treasury bonds. For years and years this worked perfectly. Your stocks go up but when they don’t your bonds go up. This worked until 2022. Since then, stocks and bonds have tended to trade in the same direction. Meaning, stocks up, bonds up; stocks down bonds down. Unless you have studied market history and realize that this increase in stock/bond correlation is typical within high inflation regimes you will be taken by surprise. Similar to the increase in correlations, I think we are in the beginning of another market shift that has not been seen in quite some time. That is a dollar currency weakening shift that allows international market outperformance. If you are a European investor that has a portfolio of overweight U.S. assets, you are not only dealing with the fact that the U.S. stock market has underperformed the international market by 10%, but you have also lost 10% more in your currency exchange. The U.S. dollar has fallen 10% versus the euro so far this year. What this means is that a European investor, if they did not hedge out the currency, is down 10% in relative equity performance plus 10% in currency differential for a 20% potential loss. This is causing foreign investment into U.S. assets to be reconsidered, and foreign investors look to be tilting away from being overweight in U.S. assets. 

I have said everything up to this point to get to what I really want to comment on. I am hearing people lose their minds saying hyperbolic statements like “The End of the U.S. Empire”, “The End of U.S. Exceptionalism”, or on the other side “I disagree with the ‘End of U.S. Exceptionalism’ logic”. This is causing regular investors to make crazy portfolio moves. I am much more of a long-term market participant. I want to be diversified and have the framework that I outlined in the beginning. I believe that if you have a well-constructed, diverse portfolio, that you can stay invested through all the “insert the next bold headline here” mania.  

One of my favorite investors of all time is Peter Lynch. He gave a speech to the National Press Club in 1994. In it he said this, “You should study history, and history is the important thing you learn from. What you learn from history is that the market goes down, it goes down a lot. The math is simple. There’s been 93 years this century. (This is easy to do) The market has had 50 declines of 10% or more. So, 50 declines in 93 years, about once every two years the market falls 10%. We call that a correction, that means, that’s a euphemism for losing a lot of money rapidly. We call it a correction. So 50 declines in 93 years, about once every two years the market falls 10%. Of those 50 declines, 15 have been 25% or more. That’s known as a “bear market.” We’ve had 15 declines {of at least 25%} in 93 years, so every six years, the market has a 25% decline. That’s all you need to know. You need to know the market is going to go down sometimes. If you’re not ready for that, you shouldn’t own stocks.”  I want to put this quote in here to remind us that market returns are not predictable. What we can do to minimize these corrections and bear markets is diversify and construct portfolios in such a way that these big drawdowns hurt less. These are my big takeaways: study history, don’t neglect good portfolio construction habits, and don’t let panic inducing headlines cause you to shift your long-term objectives. 

DISCLOSURES:

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