At the end of last quarter, who would have believed my assertion that the resurgence of the Delta variant was the most likely challenge for investors? But that’s exactly what happened. Adding to market woes were Evergrande, Washington D.C stimulus and budget standoffs, inflation, and supply chain shortages. Lots of drama deferred our anticipated economic rebound.

The market action last quarter reminds us to define our investment time horizons and stick to them when we evaluate our allocation and performance. In the short run, it’s easy to catastrophize over much of the pandemic related phenomena—the number of deaths, fights over liberty vs. the common good, and the sheer daily challenges—make it easy to be negative. Adding to this is the way we frame our view. We’ve profited for almost 10 years without interruption and equity positions have risen by almost 20% just this year. Against that backdrop, even small 1% or 2% drops stand in stark relief driving an instinctive loss avoidance impulse which manifests itself as short-termism making it easy to forget the length of our investment horizons.  It’s a choice: we can avoid even small losses by trying to trade the contours of how this crisis will play out, not knowing whether the Fed will make a mistake or when different variants will come back. Alternatively, we can choose to play to our strengths by maintaining a long-term perspective; especially given that most of our cashflow needs are not immediate and we have a solid fixed income allocation that will not suffer from the volatility characterizing the markets right now.

My educated guess is that the course forward will be characterized by higher long-term interest rates. Hopefully you’ve locked in your mortgage rate because I have a feeling we may not see these low rates for a while. What would cause interest rates to rise? I see three drivers: First, our internal research measures a large increase in the size of the United States monetary base. This will likely increase rates as the math behind bond yields always integrates the inflation rate. Secondly, the Fed has indicated they will reduce their bond purchases. Less demand for bonds means lower prices which counterintuitively equals higher interest rates. Lastly, we are seeing a sluggish but positive pick-up in pent-up consumer demand.

Interest rates affect stocks.  Eight of the top 10 firms in the S&P 500 are technology-related.  The top 10 comprise 29.30% of the entire stock market value and 28.20% of all earnings.  As we can see in Figure 1 below, higher rates tend to lead to declines in the price of software stocks. So rising interest rates might logically lead to a decline in the overall market. That said, there is no requirement that we must remain overweight in technology—rewarding companies for past success. Instead, notice that there are also companies that win in a rising rate environment; specifically, financials and energy companies—including renewables. As we can see in the figure below, these are the businesses that have profited the most from a rise in rates.