Category: Economic Insight

Economic Insight

Rates Can Only Go Higher

Weston J. Wellington, Vice President, Dimensional Fund Advisors

It seemed so obvious. With the economy slowly recovering last year from the worst recession in decades and the federal government seeking to tap the credit markets for over $2 trillion to fund an ambitious spending program, both laymen and experts alike seemed to agree that interest rates had nowhere to go but up. The yield on the ten-year U.S. Treasury note as of June 30, 2009 was 3.52%, down from 5.25% in June 2007 but well above the 2.09% level registered amidst the depths of the credit crisis the previous December. With retail sales and housing activity showing signs of gradual improvement, the only question appeared to be how much higher interest rates would go.

Among fifty economic forecasters surveyed by the Wall Street Journal in June 2009, forty-three expected the ten-year U.S. Treasury note yield to move higher over the year ahead, with an average estimate of 4.13%. Seven expected a rate of 5.00% or higher while only two predicted rates to fall below 3.00%. The result? The ten-year Treasury yield slumped to 2.95% on June 30, 2010 and rates on 30-year mortgages fell to their lowest level since Fannie Mae began tracking them in 1971. How many of us would have expected this during a period when gold prices soared over 33% to a record high?

Some observers may be tempted to poke fun at these hapless “experts”, implying they are incompetent or poorly informed. This interpretation is flawed since it suggests that a better team of experts would achieve a more accurate result. A more useful explanation is that even the most talented analysts are unlikely to make reliable predictions and the poor showing by this particular group is simply what we would expect to see, just as often as not, if markets are working freely and fairly. Today’s bond prices already reflect expectations for tomorrow’s business conditions and inflation and these expectations can change quickly in response to new information. However tempting it may be to believe that we can predict the future better than other market participants through careful study, the results of the Wall Street Journal survey as well as numerous other efforts suggest this confidence is misplaced.

What is the message for investors? Predicting interest rates and bond prices is no easier than predicting stock prices, and making decisions based on what appear to be certain outcomes at the time can often prove costly. Many investors reconfigured their portfolios in anticipation of higher interest rates and have penalized their results while they are waiting.

Instead of seeking to predict the unpredictable, investors are much more likely to enhance their results by focusing on the elements they can control – risk exposure, diversification and minimizing costs and taxes.

Yahoo! Finance accessed July 7, 2010. Wall Street Journal Forecasting Survey accessed July 7, 2010. Prabha Natarajan and Matt Phillips. “Stocks Drop; So Do Mortgage Rates” Wall Street Journal, June 25, 2010.

Mark Gongloff. “Two Treasury Forecasts: a Grand Canyon-Sized Gap” Wall Street Journal, April 10, 2010.

Tom Petruno. “Gold Hits Record as Investors Seek Haven” Los Angeles Times, June 9, 2010.

Weston Wellington and Dimensional Fund Advisors are not affiliated in any way with Raffa Wealth Management.


Raffa Wealth Management is an independent investment advisor providing nonprofit organizations, high net-worth investors, and qualified retirement plans with a full range of investment consulting services.  We were established to fill the need for transparency, clarity, and vision in the professional management of investment assets.   Visit us at

The Lost Decade?

As January 1st passes, there have been stories all over the financial press
about the “Lost Decade” for US Equities.  These headlines
are certainly eye-catching and feed on investor’s recent memories of
2008 where the S&P 500 lost -37% in 12 months, and another -11% through
the first quarter.  These articles are spot on when it comes to the
S&P 500, a large cap US equity index, which had an annualized loss of
almost -1% per year over the past decade.  The Russell
3000 index, which incorporates large, mid, and small cap stocks also suffered
an annualized loss of -0.20% during the past ten years.  In
order to understand the differences between these two indices, we need to
explore what makes up the Russell 3000.

Nine US Equity Styles

The Russell 3000 index can be broken into nine separate components.  The
subparts are split up by the size of the companies issuing the stocks (Large,
Mid, and Small), as well as the relative strength/value of each stock (Value,
Blend, and Growth).  Doing so allows us to see a very different story:

This chart illustrates that across all market caps, Value stocks significantly
outperformed their Blend and Growth counterparts.  Investors who
held Small Value stocks should have seen them return +8.27% per
year through the past decade.  The chart also illustrates that
Small and Mid Cap stocks outperformed their large counterparts in all
categories over the past decade.

RWM’s investment philosophy in the US Equity market is to emphasize
Small and Value stocks, while owning a percentage of each category.  Over
this timeframe, that strategy has added value compared to a more market
neutral index, such as the Russell 3000, due to its allocation to Small
and Value stocks. 

It’s also important to understand that while we believe Small
and Value stocks will offer long term excess returns over a more market
neutral strategy, over shorter time periods, that emphasis may underperform
the market.  For instance, Small Value stocks gained +20.6% in
2009 compared to the Russell 3000’s gain of +28.3%,
however even this lower relative performance didn’t stop Small
Value stocks from beating the Russell 3000 by nearly +8.5% annually
in the last decade.  RWM’s focus in the US Equity market
is to have exposure to all sectors, so that we will experience the
market return, while emphasizing Small and Value stocks which have
demonstrated added value over longer periods of time.

International Equity Exposure

We also still believe that an allocation to Developed International
Markets and Emerging International Markets play a role in diversified
portfolios.  As we saw in 2008, US and International markets
can move in the same direction, as International stocks lost over -45% and
Emerging Market stocks fell -53%.  However, these
markets snapped back even stronger in 2009, gaining +31.8% and +78.5% respectively.  The
ten year annualized returns also exceed that of the broad US Equity
markets, and we can see that Value stocks in the Developed International
Markets exceeded the returns of the market neutral index:

Fixed Income Allocation

Finally, it’s important to discuss the importance of bonds within
a diversified portfolio.  Bonds serve as a counter weight within
your portfolio, adding stability during times of economic stress, while
providing real returns to investors.  Like the trend we discussed
in the US Equity markets, bonds can, at times, actually lose value.  We
expect that those losses, however, will be significantly smaller than
those of the stocks, and will likely occur at a point when stocks are
in favor and are gaining value.  As the chart below illustrates,
adding 10% of a broad market bond fund to the Russell 3000 index over
the last ten years would have changed the portfolio’s return
from an annualized loss to a gain.

The Next Decade

While many analysts are trying to predict at what level the Dow will
close on December 31st of this year, we believe that the lessons from
the last decade and dating all the way back to the 1920s and 1930s
are still very relevant to investors:

  • Eliminate unnecessary risk from your portfolio, including individual
    company risk and sector risk
  • Have broad and diversified exposure among
    your holdingsSmall and Value stocks will likely add value over time
  • Having
    exposure to Developed and Emerging International markets will likely
    add value over time
  • Pick an appropriate allocation to stocks and bonds
    that will allow you to stay the course in turbulent markets
  • Do not
    allow short term market disruptions to disrupt your long term plans,
    as this will likely result in selling low and buying high
  • Execute
    your investment strategy as efficiently as possible


Raffa Wealth Management is an independent investment advisor providing
nonprofit organizations and high net worth individuals with a full range
of investment consulting services.  We were established to fill
the need for transparency, clarity, and vision in the professional management
of investment assets.   Visit us at

Important Disclosure

Past performance is not a guarantee of future results and there is
always a risk that an investor may lose money.  Information contained
has been gathered from sources we believe to be reliable, but we do
not guarantee the accuracy or completeness of such information. Indices
are not available for direct investment and performance does not reflect
expenses of an actual portfolio. Such expense would reduce the returns
illustrated.  Returns are shown gross RWM’s advisory fee.
The incurrence or inclusion of an advisory fee will have the effect
decreasing performance results.  For example an advisory fee of
1% compounded over a ten year period would reduce a 10% return to an
8.9% annual return.   RWM’s form ADV is available upon
request.  The form ADV is the RIA disclosure document that outlines
material arrangements and business practices.

Is the market rebound justified?

The short answer is yes. The rebound is ‘justified’ because of the way that the market prices securities – not because I know any more than you about the future direction of the economy in the short term. Let me explain…

“The financial market works as a conduit for demand and supply of (primarily) long-term debt and equity capital.”1 In other words, stock and bond prices are determined when the demand from those seeking capital meets the supply that we as savers are willing to invest. You surely remember the fascinating line charts in economics class identifying the low price of a widget at the intersection of healthy widget supply and slumping widget demand. Stock and bond prices work the same way – and I’m delighted to inform you that it’s this simple.

The foundation of our capital market started to crack in September of 2008 and what ensued was a flight of investor demand from all things risky. Stock and corporate bond prices plummeted to a level not seen since early 1997. Treasury bond prices soared. The rebound we’ve enjoyed since March has been the simple, direct response of increased investor demand brought on by the confidence that our capital market system is no longer on the brink of collapse.

So when some say that the market has gotten it wrong – it’s being suggesting that either the supply side or the demand side is incorrectly forecasting future economic growth today. One or both sides will surely get it wrong from time to time but the bottom line is that supply and demand (the market) has set the price today and that’s the best indication of the level of growth to come. News will break tomorrow that alters both sides of the equation and prices will change – quickly. Until then, the price is right!

Clearly the question is posed with the hope that I, or someone, will foresee the next downturn and help you avoid suffering another setback. I have no doubt that fear will once again shake investor confidence and drive prices lower. The challenge is that it is impossible to know when this may occur. It’s impossible because it depends on knowledge of events that have not yet occurred.

The following quotes demonstrate the challenge with trying to predict future market prices:

“Without a sustained improvement in the credit market — the seat of the crisis—it seems irrational to expect a durable move higher in equities.”
—Richard Barley, “Bond Markets Don’t Buy the Rally,” Wall Street Journal, March 26, 2009.

“New research shows corporate bonds have been far better at predicting where the economy is headed than anyone thought. Unfortunately, that suggests the economy is going to get much worse.”
—Justin Lahart, “A Warning from the Bond Market,” Wall Street Journal, April 9, 2009.

“The March stock market rally that fuelled hopes of a broader economic recovery was deceptive because ‘real money’ investors remained on the sidelines.”
—Anuj Gangahr and Chrystia Freeland, “Head of NYSE Cautious over Rally in March,” Financial Times, April 16, 2009.

“April saw the lowest level of insider buying ever recorded by research group TrimTabs, with insider selling fourteen times as high. Likewise, companies sold 64% more shares than they bought in April.”
— Spencer Jakab, “Beware the Seductive Appeal of the Suckers Rally,” Financial Times, May 9, 2009.

“Markets need volume to sustain bull runs, but unfortunately this run does not have it. In fact, trading volume on the New York Stock Exchange has been trending lower all month.”
— Michael Kahn, “This Bear Should Stay Well Fed,” Barron’s, May 20, 2009.

“We are still a long way from a viable, solvent banking system that intermediates credit independently.”
—George Magnus, “Reasons Why Bear Market Rally Will Stall and Reverse,” Financial Times, May 21, 2009.

Since March 9, 2009 the S&P 500 stock index has rebound by over 60%3 – indicating the potential cost of relying on market predictions.

I encourage you to avoid getting caught up in identifying the degree to which the market is ‘right’, or ‘justified’, in how it is pricing securities. These are interesting discussions (mildly) but not at all practical in building and sustaining long term wealth.

The important question is how we should invest in an environment in which the future is uncertain. The answer is by eliminating unnecessary risks and expenses and balancing competing priorities based on cash flow requirements and time frames. In other words, focus on the things that you can control. Successful long term investors don’t seek to avoid setbacks – they invest in a manner that allows them to endure setbacks and enjoy the recoveries that inevitably follow

The Road to Serfdom?

By Weston J. Wellington

A recent Newsweek cover story proclaimed “We Are All Socialists
Now” and observed, “whether we want to admit it or not, America
of 2009 is moving toward a European state. . . . As entitlement spending
rises over the next decade, we will become even more French.”1

Newsweek does not clarify their definition of “socialist” or
what it means to be “more French”; but for discussion purposes,
let us assume that, in the years ahead, government intervention in the
US economy assumes a greater role than in the past. What are the implications
for investors in US equities?

Based on global equity market results over the past ten years, perhaps
very little. Among the 23 developed countries with ten years of MSCI data,
the US ranked 20th in US dollar terms, with an annualized return of -1.67%.
When results are computed in local currency, the US ranking improves a
bit, to 17th. Either way, US stock returns over this period compare unfavorably
with countries often characterized by greater government intervention
in business affairs.

Were these results an aberration? Using the 39-year period ending in
2008 (the limit of MSCI data) produces a similar overall result: The US
ranks 15th among 18 countries in US dollar terms. Sweden ranked 2nd, with
a total return of 11,034%, compared to 2,921% in the US.

We are not suggesting that policymakers can enhance US equity returns
by implementing a 57% maximum income tax rate, a 25% national sales tax,
and mandating a minimum of five weeks of annual vacation for all employees.
It seems plausible to us that such an approach, although perhaps politically
popular, would likely bring about higher unemployment and weaker economic
growth. Researchers have found that high rates of employment and GDP growth
offer no assurance of high stock market returns, just as low rates of
employment and GDP growth do not predict low stock market returns.2 If
market prices reflect the expected results of government policies, investors
are not necessarily disadvantaged.


The degree of government intervention is just one of many factors
affecting expected stock returns, and investors should be cautious
in assuming it is the principal factor.

Annualized Return (%) 

10 Years as of December 31, 2008

In US Dollars

Annualized Return (%) 

39 Years as of December 31, 2008

In US Dollars

Canada8.97Hong Kong14.68
Hong Kong4.34Singapore10.65
New Zealand3.62Norway10.51


Weston J. Wellington

Vice President, Dimensional Fund Advisors

1. Jon Meacham and Evan Thomas, “We Are All Socialists Now,” Newsweek, February
16, 2009.

2. Jim Davis, Economic
Growth and Emerging Market Returns
, Purely Academic, August



Comment from Dennis Gogarty,

President of Raffa Wealth Management

Financial media outlets fill a critical role for information and news.  In
a society that requires buyers to ‘beware’ these
media sources are often relied upon to inform decision making.  The
information delivered by many in the media can do more to elicit strong
emotional reactions than to educate and inform.  Such emotions tend
to inhibit sound decision making – particularly when it comes to
money. Clearly there are many sources of reliable and helpful information.  My
word of caution is simply not to let emotions guide decision making.  If
a story you read or hear makes you feel like the sky is falling or that
you deserve to have more for less – consider if it’s your emotions
or your intellect responding.  I hate to rain on the parade but
let’s think calmly and rationally before we pronounce capitalism

Were the Experts Helpful?

The collapse in stock prices last year spared no one as share prices fell around the world. All 47 markets tracked by MSCI lost ground, with 23 countries experiencing losses in excess of 50% (total return measured in dollar terms). The US finished 7th, with a total return of −37.6%.

Among the ten largest firms in the S&P 500® Index at year-end 2007, there was a wide range of outcomes for 2008: Bank of America and General Electric significantly underperformed the market, with price declines of −65.9% and −56.3%, respectively; while Johnson & Johnson shares fell only 10.3% and Wal- Mart rose 17.9%. Other prominent firms experiencing dramatic losses included American International Group (−97.3%), Citigroup (−77.2%), Fannie Mae (−98.1%), Merrill Lynch (−77.6%), and Wachovia (−85.4%). Since all these firms are constituents of a market portfolio, the easiest way to outperform the market in 2008 was to avoid or underweight these big losers.

It seems plausible that last year’s financial meltdown was so extensive and so welladvertised that investment experts would have found it relatively easy to outperform the broad market by selecting the right stocks or sectors. But a review of several widely read sources of advice suggests that, in at least one respect, there was nothing unusual about 2008: it was just as hard as ever to outperform the market.

A few samples from the “where to invest now” articles we were reading a year ago:

  • For its annual “Where to Invest” issue, SmartMoney scoured the globe for appealing opportunities and identified a dozen companies “likely to increase profits in a world filled with trouble spots.”Outcome: From the recommendation date of November 2, 2007 through December 31, 2008, the average share price decline of the twelve named stocks was 52.4%, compared to a drop of 40.2% for the S&P 500® Index and 35.4% for the Dow Jones Industrial Average. Performance varied widely: Wells Fargo (WFC) shares declined 8.8%, while Genworth Financial (GNW) plummeted 88.9%.
    Pearlman, Russell. “Where to Invest 2008.” SmartMoney, January 2008.
  • A prominent money manager and self-described “contrarian” investor wrote in a January 2008 Forbes column: “You have to choose carefully here, since many financial stocks will not come back for a long time, if ever. . . . The safest plays are among the big banks.”Outcome: Prices for the seven financial stocks mentioned in the column, including Citigroup, Freddie Mac, and Wachovia, declined an average of 74.0% in 2008. Dreman, David. “Seize the Day.”
    Forbes, January 8, 2008. Wall Street Journal, New York Stock Exchange 2008 Trading Summary, January 2, 2009.
  • A money manager who applied detailed quantitative analysis to successfully predict the crash of 1987 was expecting a gain of 20% for the S&P 500® in 2008: “Our models show the S&P 500 is undervalued by 25%…Our indicators are extremely bullish.”Outcome: Disappointment.
    Tergesen, Anne. “What the Pros Are Saying.”
    Business Week, December 31, 2007.
  • A veteran market analyst favored “pockets of value,” including stocks which had been “excessively punished” in the subprime-related meltdown: Nordstrom, Tiffany, J. Crew, and his favorite, American International Group.Outcome: Company Price Change 2008
    American International Group (AIG) −97.3%
    J. Crew Group (JCW) −74.7%
    Nordstrom (JWN) −63.8%
    Tiffany & Co. (TIF) −48.7%
    Tergesen, Anne. “What the Pros Are Saying.” Business Week, December 31, 2007.
    Wall Street Journal, New York Stock Exchange 2008 Trading Summary, January 2, 2009.
  • Nvidia was featured in a “Company of the Year” cover story by Forbes, which reported that the firm’s sophisticated graphics chips, the brains inside popular products such as the Sony PS3 game console, were finding new applications in science and industry.Outcome: Nvidia shares fell 76.3% in 2008.
    Caulfield, Brian. “Shoot to Kill.” Forbes, January 7, 2008. Wall Street Journal, New York Stock Exchange 2008 Trading Summary, January 2, 2009.
  • A successful former hedge fund manager and globetrotting author argued correctly a year ago that a recession in the US was already underway. He was bullish on commodities (“the commodities bull market still has years to go”) and China (“there are gigantic opportunities in China and gigantic changes taking place there.”)Outcome: The Dow Jones-AIG Commodity Index declined 37% in 2008, the worst year since its inception in 1998, and total return for the S&P GSCI® Index was −46.49%. China ranked 26th among 47 world stock markets tracked by MSCI, with a total return of −50.83%. In fairness to the forecaster, he was making a long-term recommendation, not a prediction for the next twelve months. Investors who overweighted their portfolios in 2008 with commodities or Chinese stocks are hoping he’s right.
    Barclays Global Investors., accessed January 7, 2009. Cui, Carolyn. “Commodities: Great—Then Ugly.” Wall Street Journal, January 2, 2009. O’Keefe, Brian. “Hog Wild for China.” Fortune, December 24, 2007.
  • The cover of Fortune’s Investment Guide 2008 issue offered a teaser: “Five Must-Have Foreign Stocks.” With thousands of stocks to choose from throughout the world, imagine how rewarding it could be to identify a handful of the best-positioned companies. After consulting with “top foreign fund managers and analysts,” Fortune settled on the following picks:
    • Bank of Ireland, IRE (“dirt cheap,” 7% dividend yield).
    • The iShares Brazil Index, EWZ (“only Egypt has done better over the past five years”).
    • Mobile Telesystems, MBT (“more cell phone subscribers than AT&T”).
    • Potash Corp. of Saskatchewan, POT (“earnings to soar more than 50%”).
    • GlaxoSmithKline, GSX (“strong cash flow, rich dividend yield”).
      Outcome: Bank of Ireland eliminated its dividend amid rising loan losses. Brazil finished 36th out of 47 world stock markets tracked by MSCI. Shares of Mobile Telesystems couldn’t escape the collapse in Russian stock prices. Potash Corp. shares fall along with fertilizer prices. GlaxoSmithKline performed relatively well. The average price decline in 2008 for the five recommendations was −59.5%, compared to a loss of 45.2% for the MSCI All-Country World Index.
      Bank of Ireland., accessed January 7, 2009.
      MSCI., accessed January 5, 2009.
      Rosenberg, Yuval. “Harvesting the Top Foreign Stocks.” Fortune, December 24, 2007.
      Wall Street Journal, New York Stock Exchange 2008 Trading Summary, January 2, 2009.

Our take: If stock picking didn’t work in 2008, when will it work?

Weston Wellington
Vice President, Dimensional Fund Advisors

Comment from Dennis Gogarty,
President of Raffa Wealth Management
2008 has been a year unlike anything most of us have seen in our lifetimes. Investors all around the world are faced with the realty that decisions must be made in the face of uncertainty. I suggest focusing on what we can control. Specifically, the level of risk we’ll allow in our portfolios and the expenses we’ll incur in achieving the asset allocation that matches this level of risk. The reality today, and always, is that we don’t know what’s going to happen next week, next quarter or next year. We do know, however, that risk and return are directly related and that expenses directly detract from bottom line results. When it comes to investing simple is good – design an allocation strategy based on risk and keep expenses to a minimum.