New Market Regime
Since the early 80's rates have been in a long-term down trend that took yields from high teens to near zero levels by 2021. And holding bonds over this period of time then made sense and was a good idea.
Fast-forward to 2023 and the opposite is true. As we can see below, the long-term chart of the 10-year treasury yield, shows a clear breakout of this down trend and what we believe to be the beginning a new era of high interest rates going forward.
The economy has become very dependent on “cheap money” to fuel it's growth since the financial crises of 2008. When interest rates are low, and money is readily available to borrow, speculators can invest more aggressively driving prices up. Quantitative easing over the last decade, only reinforced this behavior and cheap, easily available money turned into financial speculation.
Naturally this caused inflation to rise and by 2022 inflation had reached it's highest levels in four decades and the FED had no choice but to step in and began to raise rates quite rapidly.
We have seen this type of action before but the difference this time is that we believe this is the beginning of a long-term period of higher interest rates and it would not surprise to see rates advance another 50% to 100% from current levels over the coming years.
A Market Environment of Higher Volatility
Prior to this major shift and as a result of easy money and ultra-low interest rates, volatility was dampened in most asset classes. Since early 2022, there has been a material increase in inflation that has led to monetary policy changes and a coordinated effort by the FED to increase rates which has had the expected effect of increasing volatility and we believe this new regime will continue and volatility levels will remain higher long-term.
Historically alternative investments have displayed a strong positive relationship between higher inflation and higher interest rates regimes and as a result better performance.
Additionally as we move into a period of higher interest rates increasing cash holding makes sense since now for the first time in a long time cash pays well. Bottom line making a larger allocation to alternatives and cash holding seems like a wise choice