Photo: Kessa. Source: Pixabay
It’s a hassle. The cat goes up and up, lured by birds or squirrels or some other incentive. Their retractable claws and powerful hind legs are great for climbing. Getting down, not so much. The problem comes once they’re in the higher branches. Birds and squirrels are nimble and can flit from twig to twig, while a cat never looks so awkward as when it’s swaying on a branch that’s too small to bear its weight.
Once the cat realizes its predicament, it can start to yowl. “Come save me!” it seems to say. While many cats can eventually work their way back down on their own, the cat may not be able to if it’s injured or exhausted. And a panicked kittie goes up, not down.
Investment risk and return can be like a tree, enticing us to move higher. There may not be enough return – food – to satisfy investors in the safer environment close to the ground. Investors, like cats, climb higher and higher into the riskier zones where the branches are skinny and the perches are precarious. Bond investors call this “reaching for yield,” and it usually means buying bonds with questionable credit or longer duration. They may even use leverage, borrowing short-term money to buy long-term bonds. This seems to work fine when everything is calm, but when volatility increases, and the winds make the tree sway and shake, they realize how far they are from safety.
At its heart, this is what happened in the run-up to the Financial Crisis. Folks couldn’t get what they wanted from safe investments, as the Fed lowered short-term rates from over 5% in 2000 down to 1% a few years later. One central banker wrote a haiku to describe what was happening:
When good mortgages
Don’t earn enough to suit us
Maybe bad ones will?
Bankers and investors climbed higher and higher on that risky tree, until they were stuck. You simply can’t create investment opportunities when they’re not there. When the Financial Crisis hit, everything went wrong: credits went south, investors were forced to sell, lenders called in loans, buyers disappeared. It took years to recover.
Photo: USAF Maj. John Dines. Source: US Air Force
The lesson: don’t take risks we’re not ready for; don’t climb out on branches when we can’t climb back. There may not be anyone who can help us when we yowl.
Douglas R. Tengdin, CFA
Charter Trust Company
“The Best Trust Company in New England”