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This weekend, I am thinking a lot about independence. Specifically, financial independence, Fed independence, and labor independence. Let’s get into it.

1) Financial Independence Through Asset-Liability Matching.

If you’re a regular here you know that I am a big advocate of “asset liability matching” (ALM) investment strategies. That’s the whole point of what I call Defined Duration Investing, after all. We’re defining the time horizons of specific instruments so we can match them to specific time horizons for financial planning purposes. It’s different from the traditional asset management approach because it’s not based on “alpha” seeking and risk optimization. In traditional portfolio management approaches you try to put together a risk/return optimized portfolio where you’re trying to mix assets to create the most “efficient” set of returns relative to risk. You don’t really care about whether the assets match liabilities and in fact, this strategy generally ends up ignoring risk free assets and lower risk assets because they’re oftentimes poor alpha generators (or not alpha generators at all). It also doesn’t work all that well because predicting where future alpha will be is really hard. But that’s also why the financial industry is dominated by firms that focus on alternatives and stock picking. Those approaches sell the hope of alpha in exchange for the guarantee of high(er) fees. It’s alluring because high returns are alluring. And selling the hope of high returns is a very lucrative business.

Anyhow, I was ecstatic to see this video of one of my financial industry heroes (William Berinstein) going into detail about ALM investing and why he’s become such a big advocate of it (hint – because it just makes a ton of sense, duh). It’s only 40 minutes long, but it’s worth your time. A lot of this will sound familiar to regulars here, but I especially loved the part about human capital and how your job is like a bond. I can’t recall anyone else ever saying that (besides myself), but I found myself nodding my head a lot. It’s probably confirmation bias to some degree, but I am increasingly convinced that this is the way most financial planning will be done in the future.

My only gripe with Bill’s approach is that he tends to only apply the asset matching to the bond piece of the portfolio. That’s what virtually all of the old liability driven investment strategies do. I am trying to take this to the next logical step by introducing other assets into the equation with the goal of giving investors a portfolio that matches all of their assets to specific time horizons and liabilities. I also think it’s incredibly useful to clearly communicate the proper time horizon of something like the stock market because it sets proper expectations about what that instrument can reliably do over time.

But what I really love about this approach is that it’s perfectly consistent with financial planning and a low cost Boglehead style investing approach. The ALM approach flips the traditional alpha seeking approach on its head. The ALM approach doesn’t care about “alpha” because alpha isn’t always consistent with generating returns that match our liabilities. Of course, you want alpha and portfolio efficiency, but it’s a secondary goal behind creating financial certainty across time. And beating the market is not a proper financial planning goal in the first place because the highest alpha generating assets in the financial system will typically come with higher levels of risk that might actually make your financial life more uncertain at times. The traditional alpha seeking approach is largely at odds with sound behavioral finance and financial planning. This is part of what makes investment management and financial planning so hard. We’ve been fed a narrative about optimizing alpha, but generating alpha isn’t necessarily consistent with building a stable financial plan and seeking it out might actually destabilize your financial plan by incurring high fees and higher levels of uncertainty along the way.

I strongly believe ALM approaches are the future of investment management because they mesh with financial planning too perfectly. The evolution of investment management started with the efficient frontier and alpha seeking and then evolved to Bogle style low cost indexing and now it’s moving to asset-liability matching strategies where the investment management can be seamlessly plugged into an underlying financial plan.

2) Central Bank Independence.

Central bank independence is the talk of the town as Trump begins filling the Fed with his people. There’s a lot of commentary about how the Fed’s independence could become comprised if there are too many people aligned with the Executive Branch and its political desires. The basic worry there is that you end up with economic policy that becomes too procyclical. For instance, in 2022 the Fed raised rates in a countercyclical manner relative to the rest of the government. Congress was still passing huge deficits at the time and the Fed was able to come in and slow inflation by counterbalancing some of that. This is what an independent Fed should do. If inflation is high they raise rates and slow the economy even though politicians never want to see a slowing economy. And in theory, if you got a bunch of people in the Fed who were doing the bidding of the Executive Branch then you’d get a more procyclical policy approach. And in an environment like that you might have a Fed that doesn’t raise rates in years like 2022 and you end up with much higher inflation.

The discussion is so controversial that Treasury Secretary Scott Bessent wrote an op-ed in the WSJ outlining why the Fed’s independence is under fire. Bessent argued that policies like QE were overreach and have created economic distortions that compromise their independence. I can’t say that I really disagree with this notion. I’ve been a long-time critic of QE. Not because I think it distorts the economy, but mainly because I think it doesn’t do what most people think it does. And what it does is generally far less powerful than many people assume. But Bessent is right in arguing that these policies compromise confidence in the Fed. Even if QE doesn’t actually do much, the majority of people think it is a massive money printing operation that distorts the economy.

I am also a bit critical of the haphazard manner in which we change rates. I’ve said many times in the past that if I was nominated to run the Fed I’d fly to Washington hand over an interest rate algorithm and get back to California as fast as possible because I am allergic to politicians. You could so easily automate interest rates instead of the highly discretionary manner in which it’s done today. So yeah, I do think there are areas where the Fed could be improved and still remain independent.

On the other hand, I think it’s kind of lame that Bessent is writing articles justifying this sort of assault on the Fed’s independence. I don’t think he’s wrong about QE, but the way Trump is stacking the Fed with yes-men is not a good precedent.

3) Labor Independence.

On Friday we found out that more and more people are being, um, liberated of their employment opportunities. It was a really interesting report as total employment gains were just 22K and wage growth slid to 3.7%. As I’ve been saying for years now, the labor market is not tight. Which is, ironically, affirming the way Trump wants to stack the Fed because it does indeed look like the Fed is at risk of being behind the curve. At the sector level the slowdown in services and information was especially large. It makes me wonder if these sectors aren’t experiencing slowdowns due to AI. But that brings me to another interesting point – the labor market might not be slowing down because the economy is slowing a lot. The labor market might be slowing down because technology is about to make a lot of jobs irrelevant. That means firms are becoming leaner and more efficient. And that appears consistent with the fact that my Recession Rule is actually down to 2.5, the lowest reading in 2 years.¹

Then again, I’ve gotta think that any significant amount of layoffs will hit the economy at some point. We might have this Wile E. Coyote moment where firms cut back because they’re getting leaner and meaner, consumers borrow to offset the lost income and then the slowdown in income growth causes a real slowdown in consumer expenditures. Which, then makes firms weak. Or maybe not. I have no idea. The last few years have been the weirdest economic environment I can remember in a long time.

Speaking of time and independence – last weekend I went to Sequoia National Forest where we got to see the largest living organisms on Earth. Really incredible stuff. You should go if you ever have the chance. You can see in this photo that my oldest daughter was incredibly impressed by it all. I was trying to explain to her that that tree in the background is TWO THOUSAND years old. I guess the only people who don’t find that amazing are people who still don’t really understand the concept of time. But man, two thousand years old…Try matching assets and liabilities to that time horizon!

Well, that’s all for now. I hope you’re having a great weekend.

1 – Speaking of which, the Macro Dashboard will be down at points in the next few weeks. We’re updating some things on the website in the coming months and so some pages will be intermittently out of service. Sorry for any inconvenience.

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