Inflation, Markets, Interest Rates and More

I have been receiving more questions about inflation, markets, interest rates and those associated items. It seems like now is a good time to tackle all these related topics. The easiest way is going to be in bullet-point format, so let’s get to it.

• Interest rates have been at historically low rates for what seems to be forever. It is important to remember the Fed (Federal Reserve) raises interest rates when the economy is doing well.

• Unemployment is low, wages are rising, the market ended the year high, GDP is doing well, people continue to spend, and more continues to prove how well the economy is doing. It is now time to start reining things in a bit.

• Unfortunately, inflation continues to be high. I mentioned in my year-end market highlights how both Core and Headline inflation numbers were higher than normal. As a reminder, Core excludes food and energy numbers.

• The easiest way for the Fed to battle/tame inflation is by raising interest rates. Raising rates takes money out of the economy so it should cool things down. The trick is to not raise them too early or too late, as well as too much or too little. Talk about an easy job.

• For the most part, markets do not mind rising rates. However, there are sweet spots. Too low and nothing happens and too high is when things really begin to harm the economy. I am trying to remember the number I saw years ago in a presentation. I think the sweet spot ends around 5% for interest rates. You get higher than this and the stock market tends to suffer.

• Some sectors like rising interest rates while others not so much.

• Financial companies such as banks like rising interest rates. Why? Well, because they can start charging more and paying out less to depositors. I’ve always said banks are like casinos – the house always wins.

• Certain dividend companies typically like rising interest rates too.  Keep an eye out here for companies that have always paid a strong dividend to continue to pay them and possibly increase dividends.

• The tech sector is one not excited about rising interest rates. The simplest explanation is many of these companies do not make a profit. When rates were at 0.0% many bond holders decided to take a chance on tech stock returns. Now that it looks like rates will rise and bonds may start paying out something, they are shifting from tech to bonds. Actually, they are probably moving from tech to dividend companies while some dividend owners are moving to bonds, but I digress.

• When it comes to bonds, for now there are a few spots to pay attention to. TIPS (Treasury Inflation Protected Securities), Floating Rate Bonds, and bonds on the short end of the duration spectrum. Holding long-term may not be such a great idea now as rates rise. The short answer is why would you hold a 20-year bond that is paying 2% when it looks like newer 20-year bonds will pay more as rates rise. Basically, until the Fed signals it is done raising rates bonds on the longer end of the spectrum may be a little more challenging. But, bonds built to adjust with inflation rates should do better.

• Going back to how rising rates cool down the market, this is done by people having to pay more for debt. Expect things like mortgages, car payments and credit cards to charge more. Who am I kidding. Credit cards have always charged a ton and will continue to do so.

• I am starting to see a shift already in the mortgage market. I get emails all the time from mortgage brokers and things must be slowing down for them. The themes have shifted from buying a new home and/or refinancing for a lower rate to refinancing to take equity out of your home. Funny how when you are paid based on activity/sales how industries find new ones to help you get active/buy something new.

You may want my opinion. How about we quote Bruce Lee – “Be like water, my friend.” What I mean is the market will settle down once it has direction. For us it is a time to be flexible and adaptive. There are guesses all over the place right now as to how many rate adjustments will be made this year, next and beyond. They are all guesses right now. I shared a few weeks back the odds were four (4) rate increases this year. I just saw something this morning (Monday the 10th) that Goldman is now expecting the same.

I firmly believe, heck, I know that once the market has taken in the information and made the necessary adjustments it will be just fine. Again, the economy is doing exceptionally well. Personally, I don’t get how people think it isn’t, but everyone can have their own opinion. Rising rates are a good thing. It has just been forever since we have had to deal with them and maybe we became a bit too comfortable with low or no rates.

In the meantime, expect some more volatility. Remember one of the useful facts I shared in the year-end commentary. The market has averaged intra-year drops of 14% since 1980. However, it has ended up positive in 32 out of 42 years.

Also, please remember the market moves on emotion in the short-term. Although there are lots of numbers and formulas in my world, it is still mostly driven by behaviors. Heck, while economists are scientists they are social scientists studying human behaviors. It isn’t as clean of science like sending a telescope into an orbit one million miles away from Earth (which still hurts my head thinking about).

Let me be clear with my final point. I am NOT advocating trying to time the market, make a bunch of active decisions, nor attempting to guess where to invest in the short term. My philosophy is based on the fact the average investor does best by picking a solid asset allocation and investment strategy and following it. One thing I’ve learned over the years is those who benefit from lots of activity and trading in accounts is the financial services industry. Please continue to focus on your personal financial goals and ignore the noise.

This information is just that – information for your own education. Feel free to impress coworkers around the watercooler or on a Zoom call. In the meantime, be like water.