The stock market has been testing the patience of investors all year and is likely to continue through the remainder of this year. Market declines are never comfortable, and market volatility and investor anxiety have been above average this year. Slowdowns and even recessions are a normal and regular occurrence in modern economies. These are not events that can be avoided. Some last longer than others, but they eventually lead to expanding economies, more profitable businesses, and rising stock markets.
So, what is spooking the stock and bond markets? The short answer is inflation. The US, and many parts of the world, have been experiencing the highest levels of inflation seen in the last 40 years. Just last week the August Consumer Price Index reading came in hotter than expected at 8.3%, which is the sixth straight monthly reading above 8%. Even though energy prices have been falling over the last month, food and housing costs have remained stubbornly high.
The predominant tool a modern economy has to fight inflation is to increase interest rates. This year we have witnessed unprecedented interest rate increases as the Fed aggressively tries to bring inflation under control. The Fed has raised the Federal Funds Rate by a total of 2.25% this year, with another 0.75% increase expected this week at the September meeting. At the beginning of this year, a Treasury Bill maturing in one year was yielding 0.38%. As of Friday, September 16th, a one-year Treasury Bill is now yielding 3.98%. The Prime Rate is currently at 5.50%. After this week, it will likely be above 6% which means Home Equity Loans will cost borrowers 7% to 8% to borrow against the value of their home equity, and consumers carrying credit card balances will be paying north of 20% on most credit cards. The average 30-year mortgage rate is now above 6% and likely to climb higher in the coming weeks.
As interest rates rise, they negatively affect the value of bonds, stocks, and real estate. As the cost of money increases, consumers and businesses tend to slow their spending which means economies slow down. This is exactly what the Fed is trying to do. However, the Fed is trying to walk a tight rope between taking excesses out of the economy and going too far and causing a recession. The verdict is still out if this will be possible.
If we are likely to go into a recession, shouldn’t we sell stocks now? No, we do not advise it. Trying to time the market is not a strategy that is likely to prove financially rewarding over time. Making major changes to your portfolio in times like these can feel like a smart move, but history paints a different picture. In times of market stress, the smartest long-term decision is usually to either rebalance your portfolio, which forces you to buy more of the asset that’s the most depressed (i.e., buy low) and trim the asset that’s done the best (i.e., sell high), or ignore the market’s short-term thinking and actively do nothing. Getting caught underinvested when the market turns can have major implications to your long-term wealth.
We know long bouts of stock market turbulence like we have experienced so far this year can be stressful and emotional, but if you can ignore the noise and the markets daily moves, you will be rewarded in the long run. As legendary money manager Peter Lynch reminds us, “the secret to making money in stocks is not to get scared out of them.” Please let us know if you have any questions or if you would like to discuss your financial situation in detail. Thank you for being clients of our firm.
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