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Investment Portfolios Stabilize – Sort Of

Investment Portfolios Stabilize – Sort Of

October 25, 2022
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Day to Day fluctuations Have Been Nauseating – But Market is Recovering this Month

Markets continue to gyrate wildly from day to day depending on the latest economic news or financial reports.  But for October – a month commonly associated with some of the worst market crashes in history, stocks are up nicely.  The S&P 500 is up almost 5% so far this month.  Bonds, however, have added to this year’s losses, as interest rates have continued to move higher. 

Are We Heading for a Recession? 

The assumption among most of the so-called “experts” is that, yes, the Fed is going to have to continue increasing interest rates until the economy stalls.   According to these “experts” the Fed will have to continue squeezing the economy with higher interest rates until inflation comes down.  With inflation as stubbornly high as it is, it is unlikely that demand will be reduced in a meaningful way without a recession.  The consensus view is a mild recession in 2023.  Once we enter a recession, inflation should slow, and the Fed can ease off the interest rate increases. 

What Does that Mean for Stocks? 

Not much frankly.  Stock and bond prices today already reflect the consensus view that the Fed will continue to raise rates into early next year, after which there will be mild recession.  If those forecasts are right, there should be no big drop to stock or bond prices as we enter a widely expected and predicted recession. 

So, if a Recession is Already Priced into Stocks, is it Time to Invest More Aggressively?

Maybe yes, maybe no.  If everything works out as described above, then it probably is a good time to add to your stock portfolio.  Historically the best time to invest is just as the economy is entering a recession.  But there is a huge amount of uncertainty surrounding the “consensus” outlook.  This inflationary / rising interest rate situation we are currently experiencing is something we haven’t experienced in over a generation.  The world has changed a lot since the 1970s, so how the economy (and the world) will react to the Fed’s inflation fighting is a big unknown.  The CEO of Bank of America recently questioned the entire assumption that we are heading into a recession.  He looks at strong employment, strong consumer demand, and a (right now) robust economy and concludes that the economy will absorb these higher rates without ever tipping into recession.  Others look at increasing economic instability, especially overseas, combined with the persistence of inflation which is remaining strong and conclude that we may be in for still higher interest rates and ultimately a more severe downturn.  So, it depends on who you believe!  As always, it is impossible to predict, and the best outcomes tend to come to those who stick with their planned asset allocation through good times and bad. 

Are Bonds a Good Investment Right Now (after their worst year in a generation)? 

I think bond investments look a lot better now than they did a year ago.  A 10-year treasury bond that had gone as low as 0.9% is not paying 4.25%.  If the consensus view holds, we would not expect that yield to change too much.  And getting 4.25% interest guaranteed by Uncle Sam isn’t such a bad deal.  More importantly, if we have a more severe recession than expected, the Fed will probably have to cut interest rates to stimulate the economy.  Bonds are now well situated to rally if rates fall (and would provide their usual offset to stock market losses).  The one outcome under which bonds will continue to lose value is if inflation refuses to come down, and the Fed must raise rates even higher than is now expected.   For now, I like short term bonds and CDs that are paying 4% or more in interest.   If rates go higher, we can just reinvest into even higher yielding product in the future! 

I Hear Interest Rates Keep Going Up, But My Bank is Still Offering Super Low Interest – What Gives?

The Federal Reserve only controls certain very short-term interest rates that it charges to its member banks.  They do not control what the banks pay to you.  Banks will pay as little interest as they can get away with to raise the money required to make loans.  The truth is, most retail banks have more money than they need, thanks to the large cash balances that retail customers keep.  So they are in no hurry to raise rates to attract more money.  Other banks, however (especially online and other non-retail banks) DO need to raise funds and are willing to pay.  You just need to do your homework.  If you have large cash balances, it pays to shop around.  We’ve been finding brokered CDs paying well over 4% on the TD Ameritrade platform.  Online banks are offering CD rates well into the 3 to 4% range.  At these rates, you may not be keeping up with inflation, but you are giving it a good chase!