With the Fed about to raise interest rates, where do we go from here?
Last week saw significant volatility in the equity markets and the Fed has told us this week to expect up to a 0.5% bump in interest rates. Are we seeing a correction? GDP contracted last quarter by 1.4%. The Fed’s quantitative easing is coming to a slow end, and we now have increased interest rates baked into the cake. Could any or all of this drive us into a recession? Higher interest rates, inflation, recession. This begins to sound like the stagflation of the 1970s.
If so, it’s going to be a paired down version. That was pretty awful. What we have today is quite different. We have supply and labor shortages. This implies a new higher base rate for inflation in the decade to come. But when I say a higher base rate, I don’t mean 8.5%. I’m saying 3 to 4% instead of 1 to 2%. Regression to the mean is certainly to be expected with all the equity and other markets. All markets are expensive. Whereas rising interest rates can be good news for future retirees, today’s retiree is dealing with quite the trade off between yield and value in their fixed income investments. The answer to this, of course, in the short term is protect yourself. Stay short on your investments.
In a wonderful article by Vanguard, put out just a day or two ago, of the last 9 bear markets, the average downturn was 25%. Painful, but manageable in a diversified portfolio. However, the average bull was 99%. 1% shy of doubling in money in each one of those bull markets. These things always feel worse than they are. So it’s important to remember though, of the 20 best trading days since 1980, 9 of them, almost half, occurred during down markets.
Which brings us to the challenge we’re dealing today. This is a traditional environment. This is not a pandemic. This could be the beginning of a bear market. We don’t know, but what we do know is the best way to drive through this is to hang onto your seat and have the appropriate asset allocation, so that you can rebalance on the way down, buying future equities at a bargain price. Trying to step off the tracks always runs the risk of getting hit by the train coming the other direction.
“How to Withstand Volatile Markets.” Vanguard, https://investor.vanguard.com/investor-resources-education/news/navigating-a-down-market.