Stock and bond markets have had a rough ride so far this year, to say the least. The number one influence on prices has been inflation. We are all feeling the effects of inflation, which is defined by www.investopedia.com as “a rise in prices, which can be translated as the decline of purchasing power over time.”
To help tame inflation, the Federal Reserve has been increasing the Federal Funds Rate, which is the interest rate at which banks and other depository institutions lend money to each other, usually on an overnight basis. This rate has risen from 0.25% on 10/11/2011 to 3.25% a year later. This increase is intended to make borrowing money less attractive which, in turn, should decrease the money supply, making inflation less likely.
Rising interest rates cause bond prices to decrease, which is why we have seen a drop in the Vanguard Total Bond Market ETF price of over 15% year-to-date through 10/14/2022. This has made bonds a less diversified asset versus stocks, which have fallen in price over 24% during the same time frame.
Market prices are forward looking. Marketsare always trying to estimate current value based on events that are expected to occur in the future. One thing markets do not like is uncertainty. At the current time it is very difficult to predict how far the Federal Reserve will increase rates and what effect this will have on the economy. Third quarter earnings and revenue are expected to remain positive but slow considerably. Current market prices appear to be predicting a recession in the future. So, if recession does occur, it is likely that the market is already reflecting this economic decline.
As the future unfolds we will discover the actual impact of rising interest rates and inflation. However, until actual results are observed it will remain a guessing game for the market. Given this scenario I continue to believe, as I noted in last quarter’s newsletter, we will remain in a trading range with current levels close to the bottom. This is likely until the Federal Reserve completes their rate rising cycle.
How much longer we will deal with inflation also remains an uncertainty in today’s market environment. It is important to recognize the rebalancing we are dealing with in the Consumer Price Index(CPI) at the current time. The chart below illustrates CPI and Core CPI for the past 50 years. The 50 year average for Core CPI is 3.9%. We have enjoyed sub-average CPI growth for almost 30 years. The recent spike may be classified as a rebalancing, or catch up, in prices for long term averages.
While inflation has been wreaking havoc on most investment portfolios so far this year, there may be some ways to take advantage of this situation. Current market prices appear to offer a nice entry point for investment right now. Buying stocks and bonds at these prices seems to offer a solid long-term opportunity for growth. Now is the time to start looking for opportunities to buy stocks “on sale,” so to speak.
For your safer assets, such as emergency funds, there may also be a significant opportunity. Savings instruments, such as bonds or Certificate of Deposits, are beginning to offer higher interest rates. Much has been written lately about I bonds. I bonds are a type of U.S. savings bond designed to protect the value of your cash from inflation.These bonds may offer a nice opportunity to pick up extra funds with savings.
The current annual interest rate offered on I bonds is 9.62% until October 31, 2022. At that time the interest rate will reset. However, it appears the rate will still be relatively high. There are some pros and cons to these investments:
Pros
- High interest rate
- Low risk – bonds are backed by the U.S. government.
- Interest not taxed at the state or local level.
- Liquid after one year
Cons
- $10,000 limit for investment per person per year
- Can only be purchased through www.treasurydirect.gov. So this relatively small account will always be held separate from other investments and savings.
- Your financial advisor cannot do it for you.
- Interest is subject to Federal tax.
- Must hold for one year before liquid, or interest will be forfeited.
If you are interested in this investment, I am in favor of taking advantage of it. Please visit www.treasurydirect.gov for more information. My recommendation would be to invest savings assets such as emergency funds or other assets you want to keep safe. This will help these funds work for you rather than sitting in the bank continuing to earn next to nothing. For funds that may have accumulated in excess of your emergency fund target, it is a good time to start looking at stock and bond markets for longer term investment.
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