By: Jeff Anderson, CFA
|Close||Weekly return||YTD return|
|US Treasury 10yr Yield||3.14%||15.9%||107.56%|
Source: Wall St. Journal
Volatility was the name of game this week as equity markets gyrated wildly after the Federal Reserve hiked the overnight rate by 50 bps on Wednesday. The markets spiked higher after the announcement but quickly reversed course the following day, with the major US equity markets falling roughly 5%. Yet, despite this, the S&P 500 barely moved over the week. The Nasdaq Composite closed down less than 2%, but it sure felt like it was much worse. The yield on the US Government 10 Year Note rose above 3% as the Fed laid out plans for 50 bps rate hikes over each of the next two meetings. By the end of 2022, the overnight rate will likely be closer to 2.5% vs it’s current range of 0.75% to 1.00%. Fed Governor Powell is dead set on bringing down inflation. The Fed also stated that they will begin winding down their balance sheet with purchases of $47.5 billion of treasuries and mortgage-backed bonds in June, July, and August, followed by $95 billion of bond purchases thereafter. That is quite a reversal from late last year when the Fed was “buying” $90 billion worth of bonds. Many economists and strategists believe Mr. Powell and his team are “behind the curve,” meaning they aren’t doing enough now to bring down inflation. However, when the war in the Ukraine ends (yes, it will end at some point), and lockdowns in Asia expire, inflationary pressures from supply chain challenges should help bring down inflation. CPI has been near 8.5% but that should come down below 5% by next year. With the US Treasury yield around 3%, real rates will still be negative, but not nearly as negative as they are today. Remember, rates have been negativing in real terms for years.
The recession debate is twofold. The first debate is when we will see a recession. The other is how severe will it be. Will we have a “soft landing” and experience a mild recession or will it be a severe one. That is impossible to know. There is no crystal ball. And, importantly, for a long-term investor, it is irrelevant. The economic cycle includes recessions. They are inevitable, but they aren’t bringing on the end of the world. Never bet on the end of the world.
Times Like this Can Make you Lose Faith…. If you Let it:
We are emotionally programmed to feel losses more acutely than gains. We need $20 of gains to feel the same as losing $10. We don’t like to lose. It’s that area in the brain called the amygdala that is also responsible for processing fear. That’s a cruel trick played on the human mind. Fear can be suffocating. Fear of being hit by a bus and fear of losing money are all packaged in the same brain tissue. So, what can investors do? Are we condemned to a pattern of rushing out of investments when the seas get choppy? No, we aren’t. Understanding risk is vitally important. That is why holding a diversified portfolio of equities and bonds will, over the long-term, help investors reach their financial goals. Then why do we start to focus on one stock or fund that is doing worse than others during a market correction? Asset classes all have different risk and return characteristics. When put into a portfolio, their unique attributes tend to balance each other. Yet, in times like this, when stocks and bonds go down at the same time, what are investors to do? Is Modern Portfolio Theory dead? Is this the new normal? It likely is not. Equity markets are upward sloping over the long term. The S&P 500 has averaged around 9% annually over the long-term. But that’s the average. To earn that average, investors will experience periods of higher returns as well as periods of lower, or negative returns. Market corrections are an unavoidable part of your financial journey. Sometimes, the road is wide, smooth and the scenery is breathtaking. Other times, it’s full of potholes, sharp turns, and lousy weather. But, in the end, you’ll get to your destination.
Source: Google Images (Sculpture by Arturo Di Modica)