By: Jeff Anderson, CFA
|Close||Weekly return||YTD return|
|US Treasury 10yr Yield||3.24%||7.8%||172.7%|
Source: Wall St. Journal
The S&P 500 is down 10.5% over past 2 weeks. The Volatility Index (“VIX”) is up over 30% again which is basically fear territory. During the summer doldrums, the VIX is typically around 10%. Times are different for sure. Bear markets stink. They are a buzz kill.
School is out and those who are planning a summer vacation away from home, buckle up; it’s going to cost a lot more than last year. Inflation is running rampant, and because of that, Fed Governor Jay Powell and his merry team of regional Fed governors agreed to raise the overnight rate by 75 basis points rather than the 50 that was expected as recently as last week. Why the change of heart Jay? Friday’s CPI reading of 8.6% was enough to change his mind. They are committed to bringing inflation under control. When the rumor surfaced Monday afternoon that team Powell was leaning towards 75 basis points, the yield on the 10-year US treasury spiked 25 basis points immediately. I mean immediately. In my 22 years of investing, I can’t remember such a move. But guess what? It was necessary, AND prudent. Best we tame the inflation beast now vs letting it grow and devour everything in its path. Believe it or not, the cost of food and gasoline will come down at some point.
Is there any good news when discussing inflation? Yes. Most of us own homes, and most have mortgages below the prevailing rate of roughly 6%. As inflation eats away at your purchasing power, it also reduces the real cost of future mortgage payments. The US, unlike many western economies, has a banking system that allows investors to lock in mortgage rates for 30 years. Let’s say, for example that you refinanced or purchased a home with mortgage rates at 4% and your monthly mortgage amounts to $4,000. Inflation settles down to 6% next year, and 3.5% in year 5 and stays there. In year 10, your mortgage payment drops dramatically. And, house prices typically rise with the rate of inflation, so you end up with a real asset that increases with inflation AND your monthly payment decreases in real terms. It’s just math (granted, on the back of cocktail napkin). The point is, any debt you owe that has a fixed interest rate, inflation will be a tailwind. Since housing takes up anywhere from 25% to 40% of your take home pay, it goes a long way in helping you absorb higher costs for other expenditures. This is not to say that we welcome inflation, but merely to point out that certain assets in your total asset base are a natural hedge against it. Equities can also be an inflation hedge. Companies that can’t pass on rising costs will wither and die. Those that can get their costs down to be the lowest cost producer in an industry will survive. Equities, have over time, generated returns greater than the rate of inflation.
Recessions and bear markets are an ugly, but unavoidable, part of a capitalist system. We have booms and busts. Until we can find a better alternative, it will continue to be so. How we act during these times will have long-lasting effects. Choose to allow your emotions (i.e., fear) to take over and you could make decisions that may alter your path to retirement (or the lifestyle you expected in retirement). Remember, when making investing decisions, we don’t compare to nothing, and we don’t buy high and sell low. I’ve witnessed 4 market crashed in my lifetime. Each one had its own catalyst for that crash, and each one was unsettling. They happen. Let’s accept that. Keeping a level head and having a roadmap are the two most important things you can do right now.