Truth or Consequences
A popular game show on TV during the 50s and 60s was Truth or Consequences where contestants were asked wacky questions and if they were unable to answer correctly, they then had to face the “consequences,” which generally was an embarrassing stunt. There are times in real life where we have to deal with the truth, or a hard reality, and then deal with the consequences of whatever decision was made. For example, you might decide to attend a party and stay out late (which the author considers to be anytime after 9:30) but the next day you will have to deal with the consequences. We are now facing the truth of past action from policymakers and have to deal with the consequences in the markets.
The consequences of many years of low interest rates and a burgeoning money supply, in the form of stimulus, are now being felt via high levels of inflation, which has only been exacerbated by the pandemic and geopolitical events. Last week’s stock market weakness was attributed to comments from Federal Reserve officials emphasizing that more aggressive action will need to be taken to combat inflation. Expectations now are for half point interest rate hikes at each of the next two Fed meetings, and quite possibly the two after that. The Fed is also expected to use another tool in their arsenal to combat inflation – reduce their balance sheet by selling bonds, which would reduce the money supply. Did we mention there is even some chatter about the potential for the Fed to raise rates by as much as 75 basis points (three-quarters of one percent) at one of their upcoming meetings? We do not think this is likely, but it is certainly possible, and something to consider since inflation seemingly continues to accelerate.
The S&P 500 and Nasdaq suffered their third consecutive week of losses, with Friday being the largest losing day since the onset of the pandemic in March, 2020. Earnings season kicked off in earnest and positive momentum in the market showed promise mid-week but unfortunately this quickly faded. Many of the earnings reported were worse than the already lowered expectations or the companies provided underwhelming forward guidance. Most notably was Netflix, which showed a loss of subscribers for the first time in history.
There is no place investors are dealing more with truth and consequences of their past decisions than with the “profitless” tech stocks, many of which are down as much as 70 to 80 percent from their highs. These stocks are speculative since they are bought with a hope that at some point the company will turn a profit. However, stock prices are affected by the present value of future earnings, which are dependent upon interest rates. With interest rates rising, the present value of earnings becomes less, putting pressure on share prices. This niche of the market, which is primarily in the tech sector, strikes an eerie similarity to the tech crash of the early 2000s.
Flight to Safety???
We have touched on this in the past but it is worth revisiting given what has happened over the past few weeks. Conventional wisdom when it comes to asset allocation is to buy a mix of stocks and bonds with the thought being that bonds will perform well when stocks fall as there will be a “flight to safety.” Going further, the thought is that even if bonds do not increase in value when stocks fall, their volatility should be less, and any potential losses will be relatively small especially in comparison to stocks. Over the past few decades this has worked rather well since inflation has been fairly benign and interest rates have remained mostly steady. Now that inflation is stubbornly high and interest rates are quickly rising, this strategy is not proving to be as successful.
Year-to-date the most widely followed bond index, the Bloomberg Barclays Aggregate Bond Index has lost nearly 10%. This does not sound like something providing protection against market downturns. Longer duration bonds have performed even worse with the iShares 20+ Year Treasury Bond ETF (Ticker: TLT) losing almost 19% year-to-date. Both investments did very well during the financial crisis of 2008-2009 since investors dumped stocks and moved into the relative safety of bonds. At that time, we were dealing with a deflationary environment and interest rates were falling. Now we have high levels of inflation and interest rates are rising so the inverse relationship between stocks and bonds, especially longer duration Treasury bonds, is no longer holding and bonds are not providing the protection they once did. As can be seen, bonds have lost more value than stocks in the short-term, a pattern which very well could continue as interest rates continue to rise. We would advise looking elsewhere for protection and diversification.
Looking Ahead
It is difficult to sugar coat the stock market action on Friday since 489 out of 504 stocks in the S&P 500 lost value. This coming week major tech bellwethers Apple, Amazon, Microsoft, and Alphabet (Google) report earnings which is bound to impact how the markets perform. The S&P 500 is trading near the lows reached in March so we think we might see a short-term bounce, especially since the prospect of larger interest rate hikes from the Fed have been baked into the market. That being said, we remain long-term investors and maintain our focus on what the markets will do over the next several years versus the next few weeks. Short-term predictions are mostly for fun and not what should be used to make investment decisions. More “experts” are now predicting a recession sometime in 2023 which seems probable but often times the stock market, which is a leading indicator, reflects months in advance. And it is worth mentioning there often is a dichotomy between the stock market and economy, so a market downturn does not always coincide with a recession. If you are concerned about market volatility and would like to discuss ways to protect your assets please give us a call to discuss your individual situation further.
Have a great week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
Secured Retirement
nzeller@securedretirements.com
Please contact us if you would like to review your individual financial plan or learn how the TaxSmart™ Retirement Program can help you.
info@securedretirements.com
Office phone # 952-460-3260
