Investors face tough stock and bond markets
David T. Mayes
The current environment is proving to be one of the most challenging for investors in recent memory. After years of strong stock market gains, including an impressive rebound from the pandemic-driven sell-off. In 2021, equities posted strong gains fueled by the reopening of the global economy and low interest rates that triggered strong corporate earnings. By the end of 2021, the S&P 500 had more than doubled from its March 2020 low.
Unfortunately, the tailwinds that drove stocks higher have shifted. The low inflation environment that persisted for more than a decade gave way to price increases not seen in 40 years. Inflation has been exacerbated by both supply chain issues related to COVID-19 and increased demand for goods and services triggered by the government’s response to the pandemic. More money in consumers’ pockets would eventually lead to increased demand for goods that were now in short supply due to the pandemic. When demand exceeds supply, prices must rise. Add to that a spike in oil prices triggered by Russia’s invasion of Ukraine and you have a picture of inflation that the Federal Reserve cannot ignore.
The Fed is following its playbook in pursuit of its dual goals of keeping employment high while controlling inflation by raising short-term interest rates and reducing the money supply by leaving the bonds it bought during the pandemic fall from its balance sheet without being replaced. At its March meeting, the Federal Reserve hiked the federal funds rate by a quarter of a percent to 0.25%-0.50%, followed by a half-percent hike at its meeting. of May. His own summary of economic projections suggests that we could see a federal funds rate of 1.75% to 2.00% by the end of the year.
As a result, interest rates have risen significantly in the bond market, especially on shorter term bonds. This means bond yields have been negative in 2021. As of May 10, the Bloomberg Barclays Capital Aggregate Bond Index yield was just below minus 10%.
Most investors understand that stocks don’t go up in a straight line. Periodic declines in stock prices are to be expected and are part of the reason stocks have higher expected returns. The higher return is an investor’s gain for tolerating the extra risk. The decline in bonds may come as a surprise, however, since interest rates have generally followed a downward trend over the past 40 years.
Investors in both stock and bond markets make decisions based on expectations about economic factors such as employment, earnings growth and inflation. In the current environment, confidence in these forecasts is less, leading to market volatility. All eyes will remain on the Fed to see if it can implement a policy trajectory that eliminates inflation from the system without triggering a recession. For now, the economy appears to be on reasonably stable ground, with employment continuing to post solid gains and consumer spending holding up well. If the pandemic-related manufacturing shutdowns in China ease and the situation between Russia and Ukraine can be resolved in the coming months, the Fed has a better chance of success.
What should investors do in such a difficult environment? Will he cash in until things improve a good strategy? Not likely. The problem with abandoning your investing strategy in favor of cash during volatile times is that even if you avoid some of the downside, you’re unlikely to feel comfortable getting back into the markets. before missing much of the rise. Remember that while your investments are in cash, inflation erodes their purchasing power with no chance of recovering that purchasing power. A better approach is to assess your portfolio for rebalancing opportunities. Even though stocks and bonds have both fallen, some asset classes in your investment portfolio may have held up relatively well. For example, value stocks, particularly in energy, held up well. It may be time to sell them to buy stocks that are now heavily discounted. In the case of bonds, shifting short-term holdings into floating rate notes can be helpful as rates continue to rise. Also, you may want to consider preparing for the next recession now that bonds are on sale. This means turning to US Treasuries, preferably in the medium term, as these securities will hold up well when the Fed eventually backtracks and lowers rates again to boost growth.
David T. Mayes is a CERTIFIED FINANCIAL PLANNERTM professional and IRS registered with Three Bearings Fiduciary Advisors, Inc., a fee-based advisory firm in Hampton. He can be reached at 603-926-1775 or [email protected]