Markets Without Training Wheels
Stock market declines have a way of capturing our attention – far more so than when stocks go up. Declines concentrate our focus and seem to unleash those worries that haunt the subconscious of our minds. This past week reminded us that markets can move down, and they can decline swiftly. Always when a step decline occurs we ask ourselves the simple question, “why?”.
While there is no single factor that accounts for the market’s direction, there is often a culprit that seems to carry most of the weight for the move. In our current case, we believe the main driver of the worry in the stock market is interest rates. Finally, after years of the Federal Reserve driving interest rates lower and lower in hopes of stimulating the economy and generating some inflationary increases, the elixir is beginning to produce its desired effect – stronger economic growth and signs of inflation. The result of this stronger economy is that interest rates on both the short and long end of the yield curve are moving higher. It is the rapidity of the increase in interest rates that is serving as the catalyst for the decline in the stock market. As the 2018 year began, the yield or interest rate for the 10-year US Treasury Note was at 2.41%, as this is written, the yield is now 2.84% - an increase of over 17% in yield. Another way of looking at this increase in rates is to look at the effect on 30-year mortgage rates. At the beginning of the year, 30-year mortgage rates were around 3.75%, they are now offered at rates of 4.375%, a similar increase of approximately 17%.
The cost of borrowing money has been at historical lows for years and we as consumers and businesses alike have taken for granted that interest rates would stay low on a continual basis. The increase in interest rates does not just affect mortgage rates it can be seen in car loans, student loans, home equity loans, and the list goes on. This increase in interest rates is occurring on a global basis just as the decrease in interest rates eventually happened on a global basis. It is this increase in interest rates that is causing some indigestion for those who have been feasting at the stock market buffet.
Change can often be a disconcerting event in our lives and it is closely associated with fear of what that change will bring. We believe that stock market is reflecting concerns about present and future changes in the interest rate outlook. Stocks, in general, have had a remarkable upward run since the 2008 economic collapse and as such, a correction in the range of 10% in the stock market would be a healthy event for the future course of the stock market.
We do not believe we are entering into a long-term Bear Market, rather, it is our view that the Federal Reserve training wheels are coming off interest rates and as such we will experience more volatility or risk in our investments. We believe the economy can stand on its own and that the adjustment to stock prices is healthy on a longer-term basis. We are maintaining our investments in our stock positions.
Our asset allocation or investments in bonds has reflected our belief that interest rates would rise and as such we have shorter duration's or maturities and some of our portfolio money allocated for bonds is invested in money market positions. At some point in the future we will begin to use our money market positions to buy intermediate term bonds and extend our duration; but, that time has not yet arrived in our opinion.
As always, we are grateful to work with you.