The end of 2022 was dearly welcomed by most of the financial world. Poor performance in stocks, an historical rout in bonds and the rapid and severe deflation of bubbles in anything speculative left virtually nowhere to hide as an investor. It was a shock to the system. To tame the trend of skyrocketing inflation rates, Central banks around the globe decided, after years of easy monetary policy, that it was time to rein in the excesses, of which there were many.
Feeling flatfooted as inflation ran very hot, the Federal Reserve Bank of the US and its counterparts aggressively lifted interest rates for the first time since the 2020 onset of the COVID-19 pandemic. However, even before COVID, rates had been artificially low since the Global Financial Crisis (GFC) in 2008 and so the need to go fast and furious was apparent. The rapid and sustained pace of these increases immediately impacted interest rates on nearly everything, from mortgages and credit cards for borrowers to the interest received in savings accounts, money markets and bonds for investors. As markets continue to digest these increases, asset prices, across the board, have been in decline.
When will this cycle end is a prediction that few are likely to get right. Historically speaking, current interest rates still are relatively low. For example, you would be hard-pressed to find a thirty-year fixed-rate mortgage that costs less than today (6.42%)1 at any time before the 2001 recession/dotcom “bust.” Current rates resemble the time leading up to the GFC, when they volleyed between the mid 5% and high 6% range. At that time, there was a significant economic boom and stock prices rose. However, today, the Fed continues to signal that they are planning to keep pushing rates higher as unemployment remains very low and while inflation may have peaked, it is still running well above their target. Many clients who owned properties in the seventies and eighties can recall mortgage rates multiple times higher than todays and while a return to the Volcker days of interest rates doesn’t appear likely, there is room to go higher.
In business school and the real world, there’s an old, heavily relied upon valuation theory known as “capital asset pricing model” or CAPM for short. CAPM is a method to value assets of all types and is commonly used in publicly traded securities – stocks and bonds. Essentially what CAPM does is take the current return on a “risk-free” (HA-HA) asset and apply a calculation with the expected volatility of an asset you want to buy. The equation tells you the ‘required’ return on the riskier asset to make it worth the added unpredictability that it (you) will experience. In 2022, when the rates on risk-free assets (typically US government bonds) spiked, it created a whole new equation for literally everything else, and the new equation is signaling higher returns on all risk assets .
So, back to the question as to when this cycle will end. As prices have fallen and expected returns have increased, we know that we are certainly no longer at the peak price point. However, it is an old wall street cliché that it is very dangerous to try to ‘catch a falling knife.’ As advisors focused on your long-term financial well-being, we don’t play with knives. However, we are keenly watching the markets and seizing opportunities to enhance client portfolios. When higher returns are expected from risk assets, it may mean that higher returns will be achieved, or so we hope! These pullbacks give us the opportunity to increase diversification, improve underlying asset quality and take reasonable, appropriate risks within your individual, specific parameters.
As always, please contact us with questions or with any changes to your financial situation. We wish you a healthy, wealthy and Happy New Year!
Scott Lasky, CFP™
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All statements are opinions and should not be construed as facts. This newsletter is for informational purposes only and should not be deemed as a solicitation to invest, or increase investments in Lionshead Wealth Management products or affiliated products. Information provided is for educational purposes. Your advisor does not provide tax, legal, or accounting advice. In considering this material, you should discuss your individual circumstances with professionals in those areas before making any decisions. Further, your advisor makes no warranties with regard to such information or a result obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information.S&P 500® Index: is an unmanaged index of 500 common stocks primarily traded on the New York Stock Exchange, weighted by market capitalization. Index performance includes the reinvestment of dividends and capital gains.