Today, the big news came out of the bond market. The Bloomberg headline is “US Pays Up to Auction $179 Billion of Debt in a Span of Hours.” Shorter term notes sold at interest rates not seen in a decade. The two-year Treasury note rate rose to 2.25%. While that number may sound like good news for savers who want to buy short term CD’s, the stock market takes a different view. A move in interest rates this large and this abruptly is worrisome, and this has really been the story of this month. Rapidly rising interest rates seem to indicate that inflation is seeping back into the near-term view.
In just a few weeks February has seen a volatility in the domestic stock markets that has been largely absent for years, and investors fear there is more to come. To me, the strong upswing in January over the tax overhaul was a celebration of sorts, but it felt a bit more like the euphoria that presages a decline. February’s declines seem to be following that pattern. The big question is, however, was this a quick and painless correction or is this the first of one or more legs down. Major market indices like the Dow and S&P 500 are back to where they started at the beginning of the year, so we have to say that as corrections go this one, so far, has been less painful than most.
Why do investors care about rising inflation? I suggest the stock market is unsettled by the whiff of inflation because that may cause the Federal Reserve to accelerate and/or increase its telegraphed schedule of raises to the Fed Funds rate. As Bill Rhodes recently said on Bloomberg (2-14-18) - The great accommodation is over. The Fed is no longer going to work at keeping rates low; they are letting rates settle in to what the market will demand. If interest rates rise precipitously the anticipated good effects of corporate tax reform could be lessened. Also, the so-called acceptable price of a stock relative to its earnings declines in higher interest rate environments.
The other fear many investors have when markets decline is that the decline presages a recession. At this point it does not appear that a recession is on the horizon. The economy is growing at about 2.5%, we are at full employment by most measures, and earnings reports for 2017 have mostly met or exceeded analysts’ expectations. Absent geopolitical upsets, we should see an economy which will support continued positive market valuations through this year. This may not be a year, however, of very large gains. That was last year – the year of expectation. This year will have to deliver those expected earning gains, and it is too soon to tell if or when market expectations will be realized.
We believe the opportunity in markets outside the US offer more opportunity for the coming months. We had been accumulating cash over all of 2017 and we put some of that to work in our International positions earlier in February. In volatile markets such as we have seen recently I believe it is prudent to keep some cash for the express purpose of executing on opportunity when it is presented.
This is tax season, and it’s a great time to think about how the new tax law will effect you and your longer term wealth accumulation plans. Our next Lunch and Learn in both Greensboro and Durham will explore these issues with a CPA who specializes in personal wealth management. We need to give them time to get through the tax reporting crunch, so our event will be in May. Look for announcements about these events and be sure to register early as we have limited seating and I expect more than usual interest in the topic.
For a deep dive into where we are in the economic cycle and the investment implications of the many metrics that we watch for explanations and identifiable trends, please join us for our Listen at Lunch – always on a Friday in the first weeks of the new quarter. Grab a salad, grab a sandwich and follow along with slides you can view on our website. Lindsay will send out a reminder email or you can go to the website to mark the date.
Wishing you may green shoots in this Spring season,
Linda P. Erickson, CFP®
The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change with or without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results. Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.