Fear the Fed?

The market dropped last week because the Federal Reserve hinted they may raise interest rates in 2023, two years from now.  The Dow Jones fell about 3% as the topic of rising interest rates covered the airwaves.  The Federal Reserve also published their dot plot chart, a chart of where their members expect interest rates to be over the next few years, and several members expect rates to rise above 1.5%. Should we be concerned?

In 1994 and 1995, the Federal Reserve raised interest rates seven times, from a low of 3.25% to a high of 6%. From February 4, 1994, to February 1, 1995, interest rates jumped 85%.[1] What happened to the stock market? In 1994 the S&P 500 rose a paltry 1.3%, but it did not fall. However, in 1995 the index soared 37.6%.

From 1999 to 2000, the Federal Reserve hiked interest rates six times from 5% to 6.50%. The S&P 500 rose 21% in 1999, but it dropped 9.1% in 2000.

From 2004 to 2006, the Federal Reserve boosted interest rates seventeen times! On June 30, 2004, the Fed Funds Rate sat at 1.25%, and on June 29, 2006, it swelled to 5.25%, an increase of 320%. Despite several rate spikes, the S&P 500 rose 10.9% in 2004, 4.9% in 2005, and 15.8% in 2006.

From 2015 to 2018, the Federal Reserve increased interest rates nine times, climbing from .25% to 2.50% or 900%. The S&P 500 rose 1.4% in 2015, 12% in 2016, 21.8% in 2017, and it dropped 4.4% in 2018.

Rising interest rates are a sign of a robust economy and, potentially, higher inflation. Rising interest rates and higher inflation spells trouble for stocks. If rates rise high enough, investors will sell stocks to buy bonds or park their cash in a money market fund. For example, some investors would prefer to earn a safe 5% from a bond rather than risk their capital in the stock market.

Lately, though, long-term interest rates are falling. The Federal Reserve can only regulate the Fed Funds Rate, whereas the market (investors) control everything else, including longer-dated bonds. For the past three months, yields on the US 10-Year Treasury Note and the US 30-Year Treasury Bond are each down more than 15%. If investors are nervous about rising interest rates or inflation, the bond market is telling us otherwise.

Wayne Gretzky once said he’s successful because he skates to where the puck is going, not to where it has been. He is the rare athlete who sees plays develop before others. But Mr. Gretzky is not on the Federal Reserve Board, and predicting the direction of interest rates is hard; trying to identify the actual rate is impossible.

Jamie Dimon, the CEO of JP Morgan Chase, said in 2019, “We’ve actually been effectively stockpiling more and more cash, waiting for opportunities to invest at higher rates,” Dimon said during a virtual conference held by Morgan Stanley. “So our balance sheet is positioned (to) benefit from rising rates.” At the time of the quote, his firm was sitting on $500 billion in cash, waiting for interest rates to rise.[2] What happened? The CBOE Interest Rate Composite Index fell 98.57% over the next two years! If Mr. Dimon can’t predict the direction of interest rates, who else can?

The effective Federal Funds Rate is currently .06%. The 67-year average has been 4.74%, so who cares if it rises a percent or two? I don’t.

When the market falls again because of rising interest rates, use it as an opportunity to buy great companies at discounted prices. Since February 4, 1994, the S&P 500 is up 797%, or 8.34% per year, despite several corrections. A $10,000 investment grew to $89,740!

Rather than waiting for the Federal Reserve to hike interest rates in two years, diversify your portfolio, follow your plan, save your money, and invest often.

“It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.” ~ Henry Ford

June 21, 2021

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.


[1] https://www.federalreserve.gov/monetarypolicy/openmarket_archive.htm

[2] https://www.reuters.com/business/finance/jpmorgan-stockpiling-cash-waiting-interest-rates-rise-ceo-2021-06-14/, Jeenah Moon, April 9, 2019

Fear Rising Rates?

Investors fear rising interest rates. Since the start of the year, the 10-Year US Treasury yield is up 66% to 1.54%. It’s still low, but the speed at which it climbed is worrying investors. For the past fourteen years, the yield on the 10-Year averaged 2.33%. The high was 4.01%, the low was .52%. Does it make sense to sell stocks as rates are climbing? Maybe.

Let’s look at rate spikes during this cycle. Despite several rate spurts, the S&P is up 373% since 2008. If you bought stocks during the previous rate spikes, you’re probably sitting on nice gains today. Though we have experienced volatility in the bond market, the trend for interest rates over the years has been down.

  • The yield soared 67% from December 2008 to June 2009.
  • The yield jumped 50% from October 2010 to February 2011.
  • The yield climbed 49% from May 2013 to September 2013.
  • The yield rose 68% from July 2016 to January 2017.
  • The yield increased 54% from August 2017 to November 2018.

During the above rate spikes, stocks rose with an average gain of 11% – counter to what typically happens when rates rise.

Stocks are sensitive to interest rates. When they rise, stocks fall, and vice versa. It’s been this way for centuries. Rates threaten stocks when elevated because investors can buy bonds to realize a safe and sometimes guaranteed return. When will rates be a menace for stocks? I believe the rate threshold is 5%. A 5% guaranteed return for many will be difficult to pass up, and investors will sell stocks to buy bonds.

Additional buyers for our bonds are wealthy foreign investors and foreign governments since our rates are high relative to other countries. Here’s a look at global 10-year government bonds.[1]

  • Germany = -.274%
  • UK = .755%
  • Japan = .0122%
  • Australia = 1.786%
  • China = 3.27%
  • France = -.036%
  • Italy = .75%
  • Spain = .406%

Our rates are in line with Australia’s, but lower than China’s. However, foreign governments and wealthy investors likely will choose our market because of our safety and liquidity. As our rates climb, the money will flow into our bond market, keeping a lid on rising rates.

Rising rates may benefit your portfolio, especially if you carry a large cash balance. As rates rise, so will the yield on your money market or savings accounts. Another way to benefit is through a bond ladder. Buying bonds with different maturities can preserve your liquidity while capturing higher yields. Also, if interest rates are rising, it means our economy is doing well. And, a strong economy will benefit many.

If stocks fall because our rates are rising, I recommend buying the dip as a correction may be short-lived.

Don’t fear rising rates – for now!

Everything you want is on the other side of fear. ~ Jack Canfield

March 8, 2021

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.


[1] https://www.barrons.com/market-data/bonds?mod=md_subnav, website accessed March 8, 2021

Bye, Bye and Buy Bonds?

Interest rates are trading near historical lows, but they’re rising. Since July, the yield on the 30-Year US Treasury has soared 42%. Last March, it dropped to a low of .99%. Now it’s yielding 1.88%, an increase of 90%. Rising rates from all-time lows is not a rousing endorsement to buy bonds.

Despite the low rates, bonds belong in a diversified portfolio. Bonds are safe and consistent, and they offer stability not found in other investments like stocks, gold, or Bitcoin. Also, bonds are negatively correlated to stocks, so when stocks fall, bonds rise. During the market correction last March, interest rates dropped 36% as investors purchased US government bonds. As rates fell, the iShares 20+ Treasury Bond ETF rose 15%, while the S&P 500 dropped 12%.

Bonds are a source of funds. When stocks fall, bonds rise. You can use your bonds to buy stocks – buy low and sell high.

Another reason to buy bonds is to match the maturity with your purchase. If you’re buying a new home in two years, then buy bonds with the same maturity – two years.

My career launched more than thirty years ago in Pasadena, California, as a stock-broker hired by Dean Witter. I was young, with no connections, so my primary tool for prospecting was the telephone. I cold-called morning, noon, and night looking for new clients. One of the investments I used for calling was the 30-Year US Treasury bond. At the time, they were paying more than 8%, guaranteed. My pitch was simple: “Hello, Mrs. Jones, this is Bill Parrott from Dean Witter in Pasadena. We are currently offering a guaranteed investment paying more than 8%. Would you like to hear more about it?” I couldn’t give them away because most people thought interest rates were going to rise.  Well, they were wrong, and interest rates dropped more than 87% over the next three decades. If they bought the bonds, they could have enjoyed thirty years of 8% guaranteed income, and their bond would be worth $143 today, a gain of 43%.

Since interest rates are rising, bond prices are falling. The price of a 30-year bond will fall 22.4% if interest rates rise 1%, so my recommendation is to keep your maturities short – less than five years.

Bye, bye, and buy bonds!

January 12, 2021

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

Data Sources: YCharts

What’s a Yield Curve?

The hot topic this week is the yield curve, or more importantly, the inverted yield curve. What the heck is a yield curve?  It’s a collection of interest rates, or yields, plotted on a chart. Rates begin with the one-month U.S. Treasury Bill and end at the 30-year U.S. Treasury Bond. The curve plots all points in between.

Historically, it slopes upward and to the right because short-term rates have been lower than long-term rates. Makes sense. If you buy a 30-year bond, you want to be compensated for your risk in the form of a higher rate.

The yield curve can be normal, flat or inverted. The chart below shows all three. Blue is normal, orange is flat, and gray is inverted.

Yield Curve

A normal yield curve tells us that if we buy a long-term bond, we’re going to earn more interest than a short-term one. With a flat yield curve, it doesn’t matter which bond you buy, because all rates are the same. When the yield curve is inverted, you earn more interest with a short-term bond than you do from a longer term one.

A normal yield curve also signals a strong economy with no known issues on the horizon – ceiling and visibility unlimited. When the curve inverts, trouble awaits. What trouble? A recession. An inverted yield curve has previously been a reliable recession indicator. It’s a sign our economy may be losing steam.

It’s true, an inverted yield curve has been a good indicator. However, the correlation between an inverted yield curve and a recession is not instantaneous. It may take one to two years before a recession occurs after the curve has inverted. It takes time to slow down a $20 trillion economy.

Is the yield curve currently inverted? No. The yield on the one-month T-Bill is 2.334% while the rate for the 30-year T-Bond is 3.176%. This is a normal yield curve, sloping upward and to the right.

Parts of the yield curve are inverted. The 2-year and 5-year rates are slightly inverted. Experts are concerned that this is the beginning of the end, but this is like a driver in Houston who’s worried about a traffic jam in Los Angeles.

The Fed Funds rate is currently yielding 2%, the only rate the Federal Reserve controls. The remaining rates are left to market participants – buyers and sellers. If we compare the Fed Funds rate to all interest rates, the yield curve is normal.

Earlier this year the market sold off because interest rates were rising. Today stocks are selling off because interest rates are falling. The recent price action in the stock and bond markets can be attributed, mostly, to the uncertainty surrounding the trade war between the U.S. and China. Markets hate uncertainty. When investors stare into the abyss of the unknown, they sell stocks and buy bonds. When bonds are bought, rates fall.

The price of oil has also dropped. Lower oil prices coupled with lower rates are a positive for the consumer. The current unemployment rate is 3.7%, so 96.3% of Americans are working. When the American worker pays less at the pump and takes advantage of lower interest rates, they spend money – a boost to our economy.

In the movie Top Gun, Maverick and Goose inverted their F-14 Tomcat, so they could take a picture, and give the bird, to a Russian MIG pilot. After the encounter, they return the plane to normal, fly back to Miramar and buzz the tower. Their inversion didn’t hinder their ability to continue to fly the plane.

Slower growth doesn’t mean no growth. If our economy was travelling at 75 miles per hour a couple of years ago, it may be cruising at 55 MPH today.

Our economy is strong, corporate earnings are robust, interest rates are low, and taxes are favorable. These factors bode well for a higher stock market at some point. Follow your plan, diversify your assets, think generationally, and good things can happen.

Because I was inverted. ~ Maverick, Top Gun

December 7, 2018

Bill Parrott is the President and CEO of Parrott Wealth Management firm located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process to help our clients pursue a life of purpose.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog.

 

 

 

3 Percent

Three is not a lonely number but it is a crowd and a bit odd.  The number three appears in stories like the Three Musketeers and the Three Little Pigs. The Nina, Pinta, and Santa Maria sailed the ocean blue as a threesome.  Famous athletes who have worn the number include Babe Ruth, Dwayne Wade, Candice Parker, Russell Wilson, and Dale Earnhardt.  Let’s not forget the Three Stooges.

Lately, investors have been agitated because the yield on the 10-Year US Treasury Note breached 3%.  Rising rates usually don’t bode well for financial instruments like stocks or bonds but should we be worried?

The last time the 10-Year yield poked its head above 3% was December 2013.  If you purchased the Vanguard S&P 500 Index fund in January 2014, after the 10-Year rose above 3%, you would’ve generated an average annual return of 10.89%.  A $100,000 investment in the Vanguard fund is now worth $155,510.

The yield on the 10-Year Treasury never fell below 3% from 1962 to 2008 and peaked at 15.84% in September 1981. Since 1962 it has averaged 6.23%. Rates are relative and 3% seems low next to the historical average but high when compared to the low of 1.37% it touched in July 2016.[1]

From 1962 to 1981 the 10-Year yield soared 275%.  This period included the Cuban Missile Crisis, the Civil Rights Movement, the Vietnam War and the Iran Hostage Crisis. Despite these headwinds the stock market managed to generate an average annual return of 6.8%.  A $100,000 investment in the Investment Company of America mutual fund in 1962 grew to $547,780 by the end of 1981. Of course, the stock market didn’t go straight up, it fell several times including a 41% loss from 1973 to 1974.[2]

The S&P 500 Index has averaged 10.8% from 1962 to 2018 with interest rates rising and falling. Incorporating a buy and hold strategy in the index, a $100,000 investment in 1962 grew to $34.11 million at the end of March 2018.[3]

Should you be afraid of rising rates? It all depends on why rates are rising. Currently they’re rising for positive reasons because of our strong economy, low unemployment, and robust earnings.

To keep your investments moving forward here are three things you can do now.

Plan. A financial plan will help crystallize your goals and quantify your objectives. It will serve as the cornerstone for your investment portfolio and help guide your through a myriad of market conditions.

Invest. A diversified portfolio of stocks, bonds and cash will help cushion your investments from a rate shock.  Adding international and alternative investments to your account will further balance your portfolio.

Repeat. Rebalancing your accounts once or twice per year will keep your asset allocation intact and your risk level in your desired range.

The American economy continues to thrive, and the long-term trend of the stock market can move higher despite the gravitational pull of interest rates.  Focus on your goals, look to the horizon, and invest often.

“We ignore outlooks and forecasts… we’re lousy at it and we admit it … everyone else is lousy too, but most people won’t admit it.” ~ Marty Whitman

April 25, 2018

Bill Parrott is the President and CEO of Parrott Wealth Management an independent, fee-only, fiduciary financial planning and investment management firm in Austin, TX.  For more information please visit www.parrottwealth.com.

Note:  Past performance is not a guarantee of future returns.  Your returns may differ than those posted in this blog and investments aren’t guaranteed.  The returns don’t include taxes.

 

[1] https://fred.stlouisfed.org/series/DGS10

[2] Morningstar Office Hypothetical Tool

[3] Ibid