Conventional wisdom (at least conventional wisdom practiced by CNBC and Bloomberg) holds that when the Federal Reserve begins a series of rate increases, the stock market suffers broad-based losses. The Fed has made it clear that it intends to start increasing rates soon to combat inflation. So, is the stock market doomed to have a severe decline?
You may be disappointed to know that I do not know the answer to this question. However, after some investigation, I do know what happened to the stock market the last two times the Fed had a series of rate increases:
- From June 2004 to June 2006 the Fed raised the federal funds rate from 1.00% to 5.25%. During that same period of time, the S&P 500 increased 12.87%.
- Fast forward to 2016. From December 15, 2016 to December 20, 2018 the federal funds rate increased from 0.25% to 2.50%. Once again, during the rate hike period, the S&P 500 increased. In this case the increase was 7%.
I also looked at the effect Fed rate increases had on two different US treasury securities, the two-year note and the ten-year note. The two-year note is much more sensitive to the federal funds rate, since it has a short-term maturity. The ten-year note is more reflective of the longer-term economy and is not impacted as much by Fed rate increases. In looking at the data from those periods, it is clear that interest rate increases in the two and ten-year notes started well before the actual Fed rate increases.
1.Data sourced from https://www.federalreserve.gov/monetarypolicy/openmarket.htm
2.Data sourced from https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield
The Fed indicated their intention to raise rates at its meeting on December 15th. Since then, the two-year note rate has increased from 0.69% to 1.01% and the ten-year note rate has increased from 1.47% to 1.75%.
Does it hurt more to lose than it feels good to gain? Several studies have shown that the pain of losing is psychologically twice as powerful as the pleasure of gaining. My experience is that these studies are true. Many people forget about their gains and just focus on their current loss. Part of the issue is that stock market losses traditionally take place quickly, while gains take a long time to accrue. There is a saying that gains go up on an escalator and losses go down on an elevator.
On January 3, 2022, the S&P 500 hit an all time closing high of 4,796.56. Just 13 trading days later, it had lost 8%. There may be more losses to come. Just remember, over the last three years (2019-2021), the S&P has increased over 100% and the Vanguard Balanced Index (60% equity and 40% bonds) has increased 61%. Even with January’s losses, your accounts should still have large increases over the past three years and one month.
A Guaranteed 7% Return
The US Treasury has a special kind of bond called a Series I Savings Bond (I Bond). This bond has some special features and a few caveats. It pays an interest rate for the next 30 years of 0%! But, every year it also pays you the rate of inflation. For bonds purchased before April 2022, the inflation rate is 7.12%. So, you get a 7.12% rate of return an a US government bond! Sound too good to be true? Let’s go over some of the fine print:
- Biggest problem – each person can only purchase $10,000 of I Bonds per year.
- The bonds have to be purchased online at Treasurydirect.gov. You cannot buy them through Schwab.
- You can’t redeem your bonds for one year. After the first year, you can cash in for the amount you paid. It works like a CD.
- If you redeem before five years, you lose the last calendar quarter of interest.
Should you buy I Bonds? It would be nice if you could buy more than $10,000 per person per year, but a married couple could buy $20,000 and earn $1,400 in interest in one year. That is the same amount of interest you would get at an online bank that pays interest of 0.3% if you had invested $466,667. Over time you could continue to buy I Bonds each year and build up a nice cushion against inflation. So, to answer my question, yes, you should consider buying some I Bonds.
Odds and Ends
Last week our CPA firm, Novinger, Ball and Zivi, sent a letter to our clients about fee increases. The increases mentioned in that letter do not apply to investment fees of NBZ Investment Advisors. Your investment fees will not increase. In our 25+ year history, NBZ has never raised our fees.
Our new portal reports up-do-date account information to your computer, tablet or phone every day. (You may not want to view the portal on loss days, see Loss Aversion above.) Also, your quarterly reports will be delivered to your portal and kept in a virtual vault. You will be able to view them or print them out. The portal provides all kinds of information every day such as investment gain since inception, year to date return percentage, and the performance for each position for the year. The portal is not “live” however. You cannot trade or request distributions. It is a view only website.
If you have not signed up for portal access yet, call any member of our team and we will get you started. Also, if you have any questions about your account, the market, or the new statements, always feel free to call or email and we will be glad to talk with you.
The information herein has been obtained from sources believed to be reliable, but NBZ does not warrant its completeness or accuracy. Prices, opinions and estimates reflect NBZ’s judgment on the date hereof and are subject to change at any time without notice. Any statements nonfactual in nature constitute current opinions, which are subject to change. Projections are not guaranteed and may vary significantly. Any investment strategies presented may not be appropriate for every investor and individual clients should review with their financial advisors the terms and conditions and risk involved with specific products or services. As with all investments, past performance does not indicate future results. Investing involves risk including the potential loss of principal.
NBZ is a registered investment adviser. Registration does not imply a certain level of skill or training. More information about NBZ, including its advisory services and fee schedule, can be found in its Form ADV Part 2 which is available at nbzinvest.com or by calling 865-584-1184. NBZ-22-01