Are you an investor or a trader?
Are you an investor or a trader? Do you have the stomach to make counterintuitive decisions? All of this is made more difficult by a once in 40-year event…
Higher for longer, that is the new word on the street about interest rates. We had become accustomed over the past decade to interest rates rising for a short period of time, only to fall again (usually with a little help from the Fed) to reinvigorate a stalling economy that the stimulus of low, even ultralow interest rates, had kept humming. Now, facing for the first time in decades serious inflation, the Fed is at it again pushing up interest rates to stall an economy in an attempt to lower inflation. The problem is, the driver(s) of inflation is not simply an overheated economy. I won’t get into all of the minutiae of the myriad of inflation drivers because (1) you didn’t sign up for a graduate school economics course; (2) It gets very political and I am sure I will upset someone (probably myself too), and (3) after the shock of 2022’s interest rate rocket ship (the once in 40 years event), investors can benefit from higher yields, and at some future point, even the potential for capital appreciation from these higher yields across the bond universe.
Money market funds have been the beneficiary of the rising rates, and for clients that have any near-term liquidity needs, it has been a benefit to finally receive some yield on these funds. But, here is where some investors need to be cautious. As appealing as these rates may be, long term investors are better off staying with their strategic asset allocation and not fall into the trap of having funds earmarked for growth sitting in money market…no matter how appealing the returns. Why? It is a rare investor who can look into their crystal ball and know when the stock market is going to go up (equity market capital appreciation), and interest rates are going to go down (bond market capital appreciation). While money markets finally have better returns that can be hard to resist, when rates go down…so will the money market yield, and investors may be losing their opportunity to go against their intuition and invest in bonds better suited to the inexorable peak in the Fed’s rate hikes. To use a sports analogy, money markets are great at playing defense, but they also play no offense (unlike bonds, they cannot appreciate in value when interest rates fall).
Duration is a statistical tool to measure the rate or amount a bond or bond portfolio’s price changes due to interest rate changes. In the event an allocation to bonds makes sense for a client’s objective, we use this tool to model how a portfolio may behave based upon historic data and forward looking assumptions. In addition to providing cash flow from their yield, bonds can dampen a portfolio’s value when equities are drawing down. Having suffered through the worst bond market in 40 years, it may be time to look at embracing the opportunity the bond market provides.
We appreciate your friendship and business.
We are, sincerely yours,
Dave & Drew