Rough Seas Ahead?

There is a lot of angst lately about the direction of the stock and bond markets.

Huge losses have been sustained across both categories.

U.S.Treasury bonds have traditionally been considered a safe haven for investment portfolios.

Not this year.

Long treasury bonds have declined almost 13% since January 1.

The total bond market in the United States (treasuries, corporates, high yields, state and local, etc) was about $47 trillion in 2021. Bond losses in total are probably over $5 trillion.

I saw one report in Barron's that put U.S. stock losses alone this year at over $10 trillion.

The NASDAQ composite index is officially in bear market territory having declined over 20% year to date.

The S&P 500 index is down over 13% for the year.

Losses for the owners of Bitcoin have been over $1 trillion.

It has been a horrendous year to be an investor.

However, Barron's also reported that in the previous two years household net worth in the U.S. ballooned by $34 trillion fueled by government Covid aid and the low interest and money printing policies of the Federal Reserve.

When you consider that U.S. GDP is $24 trillion, the fact is that U.S. consumers were handed almost two years of income in increased values of their homes, their 401(k) accounts and stock and bond portfolios between April, 2020 and the beginning of this year.

This might also give you some idea of where inflation is coming from today.

It is also worth keeping in mind that the last 40 years have provided the best investment environment in which to build wealth that has ever been available in the history of investing.

In those four decades all someone had to do was save and invest and it was almost impossible not to become wealthy.

$1,000 invested in the S&P 500 on June 1, 1982 would be worth over $36,000 today without taking account of dividends.

$1,000 invested in the NASDAQ composite over the same period would have grown to more than $60,000.

You could have even accumulated almost $30,000 with $1,000 invested in long-term treasury bonds over the last 40 years.

The secular decline in interest rates over the last 40 years effectively put the winds at the backs of anyone who had money to invest.

This chart graphically shows that decline in interest rates over those 40 years.

The recent increase in interest rates looks like a small blip when viewed in historical context.

Therefore, while what we have experienced this year feels bad, the reality is that for most investors it is merely a small setback compared to prior gains.

However, what lies ahead?

If interest rates continue to climb, how much will that headwind affect other asset classes?

It can't be good for most home values since increased mortgage rates limit how much a buyer can pay for a home unless incomes increase to keep up with higher rates.

That has not been the case for a long time.

Higher yields also make bonds more attractive relative to stocks.

I came across the following chart by Nick Maggiulli that shows a downward slant similar to the interest rate chart above.

However, this is a graph of the Dow Jones average from September, 1929 to July, 1932 in which the index fell almost 90%.

Credit: https://ofdollarsanddata.com/rallies-to-the-bottom/

As you can see, there were a number of major rallies along the way when investors thought the bear market was over during the early stages of the Great Depression.

Each brought false hope.

Similar volatility was seen in the 2000-2003 period where we saw a number of 20%+ rallies that turned out to be head fakes as the overall trend headed downward.

What do I make of all of this?

If you look at the big picture, the losses sustained thus far are very small in comparison to the gains that came before.

In addition, as long as the Federal Reserve is tightening and interest rates are rising, stocks, bond and house values are going to be fighting a significant headwind.

The risks on the downside appear far greater than any potential upside---by a large margin.

Expect a lot of volatility in the stock market. There will be some significant down days in the market but we should also see some big rallies.

However, the major trends are what you need to keep your eyes on.

On inflation.

On what the Fed is doing.

What is happening with interest rates.

Joe Biden announced on Tuesday that he has a three-point plan to fight inflation.

The first point he made was that he was not going to interfere with the Federal Reserve which has primary responsibility to control inflation. 

Of course, it was Biden and the Federal Reserve who were telling us last year at this time that we should expect any inflation to be merely "transitory".

That alone does not inspire a lot of confidence about any "plans" they have to bring down inflation.

In addition, right after I saw Biden's plan where he said he was not going to interfere with the Fed I saw this.

Biden says he is not going to meddle with the Fed but the first thing he does is meet with the Federal Reserve Chairman?

What are Biden's other two priorities to fight inflation?

Working to reduce prices, especially gas prices. However, Biden's policies have largely caused the increase in gas prices.

In fact, last week Biden was praising high gas prices as an "incredible transition" to allow the world to move away from fossil fuels.

Source: https://nypost.com/2022/05/23/biden-praises-gas-prices-as-part-of-incredible-transition/

Biden also said he is going to reduce the federal deficit.

No, he said nothing about reducing federal spending. That would be too logical if you wanted to curb deficit spending.

Biden is going to do it with "common sense reforms to the tax code". In other words, let's raise more taxes.

When a ship is facing headwinds and high seas you want a steady hand at the controls.

Everything points to the fact that we should expect some very choppy seas ahead.

A steady hand?

Let's hope there are enough life preservers on board.