Mark D. Goldstein, CFP®
Certified Financial Planner
NEW MEXICO OFFICE
Pueblo Plaza Executive Suites
1100 S. Main, Suite 10
Las Cruces, NM 88005
Intelligent Office Complex
7362 Remcon Circle
El Paso, TX 79912
3701 Algonquin, Suite 150
Rolling Meadows, IL 60008
"Guaranteed SAFE-Money Solutions for a Successful Retirement!"
It's so predictable. With the market PLUNGING and so incredibly volatile over the last week, my calendar is bursting with all kinds of folks fleeing for SAFETY!
And, the question that keeps coming up is, "what's causing the market to drop?"
So, in an effort to save time (and wear-and-tear on the old vocal cords), I'd like to just summarize my opinion and simply blast-email it out to y'all.
No need to read any further if this kind of stuff bores you. I totally understand!
What happened? First of all, investors are increasingly concerned about inflation. As you know, stocks have been rising since the election because the economy is strengthening dramatically. We've got unemployment at historically low levels with more open jobs than qualified people to fill them!
Now, the Federal Reserve combats inflation by raising its interest rates. Typically, the Fed decreases rates when the economy is doing poorly (as a way to increase borrowing and spending) and it increases rates when the economy is doing well (as a way to "apply the brakes" when it's afraid the economy is overheating).
But they've been unwilling to significantly raise rates over the past decade for fear of messing up the economic recovery. Well, the Fed was planning on raising interest rates slightly this year (just three times), but if inflation heats up, investors fear that the Fed will increase them more often and more aggressively than originally planned.
So what? When the Fed raises interest rates, the cost of borrowing money increases... which means that companies pay more for their loans... resulting in lower corporate profits and lower stock prices (when companies produce steady growth in profits, investors reward them by pushing up their stock prices).
How about the bond market? The stock market has been on a tear because a majority of investors have considered it the only option for a decent return. In fact, U.S. Treasury bond yields have been so low that a lot of stock dividends are paying better.
But stocks are a higher RISK investment than bonds (essentially and IOU from a corporation, city or the federal government). And as bond yields continue to rise, investors will want to move some of their money out of the stock market and into SAFER bonds... causing stock prices to continue falling.
My point is that, generally speaking, higher yields make bonds more attractive to some investors, so more money will be leaving the stock market for the bond market. And also consider that higher bond rates also increase costs for businesses. Large public companies issue bonds to raise money to fund their operations and increasing interest rates make it more expensive for them to borrow money... and can depress stock prices.
The future of bond returns? Back on September 30th, 1981, the yield on the benchmark 10-year Treasury note hit a high of 15.84% (not a typo). More than three decades later (7/25/2012), the 10-year yield dropped to an anemic 1.43%. And that, my friends, in many ways, was the big financial story of the past 30+ years.
As interest rates fell, existing bondholders made tons of money... while at the same time, those lower rates boosted enthusiasm for stocks (which appeared much more attractive than those declining bond yields).
But the big decline in interest rates is over! With the 10-year Treasury note finishing today at 2.85% (half a percentage point higher than a year ago), there's little room for rates to fall further... and lots of room for them to RISE. That 2.85% is barely above the 2-something % core inflation rate (which includes food and energy) and the ride ahead could get rough.
In recent years, the Federal Reserve has artificially depressed interest rates in an effort to spur economic growth. But as the Fed retreats from its loose monetary policy, interest rates will climb.
How high could rates climb? Well, it just so happens that, historically, bond yields have closely tracked economic growth. For example, if GDP grows at 4% (isn't that the number that's being floated around?) over the next few years, the yield on the 10-year Treasury note could be expected to rise to that level.
Not so good for the stock market?
Mark's forecast. The market will go up and down, and up and down with increasing volatility. My clients and I will participate in only the gains... and avoid all losses. We will eliminate all fees and avoid taxes while our money is growing (both qualified and non-qualified accounts). We will lock in our gains and make further gains while others (those that participate directly in the market) are wasting valuable time recovering losses.
And sleep like babies.