I want to answer 3 of our most frequently asked questions regarding the markets.
1. Will Rates Go Up More?
We don’t have a crystal ball, but the Federal Reserve will remain data-dependent. They will continue to base their strategy of rate hikes, rate cuts, or pauses on the monthly inflation and jobs reports.
Going back, inflation was at 9% in June of 2022. We all felt the pain at the gas pump, grocery store, and when booking flights. Inflation was running at 40-year highs, so the Federal Reserve raised interest rates aggressively beginning in 2022 and continuing in 2023. Before this, rates were near 0%; now they are over 5.25%, which you have probably felt if you want to buy a new home, car, or pay credit card interest. Quite frankly, the economy was overheating at a rapid pace.
While it was painful to see both the stock and the bond market down in 2022, throwing ice water on the white-hot economy was a necessary pain for us to return to a more sustainable inflation level.
The good news is that these increases, these ice baths if you will, are working – inflation in July year over year came in at 3.2%, and August inflation came in at 3.7% year over year, up .6% month over month from July. This increase was primarily driven by an increase in energy costs, which were at 5.6%, including a 10.6% surge in the price of gasoline.
The Fed just announced an interest rate pause on September 20, 2023. If they don’t raise rates again, they might have to keep it at a higher level for longer, but if they raise rates again this year, they might not have to keep it at that higher level for quite as long. The key message we expect to hear is the conversation shifting from "will they raise rates or not" to ‘the plateau’ of "how long do they need to keep rates at this level?"
Where this impacts you the most is if you are trying to borrow money - to buy a home, a car, or pay for something on a credit card without paying it back in full. If you missed our last video from Matt on the state of housing, please check it out for a deeper dive. https://www.timewisefinancialllc.com/blog/market-update-state-of-housing
2. When Will Rates Fall?
Again, we don’t have a crystal ball, but History shows that the Federal Reserve lowers interest rates during periods of economic decline.
Unemployment is near all-time lows at 3.8% but is up from 3.5% in July. We are seeing some tightening in the labor market, which is good because these are signs that the economy is cooling. This may seem counterintuitive where bad news is good news, but signs of a cooling economy indicate that we may be near the end of interest rate increases.
The goal of these interest rate hikes is to get inflation back to 2%. Anchoring it there can take time, and often times that last mile is hard. We are not out of the woods yet, but there are some positives.
- Bonds are earning attractive interest. For over 10 years when rates were near zero, we only got pennies on the dollar for holding bonds. Now, we are collecting 4% and 5%+ interest on our bonds. We’ll start to see our bonds make meaningful contributions to our returns.
- Now, we have a cushion built in, so if an economic slowdown occurs, the Federal Reserve has tools to stimulate the economy again, by reducing interest rates. We didn’t have this same cushion back in March of 2022 because rates were so low. This means that if the economy were to significantly take a downturn, the Federal Reserve can come in and save the day by reducing rates, which we are conditioned to see over previous years.
3. Should I Buy CDs?
There is no denying that CDs pay attractive rates right now. Higher than we’ve seen in decades. But the key to that statement is the ‘right now’ piece. Let’s look at CD rates over the last 5 years.
- Just 18 months ago, if you wanted to buy a CD, you would only get less than 1% to have your money locked up for that period of time. 5 years ago you could get anywhere from 2-3%, essentially just keeping pace with inflation.
- Now you can get CDs with rates between 4-5%, however, as history has shown, rates don’t stay at the same level forever.
- The biggest risk with putting a large amount of your money in CDs is the reinvestment risk; which essentially means that once your CD matures, you run the risk of not being able to reinvest that money at the same rate you were getting; forcing you to settle for less.
Not to mention, during the time your money is locked up in CDs, you may have missed the market’s biggest rallies. In the chart shown below, if you missed the market's best 10 days over 30 years. Just TEN days over THIRTY years, your returns would have been cut in half. If you missed the market's best 30 days over 30 years, you reduced your returns by 80%.
This goes to show that it is impossible to predict the market's best days, which is why investing in a diversified portfolio is key.
This doesn’t mean that you shouldn’t buy CDs with a portion of your money. It all depends on your risk tolerance, time horizon, and financial goals, but just as we preach diversification in your investment portfolio, we don’t want to put all of our eggs in one basket, CDs included.
What Does All This Mean for My Portfolio?
We continuously monitor these different data points, the Fed’s strategy, and the effects of their decisions. The Fed has to walk a fine line of getting inflation under control without overcooling the economy into a recession. While a recession is still a possibility, data up to this point has shown that both the consumer and the economy are resilient. The stock market is forward-looking about 6 months ahead, and we still see healthy corporate valuations with earnings expectations looking optimistic.
Diversification is powerful. It offers resiliency against pending storms if you don't put all of your eggs in one basket.
Lastly, it's important to remember that if your account goes down, you haven’t lost money. You only lose money when you sell, just like with your primary home. If your house's value went down by $100k, you didn’t lose $100k unless you sold your home at that point in time. The same applies to your investments.
As always, if you have any questions or concerns please give us a call. We are always happy to talk with you.
*CDs are FDIC insured and offer a fixed rate of return. They do not necessarily protect against a rising cost of living. The FDIC insurance on CDs applies in case of insolvency of the bank, but does not protect market value. Other investments are not insured and their principal and yield may fluctuate with market conditions.
*Diversification does not assure or guarantee better performance and cannot eliminate the risk of investment losses.