Summary
- Rising interest rates and inflation expectations keep the market on edge
- Diversification with your investments is a way to mitigate the risk
- Tax season is underway – it’s a good time to think about your long-term plan as you sift through tax documents
- Take a breath. Relax. Have some fun. It has been a very difficult last twelve months for so many people. The COVID situation in America is improving, and it’s a great time to begin planning a trip and summer fun.
Rising interest rates – something to fear?
Picture a year ago. The stock market was falling day after day as COVID-19 made its way into mainstream media coverage. The pandemic hadn’t begun in earnest until mid-March when New York City was the first epicenter. The market, being a forward-looking mechanism, saw something bad coming. You might not recall what was happening in the interest rate market, however.
During February of 2020, investors flocked to safe-haven assets like the US Dollar and US Treasury bonds. Interest rates fall when bond prices rise. The yield on the 10-year Treasury note dropped from slightly under 2% at the start of 2020 to 0.5% by early March. That was seen as a sign that investors were afraid to take risks. That was then.
Figure 1: US 10-Year Treasury Rate: Q1 2020 (Stockcharts.com[1])
Fast-forward to today. The same US 10-year Treasury rate is 1.50% – just a little higher than this time a year ago. Now, wouldn’t you know it, the market seems to be afraid of rising interest rates! It’s like you can’t win sometimes.
Rates increased from the March lows last year for good reason – the economy was seen as improving and investors were willing to exit the safe-haven of Treasury bonds and into the more risky stock market. Too much of a good thing can cause jitters though.
US economic growth is going to surge this year – perhaps the best since 1984 if analysts are right. GDP growth has averaged about 2% per year over the last decade, but heavy stimulus by both Congress and the Federal Reserve this time around will be a boon for the economy once things re-open in earnest this summer.
With US GDP growth comes inflation. Young investors hardly know what this is! The annual inflation rate has been steady for the better part of the last 25 years – from about 1% to 3% each year. You have to go back to the 1970s and early 1980s to find a period where inflation was a significant concern.
Nobody expects inflation to be like it was during the 70s, but traders anticipate inflation to be nearly 2.4% each for the next 5 years. That’s quite a bit higher than what traders thought a year ago.
Figure 2: 5-Year Breakeven Inflation Rate (St. Louis Federal Reserve[2])
Should we be afraid of the big bad inflation monster eating away at our portfolios? Probably not. Stocks, real estate, and commodities are often good things to own during upticks in inflation expectations and interest rates. According to Bank of America Global Research, stocks have posted positive total returns in 13 of the last 15 rising rate cycles. This study went back to the 1950s, and it found that the return on the S&P 500 was up 26% on average during 1-4 year periods of increasing interest rates (and inflation). Not too bad!
So why has the stock market been a little shaky lately? It’s simply that the increase in interest rates and inflation outlooks has been a little too fast for comfort. Take a look at figure 1 above – 5-year inflation expectations were nearing 0%; now here we are at 2.4%. That’s a big change in a somewhat short timeframe. We saw the same thing in late 2012 – which was a great time to own stocks.
We aren’t saying that the stock market is going to shoot higher from here, but every bout of volatility has to have some reason for folks to get all worked up about. This time it’s the narrative of rising interest rates and inflation concerns.
Here’s more good news – rising rates are something we have been expecting to happen. Our portfolios are positioned in various types of assets like small companies, foreign firms, and value stocks. These areas tend to beat the S&P 500 and Dow Jones when inflation ticks up. Hopefully, you and your family have had a chance to secure a low mortgage rate, too.
What should you and I do? Stick to the plan. Our investments and financial plans are designed to be long-term in nature. We rebalance stock and bond portfolios to ensure your level of risk is appropriate and so that we don’t get too heavy in any one area.
As an example, our Aggressive Growth portfolio holds US micro-cap stocks. What are those? They are the tiniest of tiny stocks in the market, and they have been on fire this year. We are prudent not to get greedy though, as the micro-cap position size jumps, we will sell a little to lock-in some gains.
Figure 3: The smaller the better! Year-to-date stock market returns by size (large caps in black, mid-caps in green, small caps in red, micro caps in blue) (Stockcharts.com[3])
Tax season update
No excuses anymore. Just about all important tax forms are available by early March, so it’s time to get down to business and send Uncle Sam your return.
The Detroit Free Press[4] notes that tax refund checks have been slower to send out this season. The IRS said it needed more time to update its systems to new tax rules and there was the prioritization of stimulus checks in December and January. Unfortunately for many Americans who use their tax refund as a means of forced savings, the average refund is also lower by 7.8% – likely due to higher taxable unemployment benefits which usually don’t have tax withheld.
Tax time is always is an opportunity to ensure you have your tax ducks in a row. You are more than welcome to set an appointment with us to get your taxes done. It makes for a convenient time to also revisit your situation and financial plan. Remember – your financial plan is always changing. It’s not like a toaster oven where you “set it and forget it.”
Plan some fun
The last year has been too stressful for all of us. Maybe just this newsletter gets you anxious – reading about mundane things like inflation and taxes. You are not alone. The American Psychological Association’s latest survey[5] found that more than 8 in 10 Americans feel heightened stress, anxiety, and sadness right now. Experts say it’s a collective case of trauma for the nation. We must be intentional about planning some fun – and now might finally be the time!
Figure 4: Stress levels are up (APA.org)
Financial planning is not just “numbers on a spreadsheet.” It’s about aligning your money with your goals to achieve happiness and purpose. Part of that is ensuring you are in a good state mentally.
With the nation poised to re-open later this year due to improving COVID-19 conditions, you should go on that vacation you may have put off last year. Mark it down on your calendar as something to look forward to. Studies show we gain more pleasure looking forward to something rather than experiencing it sometimes. Hey – it kind of sounds like preparing for retirement!
We can help you plan for a vacation to ensure your cash flow is in good order before and after the trip.
The Point
The economy is getting better. COVID is clearly on the decline. Spring is in the offing. These are great things that should help us feel better about not only our financial lives but also our overall state of wellness. Don’t get caught up in the financial headlines that are designed to make us anxious. Our long-term financial planning is designed to make you confident and optimistic!
[1] https://schrts.co/AetQaUGa
[2] https://fred.stlouisfed.org/series/T5YIE
[3] http://stockcharts.com/h-perf/ui?s=IVV&compare=IWC,IWM,IWR&id=p19434022968
[4] https://www.freep.com/story/money/personal-finance/susan-tompor/2021/02/25/income-tax-refunds-checks-irs/6822853002/
[5] https://www.apa.org/news/press/releases/stress/2021/infographics-january