The stock market suffered a sharp decline last Thursday after the Fed announced it's second interest rate increase this year of .5%. The Dow and S&P 500 both dropped over 3% and the NASDAQ fell 5% the next day as fearful investors ran for the hills. As I write this, the market has continued to fall to its lowest levels in 52 weeks. But before you consider jumping on the panic bandwagon, there are 4 things you need to know about what's going on in the market right now:
1. Inflation is the highest it's been in decades.
We can't talk about interest rates without first addressing inflation. Between March 2021 and March 2022, inflation had risen 8.5%. These are numbers we haven't seen since 1981. This rate is even higher for certain products and services, notably groceries and gasoline:1
- Meats, poultry, fish and eggs: 13.7% increase
- Gasoline: 31.5%2 increase
- Electricity: 11.1% increase
- Furniture and bedding: 15.8% increase
- Used cars and trucks: 35.3% increase
The cause behind this inflation is too many $$$ chasing too few goods and services. The result is an increase in demand and prices. The "too many $$$" is due to the government's response to Covid-19, which totaled $10.2 TRILLION dollars to date. To put that in perspective, World War II, the most expensive war in history would've cost $4.1 trillion in today's money. The Federal Reserve on its own spent $4.2 Trillion on quantitative easing and other measures to help bolster the economy. This doesn't include the $817 billion in stimulus checks that were put right into the hands of consumers.3 Additionally, interest rates were reduced to record lows near zero, making it practically free to borrow money.
The result of all this spending is a massive influx of money being spent on a supply of goods, services, and housing that has been tightened due to supply chain and employment shortages still rebounding from pandemic lock-downs and policies. The supply problem has recently been worsened by issues with major global trade players such as the sanctions on Russia and renewed lockdowns in China due to their "zero-Covid" policy.
2. To Fight Inflation the Fed Must Raise Interest Rates
The Federal Reserve’s primary duty is to conduct our nation’s monetary policy in a way that promotes economic stability. The tool they use to stabilize prices (their definition of “stable” is an inflation rate of around 2% per year) is increasing interest rates.
By making it more expensive to borrow money, the Fed creates a trickle-down effect which causes consumers to have less $ to be spent on goods and services, slowing demand and lowering the prices that consumers are willing to pay. The Fed is in charge of both pumping the brakes and hitting the gas of our economy. Economists call the goal of this slowing down strategy a "soft-landing". Ideally, this strategy will slow economic activity enough to lower inflation without hitting the brakes too fast and causing causing recession.
So the Fed raising interest rates is basic economics. Why does everyone freak out when it happens?
3. Investors Are Trying to Digest What Rising Interest Rates Mean for Stocks - And the Economy
This most recent interest rate hike was the highest single increase we've seen since 2000. Investors haven't had to experience a rate hike like this in 22 years, and feel unsure about what effect it may have on the economy. And remember - when it comes to the stock market, uncertainty always results in volatility! But rational investors (like you) make decisions on facts, not fear or speculation. Here are some facts for perspective:
- Take note, in 2000 the Fed funds rate was already at 6% when it was raised to 6.5%! Currently it's going from .5% to 1%!!! That's still incredibly low!
- The Fed projects that they will continue to raise interest rates .5% at their next two meetings in June and July. FOMC Chairman Jerome Powell said their median interest rate goal for 2022 is 1.9%, 2023 is 2.8% and 2024 stays at 2.8%.4 It's important to remember that the near 0% rates we have been experiencing are historically record lows! Throughout most of the Fed's history interest rates have been much higher, even reaching 20% in the late 70's and 80's! Sustained high interest rates can eventually effect corporate earnings and profits, but a large majority of companies are not going to be significantly effected by the rates we are seeing projected. Companies and consumers will adjust to the fact that they can no longer borrow money for free, just as they have in the past.
- Historically, the stock market reacts positively during periods of interest rate hikes! Check out the chart below5:
- The reasoning behind this growth is that the Fed is increasing interest rates when the economy is growing too fast. When the economy isn't doing so hot, they will decrease rates to try to stimulate growth. So the fact that they are needing to increase interest rates in itself means the economy is doing well!
4. We Knew This Was Coming - and We're Prepared for it!
Of course, it is impossible to predict the level at which the market will rise or fall in reaction to this kind of news, but we knew these interest rate hikes were coming and have been preparing our clients for the road ahead. We firmly believe the dip we are seeing right now is an emotional overreaction based on speculation and doesn't reflect the strength of the companies on the stock market. We expect that the market will adjust to this news and stage a recovery, but that we will continue to see volatility throughout this year, especially surrounding each of the Fed's remaining 5 meetings.
In the meantime, we've constructed your portfolio for long-term goals, and believe we are still positioned properly to face the challenges of inflation and rising interest rates. We are constantly watching the news and markets, so you can relax and enjoy your summer! And if there is something on the horizon we feel will effect your portfolio long-term, we will reach out to you to make adjustments.
Resources:
1 “Prices Are Up a Whopping 8.5%. Here’s What’s More Expensive,” Forbes, https://www.forbes.com/advisor/personal-finance/march-inflation-items-more-expensive/
2 "National Average Gas Prices", AAA, https://gasprices.aaa.com/
3 "Covid Money Tracker", The Committee for a Responsible Federal Budget, https://www.covidmoneytracker.org/
4. "Summary of Economic Projections: March 16, 2022", Federal Open Market Committee,https://www.federalreserve.gov/monetarypolicy/fomcprojtable20220316.htm
5. "History Shows Stocks Can Weather Rate Hike", Reuters, https://www.reuters.com/business/history-shows-stocks-can-weather-rate-hike-cycle-2022-03-16/
The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. Comments concerning the past performance are not intended to be forward looking and should not be viewed as an indication of future results.