Part I
In a world where supposed experts do not disclose their bias and then state their opinions as fact it’s no wonder investors become confused. Today this confusion comes in many forms…“Ok, there is inflation because I am seeing it in prices everywhere...it's because of demand, supply chain problems and easy monetary policies, but interest rates are going down? The unemployment rate is at post pandemic lows, but Washington wants a 4 trillion stimulus bill? This stimulus bill will cost nothing and therefore will not be inflationary? We have years of oil and gas in the ground in this country, yet gasoline prices are at multiyear highs and we are begging OPEC to pump more? This gasoline is at multi year highs, but energy stocks are dropping in value? Today Chairman Powell said the Fed would taper faster than many expected and yet the interest rate on the 10-year treasury dropped? That the economy is officially very strong..its humming …jobs are easy to get, are plentiful yet policy makers want to give free money to more people to ease their lack of incomes because they are not working because they have been getting free money for doing nothing… so what is this huge stimulus bill for? The Debt ceiling isn’t a real ceiling, or is it? When we go through the ceiling no one will get paid …except everyone will get paid except non-essential government organizations (non-essential??? What the heck is and why do we have non-essential government spending?). The economy is humming but each new COVID variant will stop all commerce? And further snarl the supply chains? There is a new variant every 9 weeks but the economy is humming? The way to end COVID is to flatten the CURVE, no wait, mask, isolate. The vaccine will protect you as long as everyone else doesn’t have COVID, is masked up and vaccinated? The stock market is cheap when it’s at all-time highs (last week) but now that it has dropped 5% its overpriced and going lower. Value stocks are good or bad in a higher interest rate environment…Buy utility stocks and sell technology? Interest rates going up hurt interest-bearing securities so sell utilities…How can this all be?" Add in comments about stocks being above or below their 50 or 100 day moving averages and it is no wonder we are confused. As an investor it almost seems like all of this is a trick to make one give up and not ask questions.
But the answers to these questions are really quite simple. Or at least I think they are and the remedy for an investor is even simpler. But I’m not going make this easy and you must read on to find the answers and the remedy…so…read on.
In a world where supposed experts do not disclose their bias and then state their opinions as fact it’s no wonder investors become confused. Today this confusion comes in many forms…“Ok, there is inflation because I am seeing it in prices everywhere...its because of demand, supply chain problems and easy monetary policies, but interest rates are going down? The unemployment rate is at post pandemic lows, but Washington wants a 4 trillion stimulus bill? This stimulus bill will cost nothing and therefore will not be inflationary? We have years of oil and gas in the ground in this country, yet gasoline prices are at multiyear highs, and we are begging OPEC to pump more? This gasoline is at multi year highs, but energy stocks are dropping in value? Today Chairman Powell said the Fed would taper faster than many expected and yet the interest rate on the 10-year treasury dropped? That the economy is officially very strong...its humming …jobs are easy to get, are plentiful yet policy makers want to give free money to more people to ease their lack of incomes because they are not working because they have been getting free money for doing nothing… so what is this huge stimulus bill for? The Debt ceiling isn’t a real ceiling, or is it? When we go through the ceiling no one will get paid …except everyone will get paid except non-essential government organizations ( non-essential??? What the heck is and why do we have non-essential government spending?). The economy is humming but each new COVID variant will stop all commerce? And further snarl the supply chains? There is a new variant every 9 weeks but the economy is humming. The way to end COVID is to flatten the CURVE, no wait, mask, isolate. The vaccine will protect you as long as everyone else doesn’t have COVID, is masked up and vaccinated? The stock market is cheap when it’s at all-time highs (last week) but now that it has dropped 5% its overpriced and going lower. Value stocks are good or bad in a higher interest rate environment…Buy utility stocks and sell technology? Interest rates going up hurt interest-bearing securities so sell utilities…How can this all be?“ Add in comments about stocks being above or below their 50 or 100 day moving averages and it is no wonder we are confused. As an investor it almost seems like all of this is a trick to make one give up and not ask questions.
In a traditional straight math type sense, the pundits are correct…higher interest rates lead to lower bond prices and in general inflation is good for hard assets but bad for financial assets. That’s really because bonds act like the teeter totter on a playground. On one side is interest rates and the other side is price. For example, a ten-year bond that yields 10% would have the teeter totter wood plank completely horizontal.
If rates go down (pushing that side down) the price of the bond (the other side of the plank) would rise. Conversely, higher rates lead to the other side (price) dropping.
Now this is the most basic explanation, but it should work, in general, for most bonds in most periods. But today is not a typical period. And nothing works alone in isolation. When Chairman Powell talks about ‘tapering’ he is basically saying the fed will no longer be buying bonds at the rate they have been. This should mean that there are less buyers for our bonds and the demand being less will bring about higher bond yields…slowing the economy and…helping to contain the perceived threat of inflation. Yet today there is nothing that is that simple as nothing is completely isolated from anything else. Today’s announcement, in a bubble, would have had bonds drop in value and interest rates rise but it didn’t. That is simply because the Fed doesn’t control all the demand for our bonds. So even when the Fed pulls back its buying, because there are so many ‘dollars’ sloshing around the planet, other buyers step in and buy those bonds. It used to be said that when the US sneezes the world catches a cold. Today that truism can be seen in reverse in the reactions to COVID variants. The new variant is allowing government officials the latitude to close countries and again impose draconian measures causing fear and turning some additional investors to safer investments. Those buyers are the ones, that in spite of the specter of the Feds actions, that purchased bonds today pushing rates down. The Fed spoke and it made little difference. Today….
Simple supply and demand. Not what the pundits/experts will tell you but simple human reactions based on simple facts. Lots of money looking for interest bearing securities that are safe. After all, all the money that has been printed by ALL the central banks needs to go somewhere. On days where people are told to be afraid (like by a 'new' COVID variant) investors and believe it or not, computers, buy safe US bonds. Interest rates go down as there is more buying then selling. See, simple!
Now the other currently favored ‘expert’ malarky is one that takes a real ability to believe two plus two is 5 to understand. And that is that technology companies are a bad investment in a rising interest rate environment. Now stick with me as this is truly convoluted.
(Part II)