By Ryan Turbyfill, MBA
With the warmer weather coming, mask and social distance showing success and vaccines rapidly rolling out, many parts of the economy are opening again. With the economy preparing to lift off with positive outlooks into many sectors in 2021, interest rates and inflation are also going to gain altitude as well……which could bring us a bit of turbulence.
Last year, we saw record low interest rates and much of it due to the Federal Reserve slashing rates to help limit the devastation to the economy as well as stimulus spending by Congress at the onset of the pandemic. Now we are in seeing the opposite, with businesses opening up further, people moving about more, as noticed on the highway; the economy is reopening and taking off.
With an economy heating up, why is this creating turbulence in both stocks and bonds? Much of this is due to three main reasons: fluff in the market, inflation, and interest rates.
I have had many conversations the past number of months over the large disconnect between the stock market and the economy. With interest rates so low, this created TINA (There Is No Alternative) driving a lot of money into the stock market looking for returns as CD’s and savings account offered none. The technology sector, in particular, had a lot of “fluff” and many high-flying tech companies traded at speculative/gambling levels. Another acronym for a lot of this was FOMO (Fear of Missing Out) where investors chased stocks that had phenomenal returns, wanting some as well. Valuations of many stocks went to, or close to, historically high levels and some “fluff” need(s) to come out to have a healthy long-term market.
The past few years, the Federal Reserve has tried to get inflation up a bit to their target level of roughly 2% and last year really dropped below that target. Now with the economy reopening, very accommodative Federal Reserve Policy and government/stimulus spending, inflation has become a possibility again. Inexpensive borrowing and cash from the government in the paycheck protection program and stimulus has allowed, and will continue to allow, increased spending, leading to fear of inflation, even if short term.
With inflation fears rising, this has increased interest rates along with positive outlook on the economy. When investors see positive economic outlook, they are less likely to put money in bonds or treasuries and see more return by investing in business/stocks and the economy. With less demand for bond/treasuries and increasing supply from government spending, interest rates go up to attract investors to buy these bonds.
When interest rates go up, bond prices go down (they have an inverse correlation). At Capstone, we have tried to keep a low duration (time to when bonds mature) to be less impacted from increasing rates but, have felt some impact none the less. Also, when a company’s cost of borrowing goes up, their earnings can go down, which can affect the stock price at least temporarily.
The recent turbulence has us tightening our seatbelts and makes our stomachs a bit queasy on the Sunday Blueleaf reports, and is part of our take off to a new altitude which we all hope is as close to “normal” as can be in many parts of our lives.
As always, if you have any questions, concerns, or just want to talk, please call, or email any of us here at the Capstone Investment Financial Group team.