Interest Rate Risk

Let's rewind the clock back to October, 2007.  The stock market was near all-time highs after posting 4 consecutive years of growth.  We all remember what came next....the subprime mortgage crisis that resulted in the worst bear market of our generation.  Stocks lost more than 50% over the next 17 months, and the fed began cutting interest rates in an effort to stabilize our deteriorating economy.

Why would I revisit this time period?  Because interest rates recently broke above 4.5% for the first time since October 2007.  Investors are now dealing with a risk factor that has been dormant for 15 years!  

Why Did Rates Climb?

It's simple to understand how we got here; our government's response to covid resulted in a 40% increase to the money supply, which triggered inflation levels that we haven't witnessed in decades.  Pushing interest rates higher is the textbook response to stem inflation, so here we are.   Here's a look at the rapid climb of the US Government 10-Year Treasury yield over the past 3 years.

The Impact of Rising Rates

As rates climb, it's harder for businesses & consumers to borrow funds. The bond market has suffered as a result (if rates go up, bonds lose value).  Below, you'll see the same chart (10-Year Treasury Yield), along with the bond market's performance during the same time frame.  As rates climbed, bonds got clobbered, losing more than 15% over the past 3 years.  This is not normal bond market behavior!

Are Rates Done Moving Higher?

No one knows for sure, but the federal reserve has at least paused their hikes for the time being.  I believe that when rates stabilize, the bond market will thrive.  We now have meaning yields (income/interest from bonds), and any slight downtick in rates will help push bonds higher.  Remember, when rates go down, bonds gain value.  Many investors have experienced 3 years of interest rate pain in their bond holdings.  And much like stocks, I suspect a rebound to occur rather quickly and when few expect it.  Eventually rates will stop climbing, whether it be today or next year, or beyond.  The sooner this happens, the better off bond investors will be!  Historically, periods of elevated interest rates have resulted in better returns for bonds.        

How Are Stocks Doing?

Compared to historical norms, stocks are doing what they normally do!  Up about 10% on the year, while in the midst of 10% drop form summer highs.  Stock investors are still feeling the sting from 2022, which has overshadowed any excitement related to this year's success.  Regardless of your current mood, things are better than last year (see the chart below)!   In 2022, stocks started down & stayed down, whereas this year has been the opposite.  Stock started the year up and have stayed there thus far...        

Hope For The Future

To recap, bonds remain in state of dismay, and stocks are trading the way they normally do.  The last 3 months have been sloppy to say the least, and we had a new potential war pop up on the radar.  So how do things improve from here?  First off, November has been the best month for stocks since 1950, so we're entering a strong season.  Beyond that,  here are what I see as potential growth catalysts for the future:

1. Interest Rates: I spoke at length above regarding the challenges created by rising rates.  But what if they stop climbing?  What if they even begin to decline?  What if mortgage rates, which are currently around 8%, tick down to 6.5%?    I think this would benefit stocks, bonds, and the economy.
2. Inflation: The CPI has steadily ticked down from last summer, which is evidence that perhaps rates no longer need to climb.  A confident grasp on inflation will improve rates, which should improve our investment portfolios.  
3. Fund Flows: Investors have been steadily removing money from the stock market to access money market funds, given their current interest rate levels (~5%).  If these levels begin to retreat, I suspect funds to flow back into stocks, and a rising tide should lifts all boats.      

Thanks for reading!  Tune out the noise, trust the process, and always be compounding.