The sharp spike in interest rates this year has created havoc for financial markets. U.S. stocks (S&P 500) have fallen 22%. Bonds have fallen 16%. It’s been downright excruciating for investors.
Without a doubt, inflation is the concern of the day. It’s a serious issue and the Federal Reserve has taken dramatic action to address it, raising interest rates much faster than any other time in history. How much will be necessary? When will inflation begin to abate? Will we avoid a recession?
These are questions that the markets are continually trying to answer, constantly looking ahead and trying to anticipate where the economy is headed. But it’s never a clear view. Surprises frequently occur.
The current situation is a good example. Financial markets and the Federal Reserve were both seemingly caught off guard. Lest we forget, when prices began rising, the term “transitory” was used ad nauseum to describe the increases. It seemed reasonable, given pandemic related supply-chain issues, but it turned out to be quite wrong. In the face of steadily rising inflation, stocks posted gains of nearly 27% last year. Then came the realization that it wasn’t so “transitory” after all.
We should also consider that two years ago the primary concern was persistently low inflation. Despite interest rates that remained near zero for the better part of a decade, the Fed simply could not get inflation up to its 2% target. The inflation rate stood at a mere 1.2%.
The unfortunate reality is that nobody fully understands inflation. Models and theories abound and economists feign confidence, but reality is complicated and messy. If it were well understood, it’s safe to say inflation wouldn’t be at a 40-year high.
The important lesson here is that an awful lot can change in a short period of time. Attempting to forecast the timing and exact course of events would seem rather foolish. Yet, looking ahead, although the how and when are ambiguous at this point, it’s a good bet that today’s inflation issue will be resolved. Economic challenges have come and gone throughout history, and stocks have generally responded quickly to signs of improvement along the way. As a result, patient investors with fortitude and a long-term focus have been rewarded.
Our brain is wired to avoid pain in trying times and to become overconfident in good times. This is why people don’t want to invest when times are rough and why they want to invest more in the stock market when it is hot. This is exactly the opposite of what you should do!
Your asset allocation is constructed based on how much risk you can take and your time horizon. By continued investing and rebalancing, you should come out fine in the long run. We’ve been through many market cycles – our job is to keep you from getting overly excited when stocks are running hot and to not succumb to fear and sell out when the market is in a freefall. Let us know what we can do to help keep you sane during these turbulent times.