September 22, 2022
The Federal Reserve has lifted interest rates again and has reiterated that they will fight inflation by raising interest rates even more. More importantly, while chairman Powell worked hard to avoid saying the Fed intends to trigger a recession, he was clear that they will be targeting below trend growth before rates are moderated.
In the media this is being discussed as a ‘soft landing’, but that is highly unlikely. The exceptional monetary support provided for the last two years (well, the last 14 years really, but let’s not quibble over the time frame) has created a wide variety of businesses that only work without the burden of high interest rates. Significant aspects of consumption, as well as investment decisions were made, that only makes sense when there is almost no burden from interest rates. This is true for individuals, corporations and government entities. The tide has now turned.
Unfortunately many of these decisions have had time (either two years or 14 years, depending on your view) to entrench themselves in economic projections, earnings estimates, employment patterns; and the tide is going out. It is unlikely that it will go out “just a little bit”, and so a recession should be expected.
The current estimates for interest rates among the members of the Federal Reserve (the FOMC) is that rates will be at 4.4% by the end of this year and 4.6% by the end of next year. It is September and the Fed funds rate is currently 3.0-3.25%. It would be wise to expect rates to rise by at least another 1% in the next three months. That’s going to bring a lot of pain to a lot of people.
Don’t let this be a surprise. It is being well telegraphed. It is easy to look up, and while there is a tiny bit of uncertainty, the projection is coming from the most powerful bankers in the world, not from this blog or your friend Joe or Susie at the gym. It should be relied upon as a highly, highly likely outcome.
So the question is what should you do? Well, the easy answer is to expect prices for items that require financing to fall. Expect that rising prices will slow in other areas such as food, shelter and so on. Expect that the vast majority of people will be able to save less (and therefore consume less and invest less), but those with extra money to save will be better rewarded in the future.
Another aspect to consider is that asset prices, particularly risk assets will fall. The last time interest rates were as high as they are today, was in 2011. At that time, the S&P 500 was trading at 1,350, about 60% below it’s current level. The last time rates were at 4.4% was in 2007 and the S&P 500 was close to 1,500, but this was just before the housing crisis and the market began a long and painful 50% decline.
To be sure, the Federal Reserve will work very hard to ensure that the economy doesn’t grind to a halt. A second and very important part of their mandate is ‘full employment’, and if employment begins to slow too rapidly, they will slow or stop the rate increases, but as consumers and investors, we should expect a sharp slowdown in business activity and continued declines in asset prices.
This of course leads to many questions about how to invest. There are three meaningful scenarios to consider but your age, financial status, employment status, the liquidity of the assets and more, matter a great deal. Talk to a financial advisor if you are not sure how to proceed. Simple solutions are provided here.
The first is ‘should I sell?’ This answer is very hard because many assets have already declined significantly. If you don’t need the money, perhaps hold the assets for now. If further declines will hurt your standard of living, then building a cash buffer is never a bad thing.
The second is ‘should I hold on?’ The younger you are, the more this makes sense. Even in the worst times, the economic system we live in has worked well and over the long term rewarded savers. The key is that this downturn may be long and so it makes a lot of sense for the young to hold on, but to repeat, if further declines will harm your standard of living, then building a cash reserve may be a better option.
Finally, ‘should I buy now?’ The very young, consistent savers should probably be continuing with contributions to investment plans all the time, no matter what. Over 30-40 years price swings are not that important. On the other hand if you have just come into money, or have sold something and are looking for a new place to invest, holding off will likely offer better opportunities.
This is not investing advice. Investing advice would provide you with specifics that relate to your situation, and there are always wonderful opportunities in the investment world. (Metals and Oil/Gas still stick out as good opportunities.) Overall however, there will be a lot of new opportunities in the coming year as the difficulties settle out and winners are evident and losers disappear (bankruptcies are rising dramatically in the US and Canada).
A recession is almost certain at this point, despite all of the nice words suggesting it can be avoided. Perhaps it will be a good time to plan for a moment when everything isn’t always awesome and difficulties persist.