This post is a reprint of our newsletter sent to subscribers in June 2020.
Stock market
When the next massive event threatens the stock market, you should feel some comfort knowing that the government will step in and do everything it can to keep the stock market up. After all, our capitalistic society relies on the stock market.
Every working person’s retirement account, every insurance company, and every pension fund depend upon the stock market maintaining a certain level. Without the stock market, investments in new companies and ideas would not happen.
If the stock market were to collapse and not recover, there would be far worse rioting in the streets than we are seeing now.
The government (by which I mean the Federal Reserve and / or Congress) may not get the recovery right first try, or it may take them longer than is comfortable, but eventually they get there. The fact that this shut down caused market reactions similar in many ways to the 2008 crisis meant the government knew what to do and was able to step in quickly.
The Federal Reserve’s credibility has gone a long way towards calming these markets. Their forward guidance (what they say they will do in the future, even if they don’t really do it) was convincing enough to the big money managers, and they have responded the way the Fed hoped they would.
Bond markets are working again, and the stock market has recovered.
How do we apply this? You should be comfortable owning stocks. Stocks are a long-term investment and have always bounced back. Review your asset allocation if you were nervous in March when the stock market was falling fast, but by all means continue to own stocks.
From an economic standpoint, we are in a similar situation to 2009. From 2009 until the emergence of the corona virus in 2020, the stock market had its longest bull market run in history. That history could repeat as stocks will again attract more investment than low yielding bonds.
Bonds
The Federal Reserve has said it will enter the bond market to keep interest rates low. Let me explain how this works.
Bond interest rates and prices move in opposite directions. For me, it is easier to think through the price side first since price movements are the same regardless of what item people are buying.
Let’s take a real estate example. If several couples are trying to buy houses, then to ensure that one couple gets the house they want, they must pay a bit more than the other couples. If they do, prices are rising.
Bond prices work the same way. If more people are buying bonds, then in order to ensure they get the bonds they want, investors will have to pay a little more than the other buyers. Bond prices are going up in this case.
If the bond price is going up, then the interest rate will go down. This makes sense because if there are a lot of buyers, the issuer of the bond doesn’t need to give a high interest rate to entice the buyers who are already keen to buy.
This same scenario works in the reverse. If few people want to buy, price will go down, interest rates will be higher to entice more buyers.
How is the Federal Reserve able to manipulate interest rates?
They have stated they want to keep interest rates low. To keep interest rates low, there need to be a lot of buyers of bonds. A lot of buyers mean high prices and low interest rates.
In this case, the Federal Reserve itself becomes “a lot of buyers”. They have unlimited money to buy, and can continue buying government bonds for years.
The Federal Reserve Chairperson, Jerome Powell, said on June 10th that they will be buying at least $80 billion of US Treasuries and $40 billion of mortgage backed bonds every month!
How do we apply this? Owning bonds for yield will be an impossible situation for at least several years. Investors will need to use a total return strategy, not choose investments based solely on their yield, and remember that the most important reason to own bonds is to offset stock losses.
Low interest rates make paying off your mortgage more attractive. Say you have a 3.5% mortgage. There is no bond investment available today, other than a high yield (read “risky bond” which you shouldn’t buy), that will give you anywhere near a 3.5% yield.
The Vanguard intermediate bond fund (VBILX) is yielding 2.38%, but you must pay taxes on that. The Vanguard tax-exempt California Muni bond fund (VCADX) has a distribution yield of 2.33% currently.
The average total return on 10-year US Treasuries for 2009 – 2019 was 2.94%. Paying extra towards the 3.5% mortgage looks better under today’s circumstances.
For retirees, buying an immediate annuity with the money you currently have allocated to bonds becomes more attractive. Immediate annuities do not have the fees of variable annuities and accomplish the goal of providing income for the rest of your lifetime.
It’s like buying an additional Social Security payment.
A joint immediate annuity for a 70-year-old couple currently pays 5.55%. Of that payment, only 14% is taxable.
Hopefully you and your family are healthy and doing well. If you want to schedule a meeting just email me at andrew@andrewmarshallfinancial.com.
I have been doing Zoom meetings and it is very convenient. I have found virtual meetings make it easier to help some clients because we can share screens, and I can talk them through how to buy/ sell shares, see what their accounts hold, and they can see me check or update their financial plans.