June 17, 2022Money Financial literacy Economy Good reads Professionals Commentary In the news News Trending Weekly update
What's Happening Today - June 17
A little different note today. It’s been a tough week (and quarter) in the markets, and I wanted to take the time to explain how I see things. Now many of you have heard this message before, but it never hurts to hear things twice.
I know it seems much longer than two years ago, but March of 2020 was when Covid hit and the markets went into a full meltdown (falling over 35% in a very short period). And then the recovery started. Now back then, we didn’t know when the markets would recover. And even when it began, the media repeatedly suggested that it was just a “dead-cat bounce” if you’ll pardon the graphic allusion. But recover it did, and then went on to become a strong bull market. Now here we are again. The markets are in full correction mode, and as always, the media is hyping it up and the doomsday birds are all out chirping. So what is the story? Well there’s a few things happening and I’d like to touch on each of them.
Let’s talk about the actors: First is still Covid. It’s lost a lot of it’s impact of late, but it’s still out there causing trouble (i.e. China’s zero Covid policy). But the real story is what it did to the global economy. It forced governments around the world to spend money like water, and lower rates to historical lows. Of course, this was going to create inflationary conditions. But the other thing Covid created, was a broken supply chain, which added to the inflationary story. So that brings us to actor number two: Inflation. It’s hot, and has thus far, resisted the Central Bank solution of raising rates to cool it down. That’s probably because of a couple other things. First, raising rates addresses the issue of super-cheap borrowing costs, and hence liquidity. But it can’t do much about supply. It’s the age-old story of supply and demand. If there’s a low supply and a high demand, prices go up. The good news on this front is that we’re seeing indications that the supply chain is healing, which will eventually help to reduce inflation. But that brings us to the third actor: Putin. His war with Ukraine, and the global response to it, has added more fuel to the inflation fire. Because Ukraine is the bread-basket for Europe, the war has greatly impacted the global food supply. In addition, the crippling sanctions placed on Russia by the world has had the unfortunate side-effect of helping to drive up material costs for fuel, fertilizer, etc. And since the supply chain requires fuel to distribute products, inflation goes up again.
So all of this has impacted pretty much everything in your portfolio. Let’s address bonds first. Bonds have fallen in value because rising rates have made existing bonds less attractive than bonds being issued at the new higher rates. Makes sense, but the bond values have fallen more than recent hikes would account for, as investors are anticipating further rate hikes. That’s distressing, but remember one of the major benefits of bonds: Maturity. When a bond comes due, or is called early, the issuer buys it back for its par value. So if a bond is trading at 90% of it’s par value, it will be bought out at 100%. So as long as the issuer doesn’t default, you get your money back plus full interest. In the case of a bond fund or ETF, this is happening on an almost daily basis. And then the proceeds of each maturity are used to buy new bonds at higher rates, increasing the overall yield of the fund or ETF. In the meantime, bond holders still receive their income from the investment, regardless of the value bouncing around. As for stocks, it’s a great time to get dividends. Again, market movements may show a drop in a companies stock value, but the dividends continue as they were set regardless. Remember that while we look at dividend rates as a percentage of the stock price (i.e. XYZ stock pays a 5% dividend), dividends are set during shareholders meetings as a specific dollar amount per share (i.e. XYZ stock pays a $1 dividend every quarter). So unless the company decides to lower or cut the dividend, you still get paid. And what we know from every bear market or correction in history, and I’ve seen a lot of them, is that the markets recover 100% of the time. The real question is how long that takes, and what that recovery looks like. So, as I always say, a correction is a great opportunity to add to good companies if you can. But the next best option is to ignore the noise and wait for the inevitable recovery.
Finally, let’s talk about what I think is going to happen. Eventually inflation will start to cool. Central banks are targeting that it will be back to the neutral rate by the end of the year. And they’re suggesting, in North America anyway, that we won’t slip into recession. Now that’s not carved in stone, but as the Fed showed yesterday with their 75 point hike, they’re willing to act aggressively. And I feel that once the market sees inflation coming down, it will start the recovery cycle. Now recoveries don’t come with a flashing neon sign, so it’s only after a few months of positivity that we begin to recognize them for what they are (hence the difficulty with market timing). Here comes the tricky bit though. The central banks are going to want to pivot at that point, and probably start cutting rates back down. They’ll be doing this to stimulate a slowing economy in the hopes of delivering a “soft landing” (aka no recession). And when rates go down, bond prices will go up. Remember that bond funds and ETFs have been reinvesting into higher rate bonds along the way, so their values should slingshot back into the black fairly quickly.
It will also help if Covid continues to lose it’s relevance, and if Putin quits his war of aggression. One note on that though. Looking back on every major conflict (including the World Wars), markets drop at the beginning and then start to recover during the war. Sad as it is, war can actually be a market stimulant.
I’ve touched on a lot here, so please feel free to give me a call if you’d like to chat.