rising interest rates

Will Rising Rates Derail the Economy?

© Can Stock Photo / focalpoint

At 228Main.com, we are voracious readers and consumers of information. Nothing happens in a vacuum. We therefore pay attention to the economy, the markets, and our holdings, as well as look for potential opportunities to invest. Recently it was time to sort out what it all might mean.

Rising interest rates, long expected here, have caught our attention. Home mortgage rates are at a seven year high1, and other consumer borrowing rates have increased as well. If we spend more on interest payments, we have less to spend on other goods and services.

We investigated, and learned that total household debt payments actually remain near the lowest point in many decades, although they are rising. But the total debt balances are at record highs, above the level reached before the 2008 credit crisis. What gives?

The answer is in the interest rates. Higher debt levels financed at lower rates have reduced our payments as a percent of income. If loan interest rates continue to rise, however, we will probably see more household income go to payments on debt.

There is another piece of income that doesn’t get spent: our savings rate. When we feel confident about the future and our 401(k)’s and other investments are growing, we tend to save less. When the outlook darkens, we tend to save more.

Our savings rate declined from 6% of disposable income at the end of the last recession to the 3% neighborhood now. Historically, it has been slightly lower at times—but we are probably close to the bottom.

The amount we spend is what is left after debt payments and savings—and one more thing: taxes. Taxes, like the other factors, seem to be at relatively low levels now—not likely to go lower. The 2017 tax reform cut levels sharply.

We believe it is likely that record amounts of debt face rising rates in the years ahead; our savings rate will rise sooner or later; and there is no more room to cut taxes. The net effect of these three things seems likely to eventually reduce consumer spending, which is an important driver of the overall economy.

We do not think we are on the verge of recession. Other indicators point to continued growth. But we are in the middle or later stages of the growth cycle—not the beginning. We are looking at opportunities that fit the times, as always.

Clients, if you would like to discuss this or anything else, please email us or call.

1All data from https://fred.stlouisfed.org/. Federal Reserve Economic Data, Federal Reserve Bank of St. Louis. Accessed May 22nd, 2018


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Change is Still Constant

pyramid

We wrestled for a long time with the issue of how to build portfolios in a zero-interest environment. The crushing of interest rates distorted values in the investment markets. The old ways of thinking carried too much risk, in our opinion. (When interest rates rise, bond prices tend to fall.)

So about a year ago, we settled on the concept of ballast. This enables us to tailor portfolios to address individual preferences. Different clients can have differing portfolios, while retaining common elements that enable efficient management.

Ballast refers to holdings that might be expected to fall and rise more slowly than the overall stock market. Ballast may reduce the volatility of the overall portfolio, thereby making it easier to live with. And it may serve as a source of funds for buying bargains when the market seems to be low. We’ve been able to put this thinking into effect.

A little over a year ago, monetary policy in the U.S. shifted from zero interest to a plan to raise interest rates over time. As we foresaw, this has not been great for bond prices. But now U.S. Treasury securities actually have a little bit of a yield these days, with short term maturities recently reaching over 1% for the first time in years.1

The return of interest rates on lower volatility, short term, liquid balances makes it easier to hold cash and cash substitutes as part of a portfolio structure. As interest rates continue to normalize, returns on cash could increase.

We like the portfolio framework, shown above, that we developed a year ago. We will continue to assess clients that may be suitable for this strategy. As the economic environment changes, we will review the need to adjust the tactics used in each layer of the portfolio. Change is still constant.

We will update you soon on the trends we are seeing in our long term core investments. Clients, if you would like to talk about this or anything else, please email us or call.

1Effective Federal Funds Rate. Federal Reserve Economic Data, Federal Reserve Bank of St. Louis. Accessed March 2018.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

Tactical allocation may involve more frequent buying and selling of assets and will tend to generate higher transaction cost. Investors should consider the tax consequences of moving positions more frequently.

Four Trends for Fall, 2017 Edition

© Can Stock Photo / javarman

The gap between consensus expectations and reality as it unfolds is where profit potential lives. This is why we put so much effort into studying trends and the ramifications for investors.

Here are four trends we’ve been watching for some time:

1. The cost of solar electricity and battery storage, being forms of technology, are declining year by year. In some places around the world, this combination may already be the most cost-effective way to provide new electrification. We believe we will see the end of fossil-fuel-powered generating plant construction within the next decade or so. This will not happen because of environmental activism, but because of compelling economics.

The investment ramifications are manifold. There will be winners and losers, and we have been investing in accordance with our developing understanding of how this is going to play out.

2. The world’s most populous democracy, India, may be poised for decades of economic growth much like China experienced over the past thirty years. Moreover, by 2050 India is projected to be the most populous country in the world. China will be surpassed as a result of its short-sighted ‘one child policy’ that created a huge demographic challenge with an aging population.

By getting in early, even a small investment allocation may make for significant potential gains over years ahead. No guarantees, of course.

3. The airline industry, after nearly a century of cutthroat competition that resulted in wave after wave of bankruptcies, has consolidated into a handful of companies that compete much more gently, to their mutual profit. The energy revolution may result in lower prices for fuel in the future—a large part of airline operating costs. And continuing development around the globe bodes well for air traffic volume trends.

The consensus expectation in the market seems to be for a return to the bad old days of costly competition. But we believe the industry has fundamentally changed due to the dramatically lower number of competitors after years of mergers and consolidation. Consequently, stocks in some of the major airlines appear to be bargains.

4. The Federal Reserve and other central banks around the world are set to begin unwinding the interventions used to effect the so-called “zero interest rate policy”, the policy by which the Fed kept the effective federal funds rate close to 0% following the recession of 20081. While restoring returns on bank savings and certificates may be a good thing for savers, rising rates on bonds will cause the value of existing bonds to go down. When you think about it, a 2% bond cannot sell for its full face amount in a 4% world.

Many parts of the fixed income universe appear to be distorted by the central bank policies. We believe that massive amounts of money flowed into mispriced assets in an attempt to find safety.

Clients, these are the things that have caught our attention. We cannot know the future, but it makes sense to try to get a better handle on it than the average market participant. We can offer no guarantees except that we will continue to put our best effort into the endeavor. If you have any questions or comments or insights to add, please email us or call.

1Federal Reserve Bank of St. Louis, Federal Reserve Economic Data


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

No strategy assures success or protects against loss.

Stock investing involves risk including loss of principal.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.