Money Talks: Interest rates impact the markets
On the surface, most retired investors here in paradise are aware of the correlation between the direction and level of interest rates and the direction of the overall financial markets.
Many misinformed investors look at the issue of interest rates as black and white. For those who chose not to invest in the stock market, many simply wish for higher rates in order to benefit from their time deposits such as bank CDs. Recently, a retired investor mentioned that they longed for the days of the early 1980s when bank CDs offered high double digit rates of return. Just to jog our memories, that particular era was quite difficult for the banking, financial industry as well as the stock market. In fact, those bank CD time deposits, which had been as high as 18 percent, came with a price. Here is where the old saying “Be careful what you wish for, you just might get it” comes to mind.
As robust as the short-term gains were from time deposits, or CDs, the flip side of the equation was the seemingly now incomprehensible cost of a home mortgage and the costs of debt to fund Wall Street companies. The importance of debt and the costs of conducting business cannot be overstated. The costs associated with mortgage rates in the high teens seem almost incomprehensible in this era of investing and saving. However, the costs of financing a home were not the only side to this strange equation. As mentioned, the associated rising cost of conducting business for publically traded companies put tremendous downward pressure on the stock market.
According to macrotrends.net, the Dow Jones Average touched 7,500 in 1965, by 1982; the Dow had dropped to nearly 2,000 in what was a relatively steady decent over 17 years. The Dow lost roughly 75 percent of its cumulative value during this 17 year window. No, that is not a misprint. Now read carefully here; during the same time frame, the Fed funds rate went from a low of roughly 4.25 percent to as high as 20.05 percent for a whopping 400 percent increase in the Fed funds rate according to macrotrends.net ... again, no that is not a typo. Here is a great example of our empirical knowledge, knowledge through experience, telling the story of rising rates having a significant negative impact on the stock market.
Here we can clearly see why it is critical to step back and embrace the big picture when assessing the current state of time deposits and the potential ramifications in the event that rates begin to rise with no end in sight. Similar to today’s geo-political environment, this was also a tumultuous time for both our economy and the world’s political environment. This was a toxic cocktail and the perfect storm for a financial event with catastrophic consequences.
The point here is to bring transparency to our current situation and crate some realistic perspective as to how we can and, in fact have been, affected by a rising interest rate environment. This particular scenario is completely different from our last market meltdown in 2009 as the catalyst for that particular situation was the subprime mortgage crisis which was fueled by then Fed Chair, Alan Greenspan aka; “Mr. Bubbles” and his cheap money policy which as bad as it turned out, again was completely opposite from the stratospheric rates of the 1980’s creating completely unaffordable money. Here is where investors of all types must embrace that fact that we have been in a near zero interest rate environment now dating back to 2008.
The last decade has been unprecedented in the modern history of money and investing. Consequently, we have combined the Fed’s artificial stimulus package with record low rates for record lengths of time to create what may very well be yet another bubble simply waiting for a catalyst to set the tables straight. This is why educated investors have been proactive and reallocated their portfolio with alternative asset classes which can weather the storm and smooth the ride out which certainly can lead to the life of a SWAN, Sleep Well At Night.
William F. Hague is a managing partner of Hague Wealth Management; 239-389-1999 or WFHague@earthlink.net. The opinions and observations stated above are those of the columnist.