“I’m comin’ up- so you better get this party started” – Pink, Get The Party Started
March has always been a month of transition; in like a Lion, out like a Lamb. This rings true for both the weather and the markets. This year the markets are centering in on interest rates and the yield curve as the main catalyst for continued equity market gains or a signal to flip from Risk-On to Risk-Off. February ended with a whimper with markets pulling back almost -5% for the NASDAQ and -2.45% for the S&P 500 in the final week. Was that last week a harbinger of times to come, or just a small pullback in the larger uptrend?
G Squared’s position is that volatile weeks, like the last week in February, are common and our overall thesis is still bullish for stocks. While we are watching interest rates and inflation, we feel at this time they are not spiking to the point to derail the equity rally. Why do interest rates matter to stocks? They increase the cost of borrowing, the cost of issuing debt, and increase the discount rate potentially making equity premiums less attractive. But rates have to normalize sometime. The Federal Reserve has repeatedly shown a willingness to stay dovish and keep the Fed Fund rate at its current 0.00-0.25% range until at least 2023.
Normalizing interest rates can be a good thing. They show the economy is healthy (or getting healthier) and that policy is shifting towards slowing growth and inflation vs. stimulating a flagging economy. Higher interest rates hurt the liabilities side of the balance sheet meaning potentially higher interest rates for car loans, home loans and credit cards, but they also mean more interest (eventually) on your savings accounts, CDs and bonds. This is why we recommend a short and laddered bond strategy to help combat rate hikes and yield curve swings. By having continual maturities and cash flows to reinvest back out at a higher rate allows you to take advantage of rising rates, vs. staying stagnant in an intermediate portfolio that will see potentially more price volatility.
Remember, bond prices are inversely related to interest rates and yields. So, if yields are going up, that means that bond prices are falling. We anticipate seeing some price swings in bonds and potentially a negative year from the bond market in general. The main driver of rising yields is an increased expectation of stronger U.S. growth and faster reopening and normalization- this is a good thing for the equity market and earnings. We keep bonds in a portfolio for many reasons: they are less correlated to stocks, a volatility hedge for falling stocks, as well as a source of tax-free income in the municipal bond space. Often during large volatility swings, it is best to stay the course than sell into a panic that the end of the bond market is coming. Choppy trading and price swings could be in our future; we remain buyers of equity market dips, focused on value stocks, and looking beyond daily, weekly, or even monthly market declines. As Warren Buffet has opined, “For 240 years it’s been a terrible mistake to bet against America, and now is no time to start.”