If you’re reading this column there is a good chance you’re hoping I have an answer to the question everyone is asking right now. What is going on! I will do my best do provide some context to recent market volatility.
In the mid-2000’s, the Federal Reserve Bank (Fed) was cooperating with the federal government hand in glove. Congress had earlier decided everyone in the US should be able to buy a home whether they could afford one or not. Rates were low (by historical standards), there was plenty of money, and housing prices rose because of the higher demand.
But the economy needed some cooling down. The Fed raised interest rates and caused a slowdown. In a ripple effect, some people could no longer afford their mortgages. They were too high for them in the first place. The loans had been financed through mortgage-backed bond funds and sold to the world. This was according to plan.
But all bubbles do burst. You remember the rest, unless you are younger than age 24 or so now. The loans defaulted, therefore the bonds were no good, and the so-called Great Recession occurred.
In their computer-model-aided wisdom, the economists determined that zero interest rates for all would save the day. However, Dodd-Frank legislation made it almost a federal crime for a banker to lend money that might not be repaid. Trillions in liquidity, but not a drop to lend!
Actually, you could easily borrow money if you did not need it. Therefore, billionaires and multimillionaires grew richer. The poor grew poorer. Regular folks like us were paid less than 1 percent on 5 year Certificates of Deposit. We could not spend much to reinvigorate the economy on that, could we? Result? The slowest economic recovery in American history.
Fast forward 13 years. The Fed should have raised rates 10 years ago, but missed its chance. But we finally had worked our way back. Things were clipping along with low unemployment. But we had to get rid of the Orange Man. Thankfully Covid-19 came at just the right time.
Then since they have to do something, even if it’s wrong, the Fed created still more trillions to save us. The government is printing trillions and sending it to you. Banks and others are lending it out. Voila’! The economy is overheated.
Even without Fed rate hikes, interest rates have been rising. Why? Bondholders and bank depositors are sick and tired of getting almost zero returns. In 2021, the iShares Barclays Aggregate Bond Fund, a proxy for major bond holdings, declined in total value by 1.67 percent. Thus, compared to the 7 percent inflation reported by the Bureau of Labor Standards, this bond measure had a real loss of 8.67 percent in purchasing power.
Will an expected .75 percent rate rise in 2022 kill the stock market and the economy? No, I predict it will not. It certainly need not do so.
But part of the problem is that otherwise smart people like economists with Ph.D’s always think they are wiser and more powerful than they are. The next actual recession and the next recovery will be caused by their interventions, either too slow or too much. This is why the wise professor Milton Friedman believed so strongly that Fed money creation should be slow and steady.
For now, the stock market will likely be in a period of higher volatility as the big dogs, so-called FANG stocks, (for Facebook, Amazon, Apple, Netflix, and Google) become sold off from their ridiculously high market values. But some stocks will perform really well. The winners this year will likely be bread-and-butter companies currently much less pricy.
Interest rates are likely to continue to rise and the value of the bonds you currently hold will decline. Interest rates rose from 1946 to 1981 and bonds suffered for all those decades. Bonds are now a safer way to steadily lose money.
There’s a chance this explanation produced more questions than answers. If so. Feel free to reach out to me. I always enjoy a deeper discussion on these issues.