Fed Funds 5.25% - 5.5%, US Ten Year 4.837%, Crude Oil $85.20
Stocks continue to exhibit volatility, so dependent are they on the latest economic data on inflation and on interest rate expectations. Since August they have moved downward more than upward, as the well-publicized “higher for longer” interest rate scenario continues to hold sway. Today the preferred inflation indicator, the Personal Consumption Expenditures (PCE) Price Index retreated from August’s 3.8% to 3.7% in September. With this very modest drop in inflation the expectations for another increase in Fed Funds declined to almost zero, high growth NASDAQ stocks rallied, and the ten-year treasury yield fell below 5%.
So, are happy days here again for stocks? Short answer, no. Short-term rates at 5% and higher make cash an extremely attractive alternative to equities. Even high yielding stocks in the Consumer Staples, Financial, Health Care and Utility sectors have performed poorly this year, their hefty 3% dividend yields looking pale next to money-market funds paying over 5%.
Now, keep in mind that this underperformance often indicates that these sectors might be winners next year, with “reversion to the mean” and all that, especially once the central bank does begin lowering rates. So, how soon can we expect that? Not too soon, I would opine. Despite the slight drop in inflation, at 3.7% it is still stubbornly high, and well above the Fed’s target rate of 2%.
If that is the case, should investors rush to put all their assets into cash with their hefty current yields and unmatched liquidity? No again, because when these rates start to fall, they can do so as quickly as they climbed.
Chart: St. Louis Federal Reserve
Because of the difficulty in timing the market investors should always maintain some exposure to both equities and fixed income investments, as one does not want to be caught flatfooted when the worm turns. Over long periods of time cash significantly underperforms both stocks and bonds. Except for the hyper-inflation and stagflation of the 1970s, and the financial crisis of the 2000s, this is borne out in the returns below.
Courtesy: The Hartford. Data: Morningstar
Keep the bulk of your cash in short and intermediate term fixed income securities. Unlike money-market instruments, with US Treasury securities one can lock in 5% and higher yields for up to two years. The short maturity will guard against sharps drops in principal value if rates rise. The securities themselves are very liquid and can be sold and settled in one day, unlike Certificates of Deposit that often impose penalties for early withdrawal. And the interest on government securities is exempt from state and local taxation. In the meantime, let us hope for that year-end stock market rally!
Wishing you a Profitable Week