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We’ll Get What We Expected

We expected volatility and we got it. That’s because volatile markets are normal. Have we become desensitized to volatility? Well, yes and no. For example, a 500-point move in the stock market, on a percentage basis, is not as much of a move as it used to be.

When you have a Dow at 35,000, that’s less than one point. Actually, we haven’t really seen too many big swings, so I would say we have become desensitized. We’ll see a few intraday swings, and that may upset some people, but the point is no one should overreact when these swings occur. That’s why you remove your emotions from investing.

You have your MASTERPLAN® and you should stick to it. Sure, you might want to make little tweaks here and there with your advisor, but you also want to make sure you have flexibility. If the markets experience an unexpected or unjustified drop, you want to adjust to what’s happening and be flexible enough to make your next move if necessary.

What’s Happened Already is What We Expected

What is expected for 2022 has already been priced into the market. And that is, for the Federal Reserve to raise interest rates four to six times. That’s why, starting in the fourth quarter of last year and into January, we had the big selloff in the U.S. Treasury market. We’ve already seen the market move toward higher rates.

I have been preaching “Baby Steps,” where everything will happen slowly, methodically, and very controlled. Federal Reserve Chairman Jerome Powell is still buying bonds, so it’s about his timing of everything. He’s tapering the bond purchases—meaning, he’s buying bonds—and we’ve got a lower rate. That’s going to turn from easing to tightening as he moves away from buying. This is both unprecedented and interesting to watch. Between easing and tightening, for him, there is no in-between … no pause … and no break in the action.

Raising the federal funds rate will prop up what we’ve seen already – the short end of the curve at 1.15 on the 2-year Treasury – a big jump from where we were last year at this time. In addition, everyone’s talking about the flattening of the yield curve. Well, I can tell you, it’s already here. It’s flattened.

And so the next tool Powell plans to use will be the “unloading from the balance sheet,” with mortgage-backed securities and bonds we’ve been buying at Hefren-Tillotson. When he sells those bonds, it’s going to prop up the rates (somewhat) on the long end.

The Fed Chairman’s Inflation

I respect Fed Chairman Powell. It’s easy to disagree with him, but I yield to his expertise. Most people wanted him to move faster on his tapering, but you know what? The market has already moved. It’s usually a good few months ahead before these decisions come into play. The Chairman is very predictable, which makes for fewer surprises. That’s a benefit, because the markets don’t react well to surprises or uncertainty. Predictably, he will say this or that, and that’s the idea. The Federal Reserve wants to be fully transparent. The last thing they need or want is any kind of a surprise. Powell appears to be more measured and cautious – more cautious than one former chairman, Ben Bernanke, was.

Protection Against Inflation is One Aspect

Our fixed income rates are getting better and when our rates get better they can move to give us real returns. Then, we can beat the inflation rate. It was 7% in December 2021.

Inflationary pressures are likely to last well into the middle of 2022, and Fed Chair Powell pledged to do what’s necessary to contain an inflation surge including increasing interest rates.

When you look to municipal bonds, you look for the income flow. Don’t let the rates deter you; they are where they are. If you’re looking for income, you have to keep your head down and buy when the market dips – when everything’s on sale – and have cash on the side as well.

You always want to maintain that income flow. I watch the markets on a daily basis and maintain that outlook. I take the daily investing out of our clients’ hands. Remember too, that the biggest benefit to owning bonds is capital preservation – protecting your money. 

You’re putting your money into a safe bond and, most times, you’ll get your money back. And that’s the name of the game. You could take less yield, for peace of mind, but you want to know your money is always going to be there five or ten years down the road.

Regarding duration – how much bond prices are likely to change if and when interest rates move – you’ll want to buy into the medium, or the “belly” of the curve, so you shouldn’t mind going five to 15 years out, which is a good range. I would not go out past 20 years because of the anticipation of rates dropping on the longer end.

Currently, we’re flat, with the unloading of the balance sheet from the Fed to push rates up in the long run. Basically, you don’t want that kind of exposure to that kind of potential loss. Being on the shorter end, you minimize exposure and maintain that income flow.

What I have been buying all along, and I stress this even more now, is a higher coupon bond. That’s because the lower coupon bonds are worse performers in this rising interest rate environment, so I’ll pass on the 2% coupons most of the time unless they’re shorter.

Higher quality bonds, AA, AAA, perform well and I buy them when I see them at the right price. They perform better in volatile markets and, as you know, we’re expecting a bumpier ride over the next year or two. It might not be a surprise to you that inflation is here to stay.

People think prices are going to come down. They’re not. You won’t see your favorite restaurants reprinting their menus advertising lower prices for breakfast from $14 to $11. So, my advice is: watch your money, be conservative and have fun.

DISCLAIMER: Past performance does not predict future results. This report is based on data obtained from sources we believe to be reliable. Hefren-Tillotson does not, nor any other party, guarantee the accuracy or completeness of this report or make any warranties regarding results obtained from its usage. All opinions and estimates included in this report constitute the firms judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation to buy or sell the securities herein mentioned.

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