Most investors want to know what is driving the economy—where are we and where are we going? And, most importantly, what does this mean for the investor? While there are many moving parts to an economy, some of the catalysts that are affecting today’s economy include the Federal Reserve’s monetary policy, the U.S. government shutdown, and our ongoing trade war with China.
Let’s break this down piece by piece. Given the current economic conditions including employment, gross domestic product growth, and inflation, those indicators would suggest raising the Fed Funds rate may be a wise move. The Fed lowered interest rates through the Great Recession and employed several rounds of quantitative easing to create an easy money policy. Now that the economy is on a healthier track, the Fed raises rates to combat inflation.
The Fed Funds rate has a lot of influence over short-term interest rates, while long-term interest rates are more indicative of the general concepts of where the economy is going. When the Fed raises rates, short-term bond rates tend to increase; however, that also means long-term bond rates could decrease. This can cause the spread between short-term rates and long-term rates to narrow or even invert to where short-term yields are higher than long-term yields. Many believe this inversion can portend a recession down the road, which is what mainstream media often runs with.
When we analyze the economy, we look beyond short- and long-term rates, to the spread between corporate bond yields and U.S. Treasury bond yields. Generally, the riskier the investment, the more an investor expects to be compensated with a higher interest rate. Currently, the spread between what high quality corporate bonds pay vs. treasury bonds has not widened much, indicating investors in the bond market are not worried about corporate defaults.
Many investors are also beginning to ask questions about the U.S. government’s shutdown. Most importantly, don’t confuse policy with politics. The current situation in Washington is about politics. While Wall Street may have initially reacted to the shutdown, the major indices are up an average of 14% since the shutdown began.
This is why we advocate using the Ten Year Rule. Those who have a time horizon of 10 years or more should stay invested in the stock market. Those who sold when the market dropped likely missed out on the recovery.
We still believe the tariffs and actions toward China taken by the Trump Administration are part of a negotiation tactic to get fair trade deals for American businesses. There are a lot of distortions surrounding international trade. It is likely that adding in tariffs might force a change to “unfair trade practices” when it comes to respecting intellectual property and treating American businesses fairly in joint ventures. Perhaps we’ll learn more during this week’s World Economic Forum annual meeting in Davos-Klosters, Switzerland, where more than 100 countries will come together to focus on key global economic concerns.
If you follow the Henssler Ten Year Rule, your liquidity needs should be met for the next 10 years or more, so the short-term pain you may experience should not impact your overall strategy. If you have questions regarding your investment strategy, the experts at Henssler Financial will be glad to help:
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- Email: experts@henssler.com
- Phone: 770-429-9166.
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