Higher Rates, More Volatility

Submitted By David Vomund from David Vomund Investments

Stocks and to a lesser degree bonds have had daily swings of a size seldom ever seen.  I am almost getting used to them.  Almost.  Why the volatility?  Has the outlook for earnings and interest rates changed?  Yes, a little better for the former, and yes a little higher for the latter.  There are also valid concerns about Gaza, Iran, Ukraine and Taiwan.  Where on the globe are risks falling?  Nowhere.  No wonder investors are concerned about the outlook.  No wonder prices are volatile.

The March CPI numbers confirmed that making progress on the inflation front is slow going at best.  Increases for a month or two can be explained away.  But four months is a trend.  The CPI understates inflation because some key items (rising mortgage and credit card interest rates, for example) have been removed.  Shoppers are not easily fooled.  They see the pump prices en route to work or the grocery store.  They needn’t be monetarists or think like Milton Friedman to see inflation is still a problem.  

Rising government debt isn’t helping matters.  Unfortunately, the deficit in the trillions will be with us for the foreseeable future and with them upward pressure on inflation.  Interest expense rose 43 percent and is on a course to overwhelm income.  As long as significant reforms to Medicare and Social Security are off the table, deficits will grow and interest expense will become the largest item in the budget.  That’s inflationary.  

The risks from inflation and debt should be on people’s radar (it’s on ours) but there is no reason to change portfolio allocations.  Why?  Because the bond market says so.  If the bond crowd were very worried about deficits and inflation yields would be much higher.  The ten-year Treasury’s nominal yield is 4.6 percent, which after inflation puts the real yield closer to 1.5 percent.  Not a sign that investors are worried that inflation will soar. 

What does all this mean for the Fed and investors?  For starters, the rate cut expected in June is off the table.  There may be no cuts at all this year.  As for stocks, which recently had their longest losing streak since October, we can expect more swings as the interest rate picture comes into focus.  I have often quoted John Templeton, who said stock prices are a lot more volatile than stock values.  Indeed.  All too often we see how true that is.

David Vomund is an Incline Village-based Independent Investment Advisor.  Information is found at www.VomundInvestments.com or by calling 775-832-8555.  Clients hold the positions mentioned in this article.  Past performance does not guarantee future results.  Consult your financial advisor before purchasing any security.