Stock And Bond Investors: Markets Headed To Shakeouts

The concern about bonds and stocks falling together is going to worsen. The cause is rising interest rates – the key determinant of both bond and stock valuations.

There is good news coming, though. As interest rates near their true, capital-market determined levels, the bond and stock markets will reach a solid foundation. Investing analyses and strategies will be sounder as well, with the currently ingrained low-interest-rate version of thinking, valuing and forecasting finally overturned.

Call this shift a return to reality capitalism and capital markets.

Note: I explain the dynamics in “Investors: Federal Reserve’s Inflation Fight Moves From ‘Passive’ To ‘Active’ Tightening – Powell’s Promised Pain”

Why aren’t today’s lower-priced stock and bond markets attractive?

Because these three ways of viewing the markets are about to change, making current prices too high:

Thinking – That the Federal Reserve’s interest rate setting is capitalism at work, and that it is the investor’s best friend

Valuing – That investor demand, alone, determines valuations

Forecasting – That future growth of something (earnings, sales, assets, customers, patents, etc.) is at the heart of a stock’s desirability

Thinking is in the process of being revised as the Fed fights inflation and closes out its lengthy, low-rate interest policy. The revision will be finalized when the Fed hits its new, apparent goals: A short-term interest rate of about 6% and an inflation rate of about 4%.

(Note: While 2% inflation remains the stated final goal, likely the Federal Reserve will pause when the 4% [perhaps 5%] level is reached. If the economy has slowed appreciably by that time, the Fed could allow conditions to settle down.)

Valuing based on classic methodology will once again replace wishful thinking and clever sounding schemes. Valuation is the discounting of forecast financials, particularly payments to investors. And that discounting will be based on the coming higher interest rates. (That means, as rates rise, valuations of future payments decline.)

Forecasting will take a more realistic stance, lessening visions that are built on exciting, but unlikely or highly uncertain, possibilities.

Multiple signs show the movement

Here, now: Trimmed expansion and hiring plans. Layoffs. Closures. Retrenchment. Management shakeups. Debt reduction. Focus on capital spending vs share buybacks.

Coming soon: Refocused strategies. Takeovers. Consolidations. Spin-offs. Divestments. Bankruptcies.

These alterations and reversals from one year ago are healthy steps to creating a sound foundation for the future. They are also the ingredients of major shakeups, especially in Wall Street.

Wall Street as a catalyst and guidepost

Wall Street firms, already trimming back, will restyle themselves. The highly competitive finance world is always quick to toss aboard what isn’t working and to adopt new, winning strategies, even if it means shaking things up

Very importantly, once Wall Street shifts, it becomes a driver of market analysis and actions; corporate structuring and strategies; analytical models for valuation and forecasting; economy and financial outlooks and probabilities.

During this period, avoid unreliable sources of information

Most media economy and investment reports are by reporters lacking experience, knowledge and insight to understand major changes. Instead, reporting is based on simplistic, dramatic -yet meaningless – observations, like “worst in twenty years.”

Website-reliant investors use here-and-now jabber to find potentially superior stock returns. They expect fast action from “enlightened” high-return investors focused on the latest and brightest ideas. The problem is their confidence is built on fleeting success and hubris (pride, arrogance). That latter driver is not new – nor is it long-lasting. It always dies out completely with the fad that created it. (And that is where 2021’s speculative fever is now – in its final stage.) This exciting type of investing will return sometime later, but in a totally different form when a new speculative spirit meshes with a new, exciting up-forever fad.

The bottom line – Be optimistic, but adopt a conservative, realistic investing approach

Conservative means ensuring you are getting a return (or likely potential return) appropriate for the risk taken, and that the risk is appropriate to you, personally. (Importantly, it means you do not have to be fully invested at all times. Cash reserves are a perfectly acceptable investment, particularly now that they can earn a decent return.

Realistic means not expecting something like a Fed pivot (interest rate drop) or a return of 2021’s speculation to drive stock and bond prices back up. Being realistic means accepting that the price trend is down for both stocks and bonds. Therefore, be wary of any investments that depend on capital gains – a rising price.

As to bonds, don’t compare 4% to last year’s 0.25%. That low rate (and the many others over the past fourteen years) is so abnormal that it will not repeat for years (decades?) to come. Instead, focus on the former, decades-long capital market (and common sense) determined rate levels. Those rates were at least as high as inflation (to compensate for the loss of currency purchasing power) but were more often higher.

Imagine earning a real (inflation-adjusted) return by holding a 3-month Treasury Bill or a money market fund. That day is coming, but interest rates need to rise further (4.5% is expected in December). So, the best strategy appears to be staying with money market investments, while anticipating higher interest rates and declining inflation rates to meet up once again.

Disclosure: Author is fully invested in money market investments