by William Hepburn | May 26, 2023 | Miscellaneous | 0 comments
When everyone expects something to happen in the financial markets, normally the opposite happens. Lately, it seems that everyone expects the US to slide into recession. Think for a minute. Do you know anyone who thinks otherwise?
Employment appears strong and, although there are pockets of recession that have moved through the economy recently (tech and finance), the data doesn’t show anything resembling a widespread economic slowdown.
The Federal Reserve has increased interest rates by 5% at a record-setting pace, but this has had almost no effect on unemployment. Strong demand for labor may be due to our aging population rather than people just not wanting to work, meaning that the unemployment metric may be misleading the Fed and assorted pundits.
There is a huge amount of money that has moved out of the financial markets over the past 18 months as both stocks and bonds declined. When those investors decide that the worst is over and begin investing again, all that cash will be like rocket fuel for the markets. The resulting rally at the end of this bear market should be remarkable when that rocket goes off. It is something that every investor should want a piece of.
The fly in the ointment for the financial markets could be problems in the banking industry. Bankers are now competing with attractive interest rates in other investments, causing an outflow of deposits and pressure on the banks. Most commercial real estate loans are made by local and regional banks, and commercial real estate is a mess these days. Many workers are not going back to offices after the work-from-home days of the pandemic. On-line shopping keeps draining business away from sticks-and-bricks retailers. Losses from those commercial real estate loans could be the straw that breaks the camel’s back.
I mentioned that interest rates in competing investments are causing outflows of deposits from banks. Most of this competition is from money market funds (MMFs) which are a form of very short-term bond mutual fund. Someone on our monthly webinar asked whether they should just move to a MMF or a CD in light of all the uncertainty in the stock markets. I understand the temptation, as the rates available today are the highest in 15 years. However, what our clients sometimes may not realize is that (at least in our portfolios), much of your uninvested cash is already in US Government MMFs.
Moving out of the market into something like a MMF requires two market-timing steps to be successful. First, knowing when to move out of the stock market, and second, knowing when to move back in. And your timing needs to be right on both to be successful.
Since the most powerful moves in a new bear market are at the beginning of an uptrend when current events are still dominated by bad news (the markets are always looking ahead), most people who move out get stuck not knowing when to move back in. We address this problem for our clients by having systems that indicate when we should move out and back into the market.
Furthermore, we use only MMFs that invest in US Government guaranteed bonds, which have no default risk as long as the US Treasury can run those printing presses. Currently, our MMFs are paying in the 4% range and yields are expected to rise following those of T-Bill rates as old holdings mature and are replaced with currently issued, higher-rate T-Bills.
But be careful if you are tempted by the high rates that savings vehicles offer these days! In addition to the market timing risks I mentioned, please understand that not all MMFs are created equal. Investors who shop for the highest paying money market funds may end up with a junk bond fund or an account at a bank which really, really needs the money because they are close to insolvency. Then the risk becomes not just missing out on a little interest. The risk can become not getting all of your principal back. Caveat investor!