The huge decline in interest rates and the drop in stock prices leads me to the following forecasts.
One of the first things that I think needs to be noted is that the peak in free market interest rates for this cycle occurred in late September. Interest rates around the world have dropped significantly since then, with countries such as England, Canada, Germany, France, Australia and New Zealand at or near their lows as measured by their 10-year sovereign debt. Simultaneously, interest rates in the U.S. are high by world standards as measured by U.S. Treasury Securities.
Next, the Federal Reserve may have already raised the federal funds rate too much. One to two more ¼ of 1% hikes are already discounted by the markets and may cause the entire yield curve to invert which would predict an economic slowdown or recession in 9 to 15 months. In fact, if the Fed was not unwinding its balance sheet (selling $50 billion of securities regularly into the markets), our longer-term yields might even be lower. Our high interest rates and corporate tax cuts have attracted foreign monies and caused our currency to appreciate against most of our trading partners.
In addition to the environment in interest rates, many commodities’ prices have declined, with oil prices having plunged by over 25% in the last couple of months.
Given what I’m seeing in interest rates, stock markets and with commodities, I believe the economic growth slowdown that is occurring in other countries could come to the United States late next year.
With today’s headwinds, we’ve generally structured our bond portfolios in a 65% long-term/35% short-term manner to lock in higher yields. This has resulted in bond portfolios having the longest average maturities in the last five years.
On the equity side of client portfolios, we are 10% to 15% invested in absolute return strategies in order to decrease the impact of below average equity returns.
Although the above are my best guesses, they are my forecasts which could prove to be incorrect. With this said, the best path forward in volatile times in stocks and bonds is to stay the course and only make 10% to 30% adjustments to sound strategic asset allocations that are suited for one’s goals. Closed-end funds trading at significant discounts to their net asset values are the best way to invest in today’s markets with large discounts mitigating much of the investment risk.