Falling markets are discouraging and disconcerting. It is natural that investors want to protect their portfolios when it seems like the market is going down on a daily basis. Stock markets are volatile but the pendulum tends not to swing in one direction for too long. At some point, the market will price in all the (perceived) bad news and start to recover. During these turbulent times, the best course of action is to control your emotions and not lose perspective. When we are faced with such extreme volatility we always ask ourselves the following question. Am I certain that my assessment of the current situation is rational or am I being influenced by other factors?
Yesterday, the Federal Reserve Bank in the U.S. decided to raise interest rates. While it appears that interest rates are heading higher because of particularly strong economic growth in the U.S., the worry is that interest rates will rise too far too fast. The level of interest rates is very important to asset prices. When interest rates rise, it makes riskier assets like stocks, less attractive. Even though interest rates are still quite low by historical standards, the market was spooked by the Fed’s statement that rising interest rates are inevitable. Rising interest rates are not a new phenomenon. Interest rates in the U.S. have now been raised nine times since 2015.
If the Federal Reserve has so much confidence in the U.S. economy, why doesn’t the stock market? In the short-term the stock market’s behavior can be completely irrational. Many have said that the stock market is a forward indicator, however, the data suggests that the stock market has a terrible track record of predicting recessions. https://awealthofcommonsense.com/2018/10/can-the-stock-market-predict-the-next-recession/.
Our strategy in the face of market declines has remained consistent for over 25 years. In February of this year, the U.S. stock market sold-off on worries about a potential recession. The most recent drop is due to worries about interest rates rising too fast because the economy is too good. We believe that the North American economy is neither so good that interest rates will rise too far, nor is it so weak that a recession is imminent. Just as it has in the last ten years, we believe that the North American economy will continue its slow ascent and will suffer its usual fits and starts. We are moving ahead with the same cautious approach we have always taken. While we remain fully invested, we will stick to high quality corporations that have strong balance sheets, that generally have a history of raising dividends and that have a long runway of growth for their products and services. As a result of slowly rising interest rates, we are keeping bond maturities very short in the hopes that we will be able to earn better returns on fixed income going forward.
As always, please feel free to contact us if you have any questions.
