Financial Market Update – Autumn 2023
INTEREST RATES!
INTEREST RATES!
INTEREST RATES!
By: Peyton Gentry
If you take nothing else away from this article today, I hope you remember that interest rates have been firmly in the driver’s seat of this back-and-forth market we have found ourselves in for the last 18 months or so. Before we can dig into HOW they have been swinging this market, we must first understand WHY they are rising in the first place. Which brings me to the second most important takeaway from today’s letter - INFLATION.
Simply put, inflation is too many dollars chasing after too few goods and services. During the COVID-19 pandemic, we saw money pumped into the financial system at a rate we have never seen before. This was achieved through rock-bottom interest rates, business incentive programs, and those oh-so-popular rounds of stimulus checks. All of this was done to help stabilize and lubricate the economy in a time when it had seemingly ground to a screeching halt, and we had no idea if or when it would resume business as usual. Couple all that excess cash with the lack of availability of parts, materials, and service people (see the “supply chain” problems that we have all grown very tired of…), and you get the exact recipe for inflation that I laid out at the top of this paragraph.
Enter the Federal Reserve. One of The Fed’s jobs is to bring some stability and balance to the financial system by keeping inflation in check. It has a couple tools it can use to do so, but the one that we all feel the most is the raising or lowering of those pesky interest rates that we talked about at the beginning. When The Fed raises borrowing rate for commercial banks, the commercial banks we are all used to dealing with must raise their interest rates to ensure they can still maintain profitability and liquidity.
The rationale is that by making it a little pricier to borrow money, businesses and individual borrowers will be a little more hesitant to take out loans, thus there will be less money flying around in the economy chasing after those already scarce goods and services. If they can achieve this, it should put some pressure on the suppliers and contractors to lower their rates since they are competing for fewer and fewer dollars in the market.
Alright, now that we got through that fun little economics class that none of you asked me for, I want to finish up by talking about what all of this means for the stock market, and by proxy, all our retirement accounts. Just as it has gotten more expensive for you and me to borrow money from our local banks (not to mention more expensive to put gas in the car and food in our bellies), the same is true for businesses.
Over the long term, the stock market values businesses based on their profitability, both now and in the future. Therefore, negative pressures like supply chain issues, worker shortages, and higher interest rates tend to make those companies less attractive to investors in the near term, especially growing companies that are more dependent on debt to help fund their growth than the blue-chip business that have withstood dozens of markets like this in the past. This is why we have been seeing the shaky, back-and-forth market that we have been in for the last little while—because investors are trying to figure out just how much the short-term economic pains will affect the long-term health of these companies that we all invest in.
The light at the end of this tunnel is that the Fed appears to be nearing the end of its tightening cycle, and hopefully in the coming months we will start returning to some level of stability and normalcy. I for one will be happy to see “unprecedented times” removed from the societal lexicon for a good long while. Ultimately, favor is on the side of the investor that can remain focused on the long term, block out the noise, and recognize that economic cycles are normal, healthy, and something that we have been through before and will undoubtedly go through again. The investor that can absorb the short-term valleys will be happy they stuck around if things head back toward the mountaintop.
Happy investing!
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