A Financial Whirlpool
Markets are in a financial whirlpool as they try to navigate the treacherous waters of Ukraine, inflation, rising interest rates, and China's recent lockdown. Stocks and bonds react violently to the headlines, and volatility is off the charts. There are few places to hide.
The Federal Reserve will raise interest rates by a quarter of a point this week to try and tame inflation, which is currently averaging 7.8%. This year, interest rates are up significantly despite the Fed's inaction, so investors already understand the impact of rising rates through lower bond prices or increased mortgage payments.
Gas prices are soaring at the pump, and the national average is $4.4 per gallon, an all-time high. In some parts of California, the cost of gas is north of $7! The higher prices are arriving just in time for the driving season.
The Federal Reserve is fighting inflation, but the recent data could send our country into a recession. At some point, individuals will decide between paying for essential items and non-essential ones. Escalating food and gas prices are taking a toll on the consumer, and rising interest rates make purchasing a home less affordable. People will stop spending money on travel and entertainment to put gas in their cars and food on the table, and when spending slows, recessions tend to follow.
If you believe inflation prevails, then stocks, real estate, and commodity investments should perform well, but bonds will not. As inflation climbs, the Fed will continue to raise interest rates. The last serious battle with inflation occurred more than forty years ago when it rocketed above 14%. It peaked in 1980, and then both inflation and interest rates dropped substantially. In 1982, stocks started one of the great bull runs in history, rising 160% before it was inconveniently interrupted by the crash on October 19, 1987.
If you are in the recession camp, bonds will perform well, while stocks, real estate, and commodity investments will not. The last prolonged recession occurred from 2007 to 2009, when the S&P 500 fell 53%, and bonds soared 26% at the throughs of the Great Recession.
Will we experience inflation or a recession? That's the $64,000 question. It's impossible to know because we can make a case for both, and that's why we're in a financial whirlpool. If you rafted down a river, you know it's hard to get out of a whirlpool – near impossible because two opposing currents cause a vortex that sucks everything down a drain. The opposite economic currents are inflation and recession, and only time will tell who wins. However, it's smooth sailing once you get out of the whirlpool.
How can you protect yourself from a financial whirlpool?
- Diversify your assets to include stocks, bonds, cash, and alternative investments. A balanced portfolio exposes you to asset classes that perform well in different economic conditions. And don't forget to add international holdings because not all countries experience recessions simultaneously.
- Eliminate your debt to ride out the storm: pay off car loans, student loans, credit cards, and mortgages. Being debt-free can bring you peace of mind, especially in uncertain times. Also, reducing your debt payments allows you to save and invest more money.
- Increase your cash position. Extending your emergency fund to cover nine to twelve months of expenses allows your stocks and bonds time to recover.
- Buy stocks. Stocks have always recovered. If your time horizon is three to five years or more, consider adding great companies to your portfolio.
- Follow your financial plan. A financial plan can help you stay invested during difficult times. We recently tested our client's plans against a 50% stock market correction and a sustained inflation rate of 5.25%. Thankfully, the results were mostly positive.
It's a difficult time with much uncertainty, so invest wisely, proceed with caution, and follow your plan.
Rivers know this: there is no hurry. We shall get there someday. ~ A.A. Milne, 'Winnie-The-Pooh'
March 15, 2022
Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management, located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM's custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.
Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren't suitable for every investor.