Investors have long shared a dream: that the Federal Reserve would always flood the market with cheap money whenever asset prices fell too far.
In 2022, that dream has turned into a nightmare.
With the Fed determined to keep inflation in check, the threat of rate hikes has knocked $10 trillion off the market value of US stocks and bonds. worst return since 1842.
You won’t be able to break through this type of market the way you have in the past few years. Buy discount money, or accumulating stocks as they fall in the belief that they will recover quickly, used to be fun; The current it will hurt. And forget about getting rich with just a few finger swipes or clicks. Those days are over – even though investors with discipline, patient and courage will still prevail in the end.
For years, investors believed the Fed would listen to their cries for pain. Think of 2018-19, when the Federal Reserve raised interest rates but then backed out after stocks fell nearly 20% — or early 2020, when the Fed cut rates again and poured cash in. market. Investors celebrated.
Professional investors call this a “put Fed,” a concept that originated with the trading of put options contracts. Owning a trade allows you to sell the underlying asset at a specified price on a certain date. That protects you from any drop below that price until the option expires.
Likewise, when the public believes the Fed is ready to pour cheap money into the market, this helps keep stocks and other assets from falling, creating an over-the-counter put option for investors. private.
Of course, the central bank has no clear policy on backing stocks, bonds, real estate and the like. Former Fed Chairman Ben Bernanke has warning that “the impact of such efforts on market sentiment is dangerously unpredictable.”
However, as William Poole, former president of the Federal Reserve Bank of St. Louis, used to write“There is a sense that the Fed posits exists” – namely that large losses in financial markets could weaken the central bank target low unemployment and stable prices. Steady economic growth is the end goal, but supportive markets can be an indirect means to that end.
From 1994 to 2008, the average stock price decline of 10% was regarding the Fed’s rate cut nearly 1.3 percentage points over the next 12 months, according to Anna Cieslak, a professor of finance at Duke University. The central bank is more inclined to cut rates during such downturns than investors expected, she said.
Tale of the Tape
Investors face a major test as interest rates rise, inflation accelerates and the Federal Reserve embarks on an aggressive monetary policy tightening campaign.
Weekly federal funds target range *
But with inflation above 8%an early rate cut would be like testing a flamethrower in an explosives factory.
Ed Yardeni, president of Yardeni Research Inc., an investment strategy consulting firm, said: “The Fed’s recommendation is wrong. “The Fed just can’t respond to the cry of the stock market when inflation is such a big deal.”
Moreover, even the new and drastic Fed cannot cool down inflation as fast as it wants.
“The idea is that we can create a painless inflation inversion without damaging the real economy,” said Carmen Reinhart, chief economist at the World Bank. “That idea is not based on previous historical experience and I don’t think it’s in the cards.”
There is no modern precedent shows that the Fed can reduce inflation by at least 4 percentage points without pushing the economy into recession.
Of course anything can happen. If the US dollar continues to appreciate, the cost of imports may drop. Russia may withdraw from Ukraine; Covid-19 may withdraw from China. Oil prices can slide.
But investors should always hope for the best while expecting the worst. Inflation will likely be even hotter and longer lasting than we’ve been accustomed to over the past few decades. That means the Fed, a paper tiger, will have to keep pushing interest rates higher until the cost of living finally comes down.
“It’s time to update the old adage of ‘Don’t go against the Fed’,” Mr Yardeni said. “Now it’s ‘Don’t fight the Fed, especially when they’re fighting inflation.’
With the Fed about to expire, what should you do?
First, avoid long-term bonds and long-term bond funds, which are very sensitive to rising interest rates and have lost 20% or more so far this year.
SHARE YOUR THOUGHTS
With the ‘Fed put’ expiring, what changes will you make to your portfolio, if any? Join the conversation below.
Be fully prepared, if you buy at a discount, to let the stock fall deeper and stay at the lower end for longer. Dives can turn into dives, and recovery isn’t always as swift as it was in the last decade.
Put your purchases on autopilot—for example, automatically buy a fixed amount once a month—so you won’t be tempted to give up near the end. In the end, opportunistic buying pays off, though it can take years.
Rely on assets that can benefit from inflation. Return Savings Bonds Phase I, or bond I, will keep up with (though won’t exceed) the rate of inflation. Some problems of Treasury protects stock inflationalthough not cheap, currently offering a small cushion if the cost of live shoots is even higher. Although stocks have fallen sharply this year, in the long run, they are still a good fence moderate inflation. One small allocation goods can also help.
Above all, don’t take great risks to try to catch up. The Fed is not going to undo the mistakes of investors anymore.
Write letter for Jason Zweig at [email protected]
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