Stocks and bonds are tumbling. housing is weakened. And I haven’t heard anything about non-fungible cartoon monkey tokens in maybe three months. Strategists are now turning to really bizarre assets – two I spoke to last week advised buying long-term government bonds. One also said that he preferred stocks of companies that generate money, and he was not talking about Bitcoin mining.
I don’t want to panic, but the financial markets seem to be on their way to normal. If left unchecked, ordinary assets can soon reach price levels that imply adequate long-term returns.
The Federal Reserve is raising interest rates at the fastest pace in four decades to play squash the hottest inflation about just as long. The short-term interest rate target is already at just over 3%, from closer to zero at the start of the year. How high will it go? Higher than inflation, sure, but one year’s inflation is more important than last year’s. The Cleveland Fed makes a full-year inflation forecast using swaps, surveys and bond data for ingredients. The final reading is 4.2%.
Or we can just look at the dots. Fifteen years ago, the Fed started publishing a quarterly card game with economic forecasts, and ten years ago it added a dot plot show where the individual participants think the rates are going. The dots are “assessments of appropriate monetary policy,” not predictions, the Fed likes to say. Good to know. The dots are just shifted higher. The new forecast in the middle — I mean assessment — is that the Fed funds target will hit 4.5% to 4.75% by the end of next year.
The dots provided a breath of fresh air in Wall Street last week. But really, they say we’re on our way to normal, not away from it. The average monthly fed-funds percentage in data dating back to 1954 is 4.6%. Mortgage interest rates are also becoming more common. The 30-year fixed rate recently peaked to 6.3%, from 2.9% a year ago. But the average in data going back to 1971 is 7.8%.
What matters to investors is whether such measures are above the long-term average, and how much has already been priced into stocks and bonds. The answers are unlikely, and perhaps many.
“The economy probably won’t be able to sustain that level for a period of time,” said Michael Darda, chief economist and market strategist at MKM Partners, of the fed funds rate potentially reaching 4.5% early next year. The dots agree. They suggest that Fed Fund interest rates will fall by a total of 1.75 percentage points in 2024 and 2025 next year.
Darda believes it will happen sooner; he sees inflation falling to 2% in a year to a year and a half. “Some of these slower, stickier measures will take longer to moderate,” he says of things like wages and rents. “But they will moderate.”
Darda advises investors to
exchange-traded fund (ticker: TLT) and short gold. The ETF has lost 29% this year — about six points more than stocks — and its investments have average returns to maturity of 3.8%. It could rise in price if inflation moderates faster than expected. The gold side of trading has to do with Darda’s observation that, while gold has been called an inflation hedge, it has been a bad one, opposing instead real bond yields, or bond yields minus inflation.
This year, the yield on a five-year Treasury Inflation Protected Security has so far increased from negative 1.6% to positive 1.5%. Gold should have fallen, but it has only fallen slightly. Darda thinks it must fall to $700 an ounce or lower or real interest rates must fall again. Gold recently brought in just over $1,670. Put it together, and if Darda is wrong about the Treasury side of his trade, he expects the other side to pay off from a gold crash.
Julian Emanuel, who leads the equities, derivatives and quantitative strategies team at Evercore ISI, has become optimistic about the same Treasury fund. He recommends buying calls and selling puts. For investors who don’t trade options or short sell, another way to interpret both recommendations is that it’s time to dive back into bonds.
“The 60/40 portfolio over the last two years has probably turned into the 65/35 or the 70/30,” Emanuel says of the traditional stock-bond split. “For the first time since 2019, there is value in longer-dated bonds.”
As for stocks, what happens from here depends on whether we get into a recession, Emanuel says. If not, the stock is probably near the bottom, but if it is, there could be one more leg down, he says.
Regardless, he recommends value stocks with high cash returns and a record of returning a lot of cash to shareholders through dividends and share buybacks. A recent screen for such companies popped up
bank of America
(BAC); houses builder
(LEN); oil refinery
(CMCSA), the cable company; and
This is a good time for old economy stocks such as manufacturing, materials, energy and banking, says Graeme Forster, who leads international equity strategy for Orbis, a South African asset manager that oversees some $30 billion . When valuations for these types of companies are low, their managers tend to under-invest, ultimately leading to deficits, inflation and rising interest rates, as we’re seeing now, Graeme says.
“You’ll see old economy companies go up and new economy companies go down,” he adds. His favorite stocks include:
(SHEL), which has a major energy trading company in high demand amid global shortages, and
(GLEN.UK), which produces and trades key metals and benefits from solar and wind energy storage and the shift to electric vehicles.