Markets and America are being tested



While Republicans push for American autocracy, markets behaved wildly for plausibly other reasons. The Federal Reserve announced last week that they might initiate 4 rates hikes this year. While also struggling not to appear surprised by the latest inflation and strong jobs numbers, global markets went sharply lower. With volatility not seen since Feb. 2021, the S&P 500 dropped about 5% and tech stock indexes were lower by almost 8% while showing some recovery late in the day on Monday.


The US House Representatives’ January 6 Committee suggested that they were making progress with their investigation along with possible criminal repercussions for the former President for his involvement in the January 6, 2021 insurrection. This showdown between parties may be the initial stage of future violence around the next election. So far, this gravitational shift in US politics has not correlated with markets, although, from studies of other autocratic countries, markets can often behave violently for very little, public reason as influence and control can be clouded in an autocratic system. China is a good example of this, as they forced Alibaba into retreat from taking US investor money, albeit so the China government can maintain its control over the company. We may not know how markets will react to a change in American democratic systems until it’s too late. A free election system is inherently required for a free market system; preventing bad actors and those without oversight from being able to influence or interfere in markets and systems.


Market strength is dependent on liquidity in the system. Interest rates have been declining for the last four decades as a result of the end of the gold standard. Inflation has declined over this time period to the point that both interest rates and inflation were almost zero in the last few years. Now, with a global recovery in reach, inflation has skyrocketed to a four-decade high globally, leaving rates nowhere to go but up.


Portfolio construction becomes increasingly difficult in a rapidly changing rate environment. Almost all investments are interest-rate sensitive and have benefited from the low-liquidity/high rate environment that we’ve all enjoyed, especially in the last 15 years. Prudently, it would be wise to decrease rate-sensitive investments and all you have to do is look at last week to determine what is and what isn’t rate sensitive.


The sectors most impacted last week were tech stocks, newly listed companies, government bonds (as expected), and even cryptocurrencies all demonstrated a high sensitivity to the Fed’s rate hike announcement. Although these asset classes have generated high returns for investors, it might be too late once liquidity is quickly pulled away from the market.


The good that comes with rate rises are a strengthening overall economy and increased money market rates on cash investments. Note that I didn’t add anything with regard to investments as nothing good comes to mind, at least in the short run.


Companies and investors will have to come to terms with the new rate environment. They’ll have to make investment decisions based on fundamentals (ie, if the company is making money or not), and manage volatility by adding bonds, even though this asset class always gets hit hard in this environment.


At Eureka Wealth Management, I help my clients make investment decisions based on their risk tolerance and time horizon while incorporating strategies that may resist the impact of rising rates. I also do financial planning, insurance, and tax/estate strategies. Call for a free, initial consultation at (760) 537-0791 or book online at eurekawealthmanagement.com.



Sources

https://www.theguardian.com/us-news/2022/jan/08/capitol-attack-committee-donald-trump-white-house-stop-biden-win