My Two Cents On: The Stock Market, Interest Rates, Fixed Income Investing (Avoid Bond Funds), and Disaster Hedging
By J.R. Robinson, Financial Planner (November 25, 2024)
As I mentioned in another post, my three financial planning blogs are devoid of political commentary. I am sure our readers get their fill of that in other forums. Additionally, in my experience, the political impact of elections on the investment markets is generally overstated or at least unpredictable.
I also like to remind people of one of Warren Buffet’s famous aphorisms that he attributes to Ben Graham – In the short run, the stock market is a voting machine, but in the long run it is a weighing machine. In other words, short-term fluctuations are driven by sentiments and speculation, while long-term performance is driven by actual results.
The Voting Machine and the Weighing Machine
The ONLY direct comment that I will make about the elections is that I was surprised by the outcome. In particular, I expected Congress to remain divided. However, if someone had asked me in advance how the stock market would react to a Trump presidency paired with a Republican congress, I would have opined that the market would go up significantly. The reason has nothing to do with Republican vs. Democrat ideologies, and everything to do with the Tax Cuts and Jobs Act.
Before the election I (along with many other financial advisors and tax advisors) had been encouraging clients to fill up their lower marginal income tax brackets in 2024 and 2025 with the expectations that the TCJA would sunset as it is congressionally mandated to do on 12-31-2025. Allowing the TCJA to automatically sunset would give the Democrats the tax increase and debt reduction mechanism they sought without expending any political capital. That seemed to be the most likely scenario, since it will literally take an act of congress to extend the TCJA. Even if that had happened, a Democratic president could veto the legislation.
Of course that is not how the story played out. Congress is not divided, and we have a Republican president. This means there is a very high probability that the TCJA will get an indefinite or perhaps even permanent lease on life. The voting machine had been factoring in tax increases on corporations and consumers. The weighing machine now says that the certainty of tax savings to corporations and more consumer spending spells more profits for companies. You didn’t have to be Nostradamus to make that call…if we knew the election results in advance.
What has been left out of the discussion thus far is that the TCJA added more than $4 trillion to the national debt. Extending the TCJA will almost certainly continue that trend. If the effect of that or any other major policy decisions turns out to have unexpected adverse consequences, then the stock market's recent performance could be viewed as the voting machine, and a subsequent downturn will be viewed as the weighing machine.
What is the Outlook for Interest Rates and Bonds?
I continue to be befuddled by the sheer number of articles in the mainstream financial news that continue to speak of interest rates falling over the next few years as a result of continued Fed rate cuts as if it is a foregone conclusion. The Fed’s primary concern has been and still is keeping inflation in check. Most economists I listen to have suggested that a limited job market in a strong economy is inflationary and that policies based on high tariffs on foreign trade partners also tend to raise prices at home. Fed Chairman Powell said as much in his November 14th remarks at a conference in Dallas –
“The economy is not sending any signals that we need to be in a hurry to lower rates. The strength we are currently seeing in the economy gives us the ability to approach our decisions carefully."
My advice is to believe the man. In my opinion, the crowd that thinks rates will return to anything close to the historic lows of a few years ago is living in Fantasy Land. There is a better chance of mortgage rates returning to 7% (or higher) than dipping back below 4%.
The best advice I can give to fixed-income investors is my longstanding mantra—FRIENDS DON’T LET FRIENDS BUY BOND FUNDS! At this time, I am even discouraging clients from buying 12-month CDs. Yields on liquid money market funds generally remain higher. I believe there will be an opportunity to extend bond ladders again within the next couple of years. For now, cash is the king of the fixed-income world.
What is the outlook for the stock market?
Earlier in this essay I explained how easy it was to explain the recent performance of the stock market in retrospect. Obviously, most people (including me) had no idea that it would go up with foresight. The stock market is efficient (i.e., fast) in reacting to stimuli, but predicting what the stimuli will be is impossible. At this time, the stimuli seem to be mostly positive for the companies that comprise the stock market. We should all know by now that the current trend can turn on a dime.
A better question to ask—and the one I believe is on most FPH clients’ minds—is, what can we do to prepare in advance for the possibility that things go extremely badly over the next several years?
Without getting too political, I do believe the risk is higher than normal for very bad things to happen. These might be caused by geo-political crises (e.g., China/Tawain, Russia/Ukraine, Iran/Israel, U.S./North Korea, etc.) or by the failure of certain untested “avant-garde” policy initiatives that have been proposed by the incoming President and Congress.
My response is that while the likelihood of a stock market crisis seems higher than normal, we always plan for the possibility of severe, long-lasting exogenous shocks to the stock market. This is why we strongly encourage clients who are retired or approaching retirement to hold as much as 5-7 years of expected portfolio distributions in assets such as CDs, Treasuries, and money market funds that carry little or no principal risk. The same general advice goes for any person who is saving for a major purchase (college, home purchase, etc.) in the next 5-7 years – that money has no business being invested in the stock market.
If you are 10 or more years away from retirement, I generally encourage you to stay invested in the stock market. In fact, I often remind people that if you are saving for a long-term goal and you are diversified in your stock market investments, you should actually hope for opportunities to invest if/when the stock market drops sharply. You should probably even hope it stays down for a while. If you are worried that it will stay down permanently, you shouldn’t be. To paraphrase another frequent Warren Buffett aphorism, it is always a bad idea to bet against the long-term success of American capitalism.
Are There Any Investments You Would Recommend as a Hedge Against a Disastrous Investment Environment?
This question has come up quite a bit lately in client conversations. I take this to mean, “What investments could we buy that might effectively hedge against rampant inflation and/or a cataclysmic decline in the stock market?”
My answer may surprise you: Gold and/or Bitcoin (preferably in ETF form for both). The performance of both may be expected to be non-correlated or inversely correlated to the stock market.
I am sure including Bitcoin in this commentary will raise some eyebrows. However, the SEC’s approval of 11 spot-price Bitcoin ETFs at the beginning of 2024 made it easily accessible to millions of investors. Bitcoin is also structured so that its supply is inherently limited. In my opinion, there is enough institutional and mainstream acceptance of Bitcoin that it merits consideration as a scarce commodity – the kind that people might flock to as a store of value if the rest of the financial world is floundering.
We may have seen this sort of reaction with the rise of the price of Bitcoin after the election, although it is difficult to parse how much of the price increase was attributable to investors’ fear of economic disaster versus speculators’ fear of missing out (FOMO) due to the incoming administration’s favorable leanings toward cryptocurrency.
There is no established guideline for allocating to gold or Bitcoin, but the prevailing wisdom in financial planning circles seems to be a 3-5% portfolio allocation. Is it also worth mentioning that anyone who invests in gold or Bitcoin as a “disaster hedge” should probably hope that prices decline over time, as that price trend might signal that nothing has gone terribly wrong with the world.
John H. Robinson is the owner/founder of Financial Planning Hawaii and Fee-Only Planning Hawaii. He is also a co-founder of fintech software maker Nest Egg Guru and the new personal finance website NestEggPF.com.
