It has only been six years since the U.S. stock market rout brought on by the financial crisis, but as far as Deena Katz’s clients are concerned, that might as well be ancient history.
“People have a thirty-second memory,” said Katz, 65, co-chairman at Evensky & Katz/Foldes Financial Wealth Management. “We’re used to an instant turnaround.”
That is particularly true when compared to investors who lived through longer periods of economic disaster, like the stagnant economy and rampant inflation of the 1970s or the Great Depression in the 1930s. By comparison, the last seven years have delivered the gift of easy money.
For veterans of several Federal Reserve interest rate hike cycles, the last several years have presented something of an abnormal condition. Rates have been stuck at the zero level, stock-market returns have been strong, and inflation has remained benign.
The economy has grown at a steady pace for several years, enough for investors to put together good gains annually. Investors have taken home an average 7.5 percent in gains on large-capitalization U.S. stocks during each year of a ten-year period that ended last month, according to Morningstar Inc.
Those who have seen several U.S. interest rate rise cycles think things are going to get more difficult.
“We have a Dow Jones Industrial Average that has basically tripled from the trading lows in March of 2009,” said stock trader Ted Weisberg, who founded Seaport Securities Corp in 1979.
“People have been spoiled,” said Weisberg, 75. “You had spring of 2009 to the end of 2014. The rising tide floated a lot of ships, but that rising tide was driven by Fed monetary policy.”
The last several years of low rates, high returns and moderate inflation are abnormal. The measure of inflation watched most closely by the Fed largely grew by more than 3.0 percent between the mid-1960s and the early 1990s, but that statistic, called personal consumption expenditures, has not topped 3.0 percent since 1992.
In the few cases when the Fed has raised interest rates in similar conditions – 1958 and 1994, for instance – many of today’s investors were not working on Wall Street. Instead, investors today have gotten used to the idea of an economy that moves slower than the markets.
Investors who want to look to the past for guidance on how to deal with the first U.S. interest-rate hike in a decade expected next week will struggle to find any comparisons in history.
The Federal Reserve has raised rates many times before, but rarely and not recently in an era of tepid inflation and fairly expensive stocks.
“When you have inflation that’s out of control like you did in the Volcker regime it’s pretty easy to know what to do,” said Alan Rechtschaffen, portfolio manager at UBS Financial Services Inc and instructor at the New York University School of Law.
Rechtschaffen was making a reference to Paul Volcker, the Fed chairman credited with tamping down inflation with painful rate hikes in the 1980s.
“The lessons of the past may not be useful to where we’re at today,” Rechtschaffen said.
When Dan Fuss is asked to find a historical analogy for the period U.S. investors are living through today, he is reminded of the mid-to-late 1960s.
U.S. government deficit spending during that period, on President Lyndon Johnson’s poverty-fighting policies and an expanding war in Vietnam, laid the groundwork for inflation that reduced stock prices by double digit percentage points in both 1973 and 1974, according to Fuss, an investor with six decades experience. The consumer price index leapt from 3.0 percent in 1972 to 11 percent in 1974, according to the Organisation for Economic Co-operation and Development, based in Paris.
Fuss said entitlement programs for aging adults and potential U.S. military interventions in the Middle East and South China Sea are pressuring the government to increase spending now. Along with rising wages, those pressures could force the Fed to slow an overheating economy with more or steeper rate hikes.
“The real fear that I have based on my own life experience is inflation,” said Fuss, 82, a portfolio manager and who also vice chairman of the board of directors at Loomis Sayles & Co LP. “It’s very hard to see it coming.”
Donald Kohn, who worked within the Federal Reserve system for 40 years, said investors can learn from the steep 1994 rate hike cycle that the pace of rate increases matters more than the initial move.
Within one year, the Fed doubled the federal funds rate to 6.0 percent. The rises bloodied investors and led to both stocks and bonds delivering negative returns that year.
Today, investors are not aligned with the trajectory in rates predicted by policymakers.
“The Fed has suggested that they see rates rising on average faster than the market,” said Kohn, 73, now a senior fellow at the Brookings Institution, a think tank. “Anybody in the market who’s counting on a much shallower trajectory could feel the pain.”
Source: Reuters
