Volatility, As Expected

As broadcast well and thoroughly by the Federal Reserve, it has started to hike interest rates for overnight money (called the federal funds rate), beginning with 25 basis points (0.25%) early in the year, and now, because the perception is that the Fed is behind the curve fighting inflation, a full 50 basis points the other day.

This is a good time to review the three most important factors affecting stock prices:

  1. The level and direction of interest rates
  2. The rate of change in earnings
  3. Sentiment

Two of these are against us right now. Interest rates are rising, which confiscates value from stocks; and earnings growth is slowing. Sentiment, while not very rosy now, changes day to day and is not a reliable indicator of value, or even the likely direction of value.

We’ve been asked ‘how long will this last?’ No one knows, but typically bear markets last up to three years. The range, however, is disconcertingly wide. We’ve seen bear markets last three months. It’s likely, though, that after many, many years of great returns from stocks, future returns will be lower, following global growth downward.

For our part, the ‘holding tank’ where we keep prospective stocks that we may want to buy is expanding. On the bond side, we can now purchase tax exempt issues at 4%. We’ll buy at that rate; later we may get a chance at 5%, where we would also buy, and so on. In an economy that has long term trend growth of about 2%, a 4% tax free rate is solid.

Fundamentals matter less in bear markets than behavior. Microsoft is not a different company at $300 a share, where it sold one month ago, than it is at $277 today. It may sell at $150 sometime before this is all over; it is still not a different company. Remaining rational about values and understanding that the downtrend in place can offer opportunities is more important than trying to time the top or bottom of the market – because no one can do that.