I hope you are enjoying the spring weather as much as I am! I just love watching the grass turn green and the flowers bloom. Just as nature goes through cycles, so do the investment markets. At the end of 2004, we had just finished two amazing years in the real estate and equity markets. So, it did not really surprise me to see the markets slow down during this last quarter. The asset classes that were hit the hardest include US small stocks and real estate. Short-term bonds were down less than one percent. On the positive side, most of the international asset classes had positive returns for the quarter.
The Federal Reserve Board is in the midst of a drive to push short-term interest rates higher, and the stock and bond markets don’t like it one bit. Financial markets have fallen in recent weeks as the triple specters of higher rates, higher oil prices, and higher inflation spook investors. Since June 2004 the Fed has been raising rates by one quarter of one percent at every one of its regular meetings. Short-term rates, at a historic low of 1% prior to last June, today stand at 2.75% after the latest rate hike in March.
Fed watchers almost universally forecast further rate increases ahead. Previous rising rate trends have not been good for financial investments (in the short term). How concerned should investors be this time?
It may be instructive to look at the last time the Fed raised rates dramatically. Back in 1994 the Fed began a preemptive strike against inflation by doubling interest rates within a brief 12-month period. The short term Federal Funds rate was 3% in January 1993. By February of the following year the rate had been increased to 6%. The rate increases were hard on investors, especially on those who held long term bonds. In fact, 1994 was one of the worst years ever for the bond market. Long-term government bonds lost almost 8% of their value that year. The stock market, which had been on a roll, gaining 55% over the previous three years, stumbled in 1994 and eked out a gain of just 1%. Small stocks lost 3% that year. But stocks and bonds came roaring back in 1995, with the market gaining 37% and long bonds gaining 32%.
Eleven years later, the 1994 downturn is all but forgotten due to the more famous bear market of 2000-02. Even so, the Standard & Poor’s 500 Index has gained 217% since the Fed began raising rates in 1994. Long-term bonds have gained 136%. Small stocks have gained a whopping 383%.
Does this mean we are due for a big turnaround next year? Not necessarily: interest rates, inflation, and the markets are notoriously hard to predict and rarely repeat in the same way. Things could be worse and the downturn longer this time, or it could end sooner and not be as bad. The point is not where we will be in a year or two but in 10 or 15 years. Smart investors will sit tight, remain diversified, and wait for the markets to resume their upward march.
Now, in order to comply with the provisions of the Gramm-Leach-Bliley Act, I am enclosing a copy of KFP’s Privacy Statement for your review. The Privacy Act requires that I deliver this to every client on an annual basis. In addition, as a Registered Investment Advisor, Keystone Financial Planning is required by state regulators to offer you a copy of Part II of Form ADV. The Form ADV is KFP’s registration with the Pennsylvania Securities Commission. If you would like a copy of Form ADV Part II, you may download it by going to the “Regulatory Compliance” page on KFP’s website (www.KeystoneFP.com). Please feel free to call me if you would like a copy mailed to you.
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About Christopher Jones
Christopher Jones is the Founder and President of Sparrow Wealth Management, a fee-only financial planning and investment management firm. Before entering the investment field, Chris was a management consultant for Deloitte Monitor. He graduated summa cum laude from Brigham Young University with a B.S. in Economics and a minor in Business Management.