Carol Perry: Uncertainty causes anxiety

Carol Perry

Carol Perry

I got licensed to trade securities in 1990 with IDS Financial services but stayed only briefly due to my aversion to cold calling.
I applied for a job with Bank of America Investment Services during a push to increase female hires in the early 1990s. I had majored in public health education, so my experience in investment banking was limited but I talked a good game so they hired me. Suddenly I was working for one of the country's biggest bond underwriters with only enough knowledge of bonds to pass the licensing exam. I was immediately in over my head.
Along came the 1994 bond market crisis which saw a big drop in prices and rising yields. The rout started in the U.S. and Japan and was precipitated by a 0.25 basis point increase in interest rates by the Federal Reserve. Having yet to perfect my skills in bond trading, I got hammered but it was a lesson I never forgot.
I learned that bond markets may seem boring but they rule the world and I best understand them if I wished to survive. It is now 2022 and once again a 25 basis point hike by the Fed (along with guidance for more rate hikes and QT) are causing markets to puke. We literally have the worst bond market since 1994 so now is a good time to remember those lessons.
Some things have changed since 1994 in bond markets but not for the better. More debt issuance, use of leverage and dark markets have only worsened. Many of the actual problems that lead to the great financial crisis in 2008 were only papered over, not structurally resolved so total estimated global debt markets are now around 250T. Can that much debt actually be repaid? The answer is no, so debt must be rolled over but with interest rates rising, now at higher rates. If more capital goes toward debt service, less goes to growth. This affects everyone, from countries to small companies.
So, should you be concerned if you own bonds and can the carnage running rampant in bond markets effect your stock holdings? Of course.
What happens in bond markets does not stay in bond markets so there are some important things to consider. If you own good quality bonds and hold them to call or maturity dates, the worst that can happen is that you get your money back plus interest. If you own bond funds, it is the fund that owns the bonds, not you, so no money back guarantees.
The lower the quality (credit rating) of the bond or fund, the higher the coupon (interest) but with rising rates you will see much larger price drops on your statements with lower quality bonds as they carry more risk of default and price moves inverse to yield. Right now headline inflation is 8.5% with actual inflation being regional and even person to person so you would need to earn at least 8.5% to break even in bonds.
Normally the longer the maturity the higher the yield but sometimes short maturities can pay you more. This is known as yield curve inversion and is usually a reliable predictor of recession. We have been seeing this inversion recently so it may be a sign of upcoming danger in the economy.
Certain stocks will be more sensitive to rising rates than others. Companies that carry high debt, use hedging or leverage extensively or whose earnings are predictive in the future rather than the present will see more price volatility as rates rise. Look for companies that are defensive (stapes, health care, REITS, utilities) or can raise prices (consumer durables, food, energy) or ETFs that will allow you to buy a basket of stocks in these sectors. Consider companies that have a history of reliable and rising dividends to provide income or cushion your portfolio against volatility.
It is hard to predict interest rates even though the Fed has taken a lot of the guess work out of it anymore. Their dot plot is designed as guidance but as we have seen recently, interest rates can rise on their own without Fed intervention. Interest rates move with inflation, geopolitical risk and liquidity and we are experiencing problems in all these areas so you should ask yourself, do you think inflation is transitory? Will the risk of further escalation of hostilities in Ukraine lesson and even if they ceased altogether, will sanctions be lifted on Russia? Will there be enough dollars to go around globally to meet liquidity needs?
All new things to consider when investing in new assets or selling existing ones.
I know uncertainty causes anxiety for many so I will share with you some advice from a battle-scarred trader who helped me back in the 1990s. He had a theory using three baskets that he would compartmentalize in his mind. He told me to visualize the first basket holding things I had total control over (attitude and behavior) second basket held things that I shared partial control over with others (family, friends, professional relationships) and then the third and by far the biggest basket contained things I had no control over. If you realize that most of what happens in markets (and life) is in the third basket, you can plan better and be a lot less stressed.


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