I suppose it’s only appropriate that billionaires like Jeff Bezos, Richard Branson and Elon Musk have taken a liking to outer space. Attempting to defy the laws of gravity is all the rage in financial markets, too.
The stock market is trading in rarified air. Traditional measures of value sit at historic extremes. Nonetheless, as mentioned in my last column, investors have adopted a palpable sense of calm about it. It’s as if they are relying on an invisible safety net.
It doesn’t take an investment guru to see that this safety net has been tightly woven together by the truly unconventional policies of central bankers and politicians, worldwide. The promise of super-low interest rates coupled with repeated injections of government stimulus appear to have altered the old yardsticks of value. In doing so, it is also skewing the longstanding rules of conservative investing.
Over the last few months, a change is underway within the Federal Reserve. Seeing early signs of possible economic overheating — shown in higher wages, a tight labor market, booming real estate prices and general inflation pressures — the Fed is finally “starting to think about starting to think about’’ raising interest rates. This cute turn of phrase by current Fed Chair Jerome Powell represents a subtle shift in policy. It is just the first of multiple, well-telegraphed steps by the Fed in coming years. That is, if things go according to plan.
After their current thinking-about-thinking-about phase, the Fed will begin to pair back, or taper, their constant purchases of bonds. Currently, the Fed spends a colossal $120 billion per month to help pin down interest rates. Their bond purchases not only work to suppress rates, they also create a steady flow of cash into the markets and economy. Naturally, investors then embark on a semi-desperate search to earn an adequate return on this newly-injected cash.
For any conservative investor out there, the real conundrum of what to do with excess cash has encouraged a not-so-fun game of hot potato in the investment world. Faced with the prospect of earning nothing, holding onto cash is hard. Even sticking to a conservative investment approach is tough.
Based on what the Fed has been signaling to investors, they might finally stop purchasing bonds sometime in 2023. It is only after their tapering phase is complete — and they deem the economy strong enough and markets well-behaved enough — will the Fed actually start to raise short-term interest rates above zero. The actual hiking of rates will undoubtedly take a good amount of time, just as it did in the years preceding COVID.
To me, the current calm indicates that investors are banking on the idea that we’ll continue to see abnormally low interest rates and continued government stimulus for a few more years, possibly even longer. If true, the Fed and our elected officials might just be able to defy gravity for a bit longer. Safety net or not, I cannot seem to shake the idea that the air is getting awfully thin up here!