June Newsletter to Clients

Enjoy this month’s edition that features a review of stock and bond markets and interest rates.

As you probably have noticed, it’s been a rough start to the investing year. Large, U.S. stocks are down over 14% on the year, small U.S. stocks are down over 16% and technology companies, as measured by the tech-heavy NASDAQ stock index, are down over 23% so far. In a way, it’s counter-intuitive that the stock market has declined when the economy is so hot. At the beginning of June, the latest jobs report showed an additional 390,000 jobs added during May. The unemployment rate is just 3.6%, a mere tenth above pre-pandemic levels. During the peak of the pandemic when the economy was on shutdown, the stock market soared. That’s because investors in companies always look forward – what will my investment earn over the next few years? Back then, investors saw earnings growth ahead. Today, they see more question marks.

There are always a multitude of reasons investors may believe a company’s earnings will be lower than today, so they believe the company is worth less: wars, possible recessions on the horizon, higher costs, etc. While all those may have had some impact this year, virtually all close followers of the stock market believe the increase in interest rates has had the largest impact. Here is why:

As the Federal Reserve raises short-term interest rates in an effort to cool inflation, it has impacts on companies. Those that need to borrow to fuel their growth will experience higher borrowing costs. Those that rely on their customers borrowing money to purchase their products, think car manufacturers and homes, may see a slowdown in their business. Slower growth, reduced earnings, a perception companies are worth less than they were all equal in a declining stock market. Is there any good news?

First, as prices decline, investors can buy a company’s earnings for less. In the small company space, for instance, their price/earnings ratios – how much in earnings one can buy for their stock price – has dropped to their 2009 levels, which was just following the financial crisis. When companies’ stocks trade at prices that are more reasonable based on their expected future earnings, that bodes well for their future performance.

Second, bonds are now providing higher yields – meaning higher income – than they did when interest rates were lower. The Dodge & Cox Income Fund that many of our clients hold (DODIX), for instance, has a current yield of 3.06%. That’s up from about 1.7% a year ago. That’s because bond mutual funds can purchase bonds with higher interest rates when their current bonds mature.

Many expect the Federal Reserve to hike interest rates by .50% another three times during 2022. If that happens, it’s not unreasonable to expect more stock market volatility – ups and downs. We would also expect our bond mutual funds to be able to pay more income than they have in the past few years while interest rates were historically low.

That’s the short term. Over the long term, history shows that the stock market declines in value more often than most of us remember. Why don’t we remember? Because it has always bounced back and continued its unrelenting climb to creating more wealth for those willing to weather the ups and downs.

Thank you for your continuing confidence.