Over the past several days, the stock and bond markets have continued to demonstrate a high level of volatility as investors react to the latest data on inflation and reassess how that might impact the Federal Reserve’s policymaking course.
We wanted to share some fresh insights from our portfolio management team.
The May consumer price index (CPI) report was released on Friday, June 10, and signaled to investors that inflation had not peaked as hoped. The market started adjusting expectations for faster monetary policy tightening by the Fed. On Monday, June 13, the 2-year Treasury note yield was at 3.25%, up from 2.81% on Thursday, June 9, prior to the report’s release.
The Fed’s policymaking committee will make a rate announcement on Wednesday, June 15. While economists are still generally anticipating another 50-basis-point hike, Fed funds futures are now placing a nearly 30% probability on a 75-basis-point rate increase this week. We view the Fed’s more aggressive tightening as a necessary tool to fight inflation.
While the employment picture remains robust, we are seeing some signs of demand cooling such as retail and housing. These signs, in addition to expectations that the Fed will have to deal more strongly with inflation, muddy the outlook for a soft landing. Our base case is that corporations have the ability to sustain an economic downturn.
Regarding Homestead’s short- and intermediate-term fixed-income strategies, we remain focused on preserving liquidity and looking for the right time to deploy capital into attractive opportunities based on our view of their risk and return attributes.
We’re also mindful of the two components of a bond fund’s return: share price appreciation or depreciation plus any income. While the fixed-income market is experiencing short-term pain on the price side as yields head higher, investors could potentially earn more income as cash is reinvested at higher yields.
Much like the bond market, equity investors are concerned that the Fed is behind the curve and will be forced to raise rates too far too fast, potentially putting the U.S. economy into a recession.
Although the current downdraft in the market is hard to stomach, as value managers we are starting to see opportunities present themselves. After several years of very high price/earnings multiples, we’re now getting to levels that we think are really compelling.
Our concern would be if the Fed does slow the economy too much, we could see earnings estimates start to come down as well. We believe our exposure to higher-quality companies should help on a relative basis, although they too could see negative impacts to their business.
We understand investors’ nervousness about falling share prices and are here to speak with you about your investment goals and portfolio. Give us a call at 800.258.3030. Fear — panic selling — can wreak havoc with your financial plan.
You may also be interested in our previous commentary on volatility, which includes a historical look at stock market performance over short- and long-term holdings periods.
Debt securities are subject to interest rate risk, credit risk, extension risk, income risk, issuer risk and market risk. The value of U.S. government securities can decrease due to changes in interest rates or changes to the financial condition or credit rating of the U.S. government. Investments in asset-backed and mortgage-backed securities are also subject to prepayment risk as well as increased susceptibility to adverse economic developments. High-yield, lower-rated securities involve greater risk than higher-rated securities.
Equity securities generally have greater price volatility than fixed-income securities and are subject to issuer risk and market risk. Value stocks are subject to the risk that returns on stocks within the style category will trail returns of stocks representing other styles or the market overall.