Stockscurrent Team | Jul 05, 2023 |
In the last 4 months of 2022 market went down too fast in fear of a Fed interest rate hike and inflation. Although the Federal Reserve has continued to increase interest rates, In the first half of the year 2023, four regional banks have failed. In Oct 2022 S&P500 was below the 3500 level, and it's currently trading above 4,350-4400 range close to 52 weeks' high. Yes inflation is cooling off but not to the normal level yet, Federal government indicated 2 more possible rate hikes before the end of the year that may or may not happen. We don't know what is driving the market but the market has bounced back and is the market too complacent in the current situation?
Let's take a data-driven approach to understanding. Currently, inflation is in the range of 4.5-5%, the auto loan interest is in the range of 7-9%, the 30-year fixed mortgage rate is above 7%, Food prices are high, and multifamily house rent is increasing 7-10%(normal range is 3-5%), apartment rents are increasing in 5-7% range (normal range is 2-4%). Housing is contributing 41% of the core CPI(Consumer Price Index) number. With the current rental growth, feel like inflation will be stubborn at this level. Whatever happens to the housing market will have a direct impact on the CPI number. Especially office real estate segment is in trouble and office vacancy is at its highest by far across the nation. Data from Green Street shows that office values fell precipitously by 28%. Five to 10 office towers each month join the list of properties at risk of defaulting because of low occupancy, expiring leases, or maturing debt that would have to be refinanced at a higher rate. We think higher interest rate will remain longer, related impact will be visible slowly.
In the United States, we had a close to zero interest rate policy(ZIRP) for almost 12 years. We are in the higher interest rate era, where a higher interest rate is here to stay for longer. If interest rates go higher, some companies will benefit, while others will be hurt. This means that borrowing money will be expensive, and interest rates for any type of loan will be higher. Businesses will experience an increase in operating costs and a decrease in profit margins. Industries such as real estate, start-up companies, and small to medium-sized businesses may find the current environment unfavorable. Unfortunately, some SMBs (Small and Medium Businesses) may not be able to survive. Some of the publicly traded companies that mentioned they will be profitable in the year 2023 or 2024 will be stretched longer and for some company's path to profitability timeline will be unknown. Companies with strong cash flow and have the operational efficiency will navigate the current situation. Investors should focus on the data related to cash flow, and operational efficiency. Due to the increase in costs, businesses are transferring the burden to consumers, resulting in price hikes across various aspects of life. Consumer personal savings are lower than the 2017 level, credit card debt is higher. Very few families have savings on the sideline, if you have savings, and cash then the good news is you can have anywhere between a 4-5% guaranteed, relatively safe rate of return in your savings account, CDs, or in short-term Treasury bills.
When you are getting a guaranteed 4-5% return it will be difficult to make a move and invest in equity which comes with risk and the rate of return is not guaranteed. That is the reason equity and other asset class face compressed valuation. Investing in equity for a long time is still the best possible opportunity. These are the macro environment which last for short term and create headwind. When you think long term(5-10 years or more not a 1 year). Warren Buffett said there is no point trying to gamble on where interest rates will go next. Instead, investors should only rely on the things that they can know. Here's what Warren Buffett had to say at the 2000 Berkshire Hathaway shareholder meeting.
The best time to buy stocks actually was, in recent years, you know has been when interest rates were sky high and it looked like a very safe thing to do to put your money into Treasury bills -- well actually the primary got up to 21.5% as attractive as that appeared, it was exactly the wrong thing to be doing. It was better to be buying equities at that time because when interest rates changed, their values changed even much more.
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