RISING INTEREST RATES VS. MARKET EUPHORIA
We are now entering an environment the markets have not experienced in over 8 years… a RISING interest rate environment. That’s right, for the first time in almost a decade, interest rates are rising. So, what’s the big deal about rising interest rates? Well, when you couple them with increasing uncertainty, volatility and instability in the
markets, a potentially very dangerous combination is created, and here’s why. Consider that the last 2 times the stock market was in trouble (2001 & 2008), interest rates were going DOWN, allowing investors to turn to bonds for safety. Remember that bonds and interest rates have an inverse relationship, which means that bonds rise in value when interest rates are declining. However, this also means that bonds will fall in value when interest rates are rising, as they are in today’s environment. Thus, the safety valve bonds have provided over the last 8 years is now closed.
According to the Wall Street Journal, USA Today and the New York Times, the stock markets’ recent market declines have been largely due to the “Era of easy money ending.” (*) What do they mean by the “Era of easy money?” Basically, by decreasing the Federal funds rate over the last 8 years, the Fed has been increasing the supply of money available
for purchasing or doing things, by making it cheaper to borrow. Thus, with the recent change of increasing rates, the Fed is attempting to shrink the money supply by making it more expensive to obtain. This means that, in spite of lower corporate taxes, corporations will have to pay more to borrow, expand and hire. Ordinary people, like us, will have to pay more to finance homes, cars and credit cards. In short, as they have historically always done, RISING interest rates will restrict economic growth, presage recession and cause continuing market uncertainty and volatility.
So, what do rising interest rates have to do with market euphoria? As the reality of a rising-interest rate environment and its impact sets in, the market “euphoria” we were experiencing at the beginning of the year, due to the regulation-slashing and tax-shrinking predilections of our current administration, has been severely diminished. Consequently, I believe we are at the final stage of a classic 4-part Bull Market evolution, Euphoria. The late Sir John Templeton, one of the world’s most successful mutual-fund managers and a legendary value investor, said “Bull markets are born in Pessimism, grow on Skepticism, mature on Optimism, and die in Euphoria.” These are the four
stages of a classic 4-part Bull Market evolution. Since we may have reached the final Euphoria stage, let’s examine the preceding stages that appear to have already come and gone.
The first stage, Pessimism, surfaces after a huge market decline, like the 57% drop sparked by the 2008 financial crisis and the bursting of the dot-com bubble in 2000 that wiped out half of the market’s value 1. This is when most investors, having been severely burned, choose to stay away from the fire. However, this is also when so-called “smart money” investors are hoping to sniff out a market bottom and acquire “bargains,” as the market slowly begins to shift upward.
The second stage, Skepticism creates a sense of suspicion and doubt for many wary investors. Even though the market has climbed well off its “bear” market low and economic indicators have turned up, the hesitation lingers. Not wanting to get burned again, they stay on the sidelines waiting to be convinced that the rising market is sustainable and will not relapse.
The third stage, Optimism is when a feeling of acceptance emerges and people conclude it is safe to start investing again. The markets seem stable again, others are making money and bragging about it, and being “left behind” begins to dominate thoughts and conversations. Moreover, fears of a recession fade, unemployment plummets, economic growth returns, and company earnings seem to be improving. As a consequence, the stock market becomes a less scary place, and even when the market dips slightly, rather than viewing that as a negative, investors buy into the dips. Confidence rebounds, as do the markets, and one feeds off the other.
The final stage, Euphoria, the phase I believe we have most recently been experiencing, is when the love affair with stocks becomes a fatal attraction. We jump in with both feet and acquire blinders to anything negative in the process. In short, we become “True Believers”. Once called “irrational exuberance”, a term coined by former Federal Reserve Chairman Alan Greenspan, this state of mind persuades investors that nothing can go wrong and stocks will go up forever. That’s the irrational part. And, when savers and CD buyers eventually succumb to the markets’ “siren song” and start buying stocks, the market historically is primed for a major fall.
So, what does this all mean for those of us who own, or who are thinking about acquiring, Fixed Indexed Annuities (FIA)?
There are 2 important answers to that.
First, although your FIA allows you to remain linked to the market and participate in market gains, it also comes with guarantees, the most important of which is safety. Rising interest rates and market declines are not a threat to the safety you’ve acquired with your FIA. The principal you put into the contract is safe! Any gains you’ve made in previous years and any gains you might make in future years are also safe! This is because FIA gains are not “paper” like those of the market. Instead, your gains are realized, added to your account and can never diminish due to market declines.
Second, whether through annuitization or an Income Rider, another very important guarantee your FIA provides is the certainty of a lifetime of income. This means that regardless of interest rate or market movements – up or down – your guaranteed income payments will be protected and preserved.
1 New York Times and Wall Street Journal, February 7, 2018. USA Today, March 8, 2018 and March 22, 2018