Too Hot, Too Cold…or Will the Fed Get It Just Right?!

Too Hot, Too Cold…or Will the Fed Get It Just Right?!

It was almost exactly a year ago that the US Stock Markets were at all-time highs, portfolio values were wonderful, and investors were optimistic. But last year we also had an appearance of a specter from the distant past — inflation. The FED and our government leaders assured us it was "transitory." Unfortunately, they were wrong, and inflation roared upwards. By March the FED stepped in to raise rates and kept on raising them through the year.

The consequences in the investment markets have not been pretty. Stocks have had an extremely volatile year. Bonds are suffering their worst year in history. As we look forward to 2023, all eyes are on the FED and their response to inflation.

The FED and Goldilocks

Do you recall the fable "Goldilocks and the Three Bears"? She had porridge that was too hot, too cold, and finally just right. The FED faces the same dilemma as they plan future rate increases. They must be careful that their rate policy is not too hot or too cold, but rather just right.

Lesson from the 1980s

The last time the US had high inflation was the 1970s. FED Chairman Paul Volcker raised rates to 19% (the current rate is just under 4%) and succeeded in stamping out inflation, but sent the US into two crushing recessions in the early 1980s. There was a happy ending though: after recovering from those recessions, the US economy and stock markets soared for the remainder of the 1980s and all of the 1990s.

What This Means for Investors

If the FED Is Too Hot

If the FED raises rates too much and damages the economy, the stock market may continue to do poorly — perhaps dropping to even lower levels. The key for an investor to survive or even thrive in a downturn is to secure their income needs so they will not have to sell investments while the market is doing poorly. We are not able to time the market, but we can help you time your income needs.

If the FED Is Too Cold

If the FED backs off too soon, inflation could persist, which is bad for bonds and bad for anyone on a fixed income. This scenario would likely push stock prices up in the short term but lead to continued economic pain through higher prices for everyday goods.

If the FED Gets It Just Right

The best case scenario is that the FED engineers a "soft landing" — slowing inflation without causing a severe recession. Historically this is difficult to achieve, but not impossible. If it happens, 2023 could be a good year for investors.

Our Approach

We are reviewing our clients' income plans to establish how much income they might need to draw from investments over the next 1–2 years. For any amount needed in that time frame, we are encouraging clients to secure it in low-risk, liquid assets now — so they don't have to sell equities at the worst possible time. We will be discussing this with you at your next meeting.