Cause and Effect
As children, we discovered that matching cause to effect could help us understand the world. As we age, we encounter complexity and realize that not every effect has a singular cause. In recent months, there were many reasons why financial markets should have gone down, but they didn't. Despite rising interest rates, slowing economic activity, and a banking crisis, the U.S. stock market was up 7.5%, with international stocks up 8.5%, and bonds up 3%.
Unknowable cause-and-effect relationships are the norm in markets, especially in the short term. Accepting that we cannot predict market performance, we stage investments to participate in long-term growth opportunities while still planning for near-term portfolio needs.
A few of the economic and market events we are paying attention to include government debt, the banking crisis, and interest rates. The U.S. government will most likely increase the debt ceiling before defaulting this summer, allowing the U.S. to borrow more. Specific to the U.S. debt, we find that over 25% of it will be refinanced in the next twelve months, and likely at higher interest rates.
Recent banking solvency concerns are different from the banking crisis of 2008-09. This time, banks are having trouble because their high-quality bonds are down in price due to rising interest rates. It's not the quality of their holdings that's the problem, but the time remaining before the bonds mature. Some banks will need money before the bonds mature. The Federal Reserve, as the lender of last resort, has provided a loan program as a bridge. Related: We are seeing banks offer higher C.D. and savings rates to incentivize deposits.
We're also watching the Federal Reserve as they increase short-term interest rates. Too early to say exactly when they would pivot to a neutral or decreasing interest rate policy. However, the forward-looking market is already cheering this possibility as it would imply that inflation levels will be brought to heel.
Ralph Waldo Emerson called cause and effect the “law of laws.” Everything happens for a reason, with effects reverberating to become their own new causes. This can feel discordant in the short term as we try to make sense of actions and reactions.
Rather than predicting the market's direction based on the 2nd and 3rd-order cause and effect echo, a non-worthwhile endeavor most of the time, we zoom out. Stay focused on aligning investment policies to goals. At Vector, we believe the best way to preserve purchasing power and grow wealth over the long term is to diversify across asset types and time periods, matching your investments to your financial life.
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