Higher Interest Rates: A Threat or Opportunity for Retirement?

Chris Perras:
Welcome, everyone, to this special Oak Harvest Roundtable on higher interest rates and what they could mean for your investments and your retirement plan. I’m Chris Perras, and Troy, Charles, and I looked at one issue that reaches almost every part of your financial life.

We started with the simple idea: Higher interest rates can lower the value of future cash flows, but they can also create better income opportunities for savers and retirees. If you missed our full discussion on higher interest rates, this is the short version. This is for you—the ideas we think matter most for retirees and near-retirees.

In our roundtable, the Oak Harvest team spent 90 minutes looking at how higher interest rates move through stocks, bonds, real estate, commodities, annuities, and your retirement plan. The biggest takeaways were surprisingly simple. Higher rates can hurt the price of assets you already own while improving the income you may earn on new money.

We also talked about why earnings and productivity can sometimes overpower rising interest rates, just as they did during parts of the 1990s technology boom. Finally, we broke down the 10-year Treasury to show why a rise caused by real interest rates can mean something very different from a rise caused by inflation expectations.

Eric and I have pulled together the strongest moments from our discussion and tied them back to one question: Are higher interest rates a roadblock for your retirement plan or a new set of opportunities? We hope you find our discussion educational and entertaining.

Troy Sharpe:
Who controls interest rates? We hear all the time on television that the Fed is going to raise rates, but that’s short-term rates. So tell us who really controls interest rates and how that’s all determined.

Chris Perras:
Thanks, Troy. So outside of times of crisis, where the government and the Treasury and the Fed will step in and try to control and manipulate long-term rates, they set short-term rates, right? They set the rate that banks borrow from the Fed at.

They moved it up last week for the first time in, I think it was three years. They had not hiked rates. They hiked rates by 25 basis points. I think the Fed funds rate went from three and three-quarters, 4%, something right around there—only 25 basis points.

That said, if you look historically, the Fed really follows the bond market. There’s been a bunch of studies done that they tend to follow the two-year Treasury with a lag. So right now, they raised rates at the short end, but long-term rates have been trending up now for upwards of five years. I think we were looking at this right before we came in. 2020 and COVID was pretty close to the secular low for long-term rates.

Charles Scavone:
We will be talking about the U.S. Treasury market because that’s the benchmark rate, regardless of whether it’s three months or 30 years. All other fixed-income products, whether that’s corporate bonds or municipal bonds, are based off of that benchmark rate. So that’s why it’s so important.

Chris Perras:
Yeah, and the whole premise for this episode, when I was thinking about what we want to do, is because you turn on the TV the last week and financial news is more or less in hysteria that the Fed raised rates for the first time in three years.

And it’s not 100% positive or 100% negative, right? There are some good things about them raising rates. If they’re raising rates for the right reasons—economic growth accelerating, real growth being okay—that’s actually beneficial for some kinds of assets.

It’s not great if you’re going to look at buying your first house, but a lot of retirees and pre-retirees already refinanced their mortgages in 2020, 2022, when mortgage rates were 3.5%, 4%. So the higher rates to them don’t really mean anything, right?

It actually means that if you didn’t lock in a 10-year Treasury at 1% at the COVID lows, you probably have some cash that you can invest at higher rates, whether it’s in the stock market or in the bond market or annuities or whatever tool you need in your retirement plan.

Troy Sharpe:
Yeah. So, okay, we have some other good questions here. I’m going to kind of rapid-fire these and just try to answer quickly so we can get to the giveaway.

Okay, so Ronald Joe just simply says, “Where do we see inflation going?” So just a brief talk on inflation because I think coming up in a couple of weeks here, October 14th, I believe, we get the Social Security COLA information.

I’m going to do a video on that once it comes out, but just generally, look, my personal opinion is a quarter-point rate hike isn’t going to do much to curb inflation. But what is your opinion, guys?

Charles Scavone:
It depends. I’ll let Chris give the definitive answer.

Chris Perras:
No, there’s no—I mean, there’s like a hundred components in a basket.

Troy Sharpe:
Talk about where it matters for people watching this in retirement, approaching retirement—the goods and services that they’re expected to buy over the next six to 12 months.

Chris Perras:
I’ll give the academic answer, and then I’ll give the financial advisor answer. So inflation’s above 2%, right? It’s running probably 3%, and it had been coming down.

There’s a couple websites out there. One’s called Truflation, which does a great job at marking to market housing prices, which are coming down in most locations. But the way the Fed looks at it, it takes a year before it comes into their—

Troy Sharpe:
Don’t they also overweight rental prices?

Chris Perras:
So rental prices, they include investment management fees, they include a host of things that make it look probably higher than most people realize.

But it is running, say, over 3%. And I hear a lot of complaints. I’ve heard it for the last couple of years, and I have to smile at times because I’ve never once heard anyone come in, a client or a potential client, and look at their portfolio and say, “My 15% returns in stocks are too high.”

And I’m like, well, that’s inflationary. You just like it, right? Or your housing. Housing prices are up since 2020 in some markets 20%. Most retirees already own their house, right? And they’ve been the beneficiary of that massive inflation in that asset they own.

So, you know, the egg prices have gone from $2 to $3, but your portfolio’s gone up hundreds of thousands of dollars. So I just implore people who are in retirement or near retirement to look at the big, big picture.

If you do have assets in the stock market or have homes and assets, step back and look for a little bit at how lucky you’ve been to be in an environment where the returns have been really good to offset a lot of that short-term inflation that we’re getting the last five years with all this money printing and giveaways and spending that’s going on by the government.

Charles Scavone:
Yeah.

Chris Perras:
Definitely more than bonds most of the time.

Troy Sharpe:
The discussion on bonds tonight has actually been quite interesting.

Chris Perras:
It is for two old bond guys. So, yeah, stock prices. A stock is the net present—you know, any asset, right, is the net present value of the cash flow it generates, or the free cash flow it generates over time.

So you discount that at a rate. The higher the interest rate, the lower the net present value. That’s pretty simple economics. It’s an equation you can do on your calculator. Makes sense, right?

With the stock market, that is historically the case. And it’s been going on now in our current stock market for almost 18 months. The multiple on the overall S&P 500 has come down—is it about three points?—from around 23 to 20 times earnings, while earnings are actually getting much better.

This last quarter, when you strip out one-time gains, it was in the high 20s, 28%, 29%. Correct? Something like that.

And the S&P 500 year to date is up 12%, 12.5%, somewhere around there. So if interest rates had stayed flat, with earnings being up 28%, 29%, you would have thought, hey, the S&P 500 might be up 28%, 29%.

That higher interest rate—I always look at the 10-year interest rate for stocks—is compressing the multiple some. Right now it’s essentially 5%, which is essentially 20 times earnings. I just flip the interest rate and kind of get the multiples.

Troy Sharpe:
In short, a higher interest rate puts pressure on stock prices.

Chris Perras:
A headwind. A headwind.

Troy Sharpe:
Earnings have gone up, but the stock market has not gone up quite as much. Typically, if we have, let’s say it’s a 15 multiple on earnings in the market, so when we talk about a multiple, if you have $1 in earnings, a 15 multiple, you’d have 15 times one—a price of $15.

Earnings have gone up. They’ve done tremendously well this year, but because interest rates have increased, it’s put pressure on stock prices. So even though we look in our accounts and everything has increased in value, if it weren’t for interest rates being higher, stock prices would be much—

Chris Perras:
Yes. I mean, and looking even more granular, the 10-year Treasury since the war in Iran started at the end of March is up 100 basis points. It’s gone from 4% to 5%, right?

So that’s essentially taken the multiple of the S&P 500—you know, a 4% 10-year Treasury, you could say, “I’m going to pay 25 times.” Now it’s a 5% 10-year Treasury; it’s 20 times. So that’s what’s been the headwind—the multiple and rising interest rates.

And you can see it in real time almost daily nowadays, depending on where oil goes and how the negotiations in Iran are going or how the war is going. The last couple of days, there’s been optimism that it was going to stop. And oil is down, I think, $10 a barrel the last two or three days.

Longer-term interest rates fell like 10 basis points. And as soon as they start falling, you can see the S&P 500 overall start rallying pretty considerably because there are computers that’ll trade this to the one basis point every day.

A lot of retirees and pre-retirees own real estate, right? And so how do higher interest rates affect your real estate holdings, whether you’re renting real estate or whether you own it and you’re looking to sell it?

I mean, that’s pretty easy in that higher interest rates lead to higher mortgage rates generally, which means the buyer of your property is going to probably pay less. Even though you might think it’s worth more given the economy and everything else, someone else isn’t going to be able to pay as much just because their financing costs are going up.

So real estate, over long periods of time, rental properties can be inflationary hedges, right? Because you can raise your rental rates. But your house itself that you’re living in—

Charles Scavone:
Raise your rental.

Chris Perras:
Little different. You can’t raise your own rent. So if you’re looking to sell now, you might be looking at lower prices than six months ago. And a lot of that might just be because mortgage rates are now over 7%, I think 7.25% for a jumbo. So definitely a major headwind for real estate purchases.

Troy Sharpe:
Well, okay, so let’s transition, though, because most of our clients, they own their home. It’s almost paid off. It is paid off.

What about investing in real estate? How does it impact investing in real estate? So we have two different types, right? You can invest in real estate through the public markets, where you buy a REIT.

You can invest in the private market, and technically there’s two types of private markets, right? Maybe not private markets, but private investments.

You can do it through a pooled investment vehicle like a limited partnership or a private REIT, and you get a K-1 and you are hands-off. You don’t get the tax benefits, but you get some income and some price appreciation potential.

Or you can do it yourself, right? Where you are out there investing privately.

Chris Perras:
Yeah, the only thing I want to say on interest rates is connecting it back to the stock market and stock market cycles. And I want to say—and I’ll put some of these slides out probably in future Stock Talks—but historically, when the Fed raises rates, if they’re raising it for the right reasons, growth is good, it usually doesn’t kill a bull market.

Now, historically, it can slow it down for the first three months. And if there’s going to be a pullback in the market historically when the Fed raises rates, it’ll come in the first three months.

Historically, it’s been as little as 5% and as much as 12% to 15% when things get really rough. Probably not expecting that in the fourth quarter, something that extreme.

But if we are going to get a move down in the market caused by the Fed, it should come relatively early because the economy is doing well and earnings are doing well.

So usually, on the other side, if it’s not an inflation blowout and the Fed says, “This is a cycle, we’re going to raise rates five times,” you get the earnings continuing to improve and you get investors exhaling. And historically, the market has very good positive returns over the coming 12 months.

The only time they’ve really, I’d say, kind of blown up a bull market cycle was during dot-com, when they raised rates and raised rates and kept raising rates in 2000 when the economy was already slowing down.

They went too far in that one and did create a problem for the stock market. One of the lone times it’s happened.

Thank you for tuning into Stock Talk.

Troy Sharpe:
Yeah.

Chris Perras:
Oak Harvest’s team hopes you have a great weekend.