Inflation, Interest Rates and Yield Curves and What That Means For Your Portfolio

 

Chris Perras: I am Chris Perras, Chief Investment Officer at Oak Harvest Financial Group, we are an investment and retirement planning advisor located in Houston, Texas. Welcome to our October 29th Stock Talk Podcast “keeping you connected to your money”.  

 

This week we are going to cover three topics.  They are inflation, interest rates, and the yield curve.  Now listeners, I want you to know up front, I am going to do this from only one perspective.  That is the perspective of a money manager, and how these factors may or may not affect an investment portfolio. I will not be covering how these factors might affect a retirement plan, or an overall financial plan.  That is a future video topic for Troy and the financial planning side.

 

This week’s podcast title, “Inflation, interest rates, and the yield curve…and what they mean for your investments.

 

First off, viewers, if you are getting your economic calls of hyper inflation from social media CEO’s living in foreign countries, please reconsider your sources.  

 

Yes, inflation has had a substantial uptick the last 15 months.  However, I have to ask, how much has this affected you, your savings, you’re spending and your investments the last 12-15 months?  I’ve probably talked to over 100 clients, prospects, neighbors and family members on this topic the past 12 months.  Their concerns have largely shifted from paper goods pricing, like toilet paper and paper towels, to meat pricing and availability.  The BQQ and grilling crowd in Texas like myself are distraught over brisket and baby back ribs pricing.  

And finally, now, everyone’s latest worry, largely because it’s the headline on TV, is energy pricing.  Now my contacts all have great arguments about their own real-time data points for their concerns.  I do not want to minimize their feelings on these things.  

 

However, what I have done and what I want to continue to try to do is minimize their concerns that these things are big things to the economy or that they are a problem for their investments or the markets. Now please remember, I am addressing the accumulation savers stage, pre-retiree, and retiree communities when I speak of these things.

 

First retirees, if you are anything like our typical client or prospect, you probably own your home and have a portfolio of stocks and bonds in your savings and retirement accounts.  The value of your house is probably 15-20% higher than it was 2 years ago, and while your bond portfolio might have some unrecognized capital losses in it, you do not own bonds for capital gains reasons, you own them to produce some income.  Finally, your stock portfolio is likely up a fair amount, since the S&P 500 is up over 25% year over year the last 12 months. And while no one should annualize a gain like that, or even the average gain in the markets the last 10 years of +10% into the future, these gains do far outpace the uptick in current inflation that you are spending your current savings on.  And for those listeners on social security, throw into the equation for 2022, the benefit of the largest cost of living increase adjustment in 13 years, at 5.9%.

 

So what I’m saying is your retirement savings accounts and net worth including your home have likely far outpaced the rise in the rate of inflation the last 12-15 months. 

 

For those of you still in the workforce or looking for part time work to supplement income?  There are 10 million job openings, and the wage increases that are being offered far exceed the current rate of inflation.

 

Which brings me to the best part of my story, inflation is likely peaking for 3-4 months, as are long term interest rates. Behind me are two charts.  One of long-term interest rates represented by the 10 year treasury bond. The second chart is one of the yield curves which I spoke of last week.  

 

One can see from the first chart that it looks like long term interest rates have stalled out and peaked into the 4th quarter just as they have done every other time this cycle for a while when the Federal Reserve started its tapering process.  That’s positive for valuations in the overall market through mid-1st quarter 2022.

 

The second and timelier chart is the yield curve as calculated from taking the 10 year interest rate and subtracting the 2 year interest rate.  This is called the 10’s to 2s curve if you want to sound like a geek at parties. 

 

We discussed this topic as one of our 4 early warning signs to tops, corrections and sometimes crashes in last week’s Stock Talk.  Let me remind new listeners that you will likely begin hearing warnings and maybe dire predictions about this dynamic.  As we try to do things at Oak Harvest in advance of what you might see on TV, we try to anticipate and address these concerns in advance. Our interpretation of the data on yield curves flattening and inverting says that for the foreseeable future, this topic should be noise.

 

A flattening and subsequent “inversion” of the yield curve, in which short-term interest rates exceed long term rates, is typically associated with a recession in the future. However, “future” is defined as 18 to 24 months after the yield curve inverts, not just flattens like it is just starting to do. 

 

With that in mind, a yield curve inversion has preceded each recession over the past 50 years.  The data compiled by Credit Suisse, shows that the market has rallied, on average, another 15% in the 18 months following the initial inversion, let alone a flattening, with a recession hitting on average 22 months after the inversion. 

 

The typical pattern is this… the yield curve inverts, the S&P 500 goes higher and tops sometime after the curve inverts, not flattens, and the US economy goes into recession six to seven months after the S&P 500 peaks. 

 

Where do we sit now?  The yield curve sits around a positive 100 basis points.  That’s down 15bps the last week but This is far above the zero line. That, in my view, is bullish.  What’s it really bullish for?  Well, I’d argue that it’s bullish for large cap technology and growth at any price stocks for the next 3-4 months.  All one has to do is look at the yield curve chart since 2010 and see when its steepening what groups and sectors outperformed and when it was flattening, what groups worked.

 

And while we are not running a hedge fund for clients at Oak Harvest, and we do maintain diversified portfolios for all our clients, we do try to, in advance of these shifts, tactically move some money around these sectors of leadership.

 

So, there it is “Inflation, interest rates, and the yield curve” for investors.  What they are, what they mean for your investments and whether we are worried about their affects right now.

 

For now, it still looks and acts like a bull market for equities, albeit having exited the 7th inning stretch. Our view is that large cap technology and growth at any price should lead an aggressive 4th quarter rally into late January of 2022.  From there, it’s likely to be a replay of our 1st half 2020 outlook which was “curb your enthusiasm.” 

 

At Oak harvest, we think our clients are best served by us helping them with their future needs and risks, instead of dwelling on the past.  Our forecasting is far from perfect, but we like to keep you up on what its saying about the uncertain future, not rehashing an already certain past.

 

At Oak Harvest, we are a comprehensive financial planning adviser located in Houston, Texas. Give us a call to speak to an advisor and let us help you craft a financial plan that meets your retirement goals. Call us at (877) 896-0040; we are here to help you on your financial journey.

Many blessings, stay safe, and have a great weekend. 

Chris Perras.