What the Raising of Rates by the Feds Means to You

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At last week’s meeting of the Federal Reserve Board, they announced that they would be increasing interest rates for the second time this year and that they intended to increase rates 2 more times before the year is over. That would be a total of 4 increases, instead of the 3 that were anticipated by Wall Street. Considering how long we have lived in a super low interest rate environment, many people are worried that rising rates will undermine our economy and be a catalyst for drops in the stock, bond and real estate markets.

What Can You Expect From These New Higher Rates?

(Updated 6/27/18) Without a doubt, increasing rates will have an impact on all 3 asset classes. Historically, increasing rates can be a drag on both stocks and real estate, but there is not a “lock step” in which rising rates are always bad. Take the period of 1949 to 1966. In 1949, the 10 year treasury was at 2.31% and in 1966, the rate was up to 4.61% or nearly double over 17 years. During that time, the Dow Jones 30 Industrial index went from 174 in 1949 to 995 in April of 1966, during the same time frame. That is meant as an illustration of stocks rising at the same time as rates are rising. There are many examples of the opposite as well. From that peak in 1966 the market dropped to a low of 2106 in June of 1982, while at the same time interest rates continued to rise until the 10 year treasury peaked in 1982 around 15%.

What Will Be the New Normal?

The point I am trying to make is that there will likely be a period of adjustment while the higher rates are digested by these markets and financial decision making adapts to the new rate environment. While things adjust to the “new normal” I would expect for many markets to be impacted.

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What You Can Do Right Now?

Depending on where you are along your life’s Financial Timeline, steps should be taken to make sure you are not hurt by this period of reorganization and re valuations. If you are close to retirement or recently retired, sustaining losses can put your retirement security at risk, if you are more than 10 years out, you may have time to recover, but you should consider the emotional damage you might sustain if there is another 50% drop in markets in which you are invested.

Bond Market:

Rising interest rates mean falling bond prices. Unless you own the individual bond, and intend to keep it to maturity, investment grade bonds are guaranteed to lose value. This is why I have previously warned readers about bond mutual funds and the fact that they will not protect you from losses in a rising interest rate environment. If you own high yield corporate bond funds (aka Junk Bonds), there are additional risks that could amplify your losses. If you have any fund that has the terms “total return”, “balanced”, “bond”, “asset allocation”, “multi asset”, or any target date or lifestyle fund that has a date of 2040 or closer, you should take a look as you are probably exposed to this type of loss.

Real Estate:

Given the current state of high valuations in residential real estate (single family homes) here in the Bay Area, you might want to pay attention to home values if selling your house is part of your retirement plan. If your house is where you plan to live for the next 20+ years, it really doesn’t matter, unless you are planning to refinance. If you are going to refinance, what are you waiting for??

Higher bond rates often, but not always, lead to higher mortgage rates. Over the last year and a half, mortgage rates have risen over 1% in most places.

On an $800,000 loan, that is more than $650 each month in higher payments. Eventually, these increases will reduce the number of buyers who can qualify for larger loan amounts. This reduces the pool of potential buyers. When there are fewer buyers than sellers, prices tend to drop over time. Since the San Francisco region currently has very low levels of inventory of homes for sale, we haven’t seen this have a big effect…….yet. I can see a time when there may be a big influx of “panic” listings from people who worry about cashing out. This is the kind of change that could happen in a relatively short period of time.

If you are thinking of cashing out or downsizing, you may want to move up your plans and get that property listed sooner than later. I am hearing about more and more listings taking 3 to 4 weeks or more to be sold. While that is still amazing, it is a lot different than even a year ago when everything was being snapped up as soon as it was listed.

In other parts of the country, there are more and more areas where prices have stalled or are declining. I have a couple of clients who have taken months and in a couple of cases over a year, to sell a home. Each of those had to do heavy discounting just to get the home sold.

For investment properties, inventory is also low, but the kind of deals that are getting done today are indicative of the late stages of a bull market. Given the low yield (cap rate) for multi family and other types of investment properties, higher rates make bonds a more attractive alternative for investors seeking income, so that could also put a damper on prices.

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The Stock Market:

For the last 10 years or so, companies have enjoyed borrowing a lot of money at low interest rates. The borrowed money in many cases was used to buy other companies or buy back their own stock. This helped to push prices higher at a pace that was far more rapid than historical norms.

By many measurements of value, including the price to earnings ratio (P/E), are at record high levels. If profits don’t dramatically increase to reflect that optimism, prices are likely to  come down to a more historically normal level. Just that activity could drop stock prices by 40% to get the P/E of the Standard and Poor’s 500 index back to the historical norms.

Also, as investors get nervous, the higher rates being earned by bonds look attractive next to stocks. After all, if I can earn 5% or 6% interest rates (we aren’t there yet, but in that direction) and the long term outlook for stocks in 7% to 8% a lot of people might jump ship from stocks to lock in those higher rates. I am not predicting the imminent drop in the stock market. In fact, we may see a rally to new highs before a major correction begins. The market is giving you an opportunity to lock in profits, it is your choice as to whether you want to take action.

What Must We Do Now?

As I mentioned in the introduction, stocks will eventually adjust to higher rates, as will real estate and bonds. It is the period of adjustment that we must navigate.

If history is any teacher, this period of adjustment could last several years or more. Take advantage of current conditions and opportunities to reallocate assets or to put in asset protection strategies. The first step is to determine where you are on your personal “Financial Timeline” and then make sure your strategies can weather the coming storm. After all, you worked hard and market corrections or interest rate changes should not keep you from enjoying a Happy Retirement!

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Do You Know Your Financial Timeline?

If we can be a sounding board or provide you with strategies to survive and thrive during these changes, contact us and we will be happy to help.