The Economy
We are going to see strong Gross Domestic Product (GDP) numbers for this quarter and into next quarter as compared to this time last year. Obviously, business/GDP ground to a halt at this time last year. Demand is picking up and will continue to pick up as we progress toward a post-pandemic economy. Interest rates are still very low from a historical perspective, so housing and other large ticket items will be in high demand. This is part of the reason that inflation is increasing.
Markets
There has been a rotation in the market away from technology stocks being the leaders.
Energy stocks and commodities have been doing very well. The winners since the fall have been small company stocks, energy stocks, commodities (do well with inflation), and financial stocks, especially banks which do well when interest rates rise.
Bonds – Inflation and Interest Rates
Inflation
We have supply-side shortages (including labor shortages) and increasing demand which will increase inflation. We recently wrote about the drivers of inflation in this blog article.
Housing and Inflation
The low interest rates allow buyers to afford homes (lower mortgage payments) even with the increased prices. With low inventory and these interest rates, the demand will continue to outpace the supply of used homes and new homes to be built. All of this increased demand, which is stressing limited supply, will increase inflation.
Inflation and Interest Rates
Increasing inflation has made longer-term interest rates spike.
Bonds and the Spike in Long-Term Interest Rates
With interest rates and inflation rising, bonds are getting clobbered. We knew this was coming at some point. We will probably have at least one more move down on interest rates but that may not be until a bit later.
Where most diversified portfolios have a large portion in bonds, especially conservative portfolios, it is a good time to assess the duration (maturity) of bonds in your portfolio. The longer the duration, the more susceptible they are to interest rate spikes. Shorter-term bonds are less volatile, so they lose less money in times of rising interest rates.
Treasury Inflation Protected Securities (TIPS) are a good alternative to long-term US treasury bonds. These bonds adjust for inflation, and although they are impacted by rising interest rates, they are impacted less than long-term treasury bonds without the inflation adjustment.
We have experienced a long-term bull market in bonds, approximately 35 years. The fun is almost over. With the next market or economic downturn, we should see interest rates fall and bonds rally but that could take some time to play out. In the meantime, the interest rate trend is up. You should review your portfolio and adjust your bond allocation accordingly.
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