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The Truth About Inflation & Bonds 🔍
Did you know that during the 1920s, the stock market experienced an incredible boom, leading to what is now known as the Roaring Twenties?
Did you know that during the 1920s, the stock market experienced an incredible boom, leading to what is now known as the Roaring Twenties?
This period saw rapid economic growth and significant stock market gains, similar to some of the high valuations we see today.
Today, we’ll take a look at the following:
Is The Stock Market Still Durable Even At Present Valuations? First, we’ll discover why the stock market remains resilient despite high valuations 📊
When Do Bonds Do Well? Next, we’ll learn about the specific conditions under which bonds perform well 📈
Will The Fed Cut Rates This Year? Finally, we’ll get insights into the Federal Reserve's potential rate cuts this year ✂️
Stay tuned as we provide you with the latest insights and analysis to help you find your way in the financial markets. Are you ready?
Is The Stock Market Still Durable Even At Present Valuations? 📊
The stock market is durable, but we might see slightly lower returns in the future, something on the order of 5% to 5.5% annual inflation adjusted returns over the next 10 years, which would mean 7 to 7.5% nominal returns.
That is because the price/earnings ratio of the market probably should be around 20, which is pretty close to where it is today.
As the P/E drifts upward, forward-looking returns have to be muted a bit.
Sometimes people will ask if I can get nearly 5% in Treasuries.
And the answer is that you’re comparing apples to oranges 🍊🍏
I am talking about 5-5.5% returns on stocks above the rate of inflation.
Treasury yields don’t correct for inflation.
Treasury inflation-protected securities, or TIPS, yield only 2%.
So a 3%-plus difference between stocks and bonds, year after year, makes an enormous difference in wealth for a long-term portfolio holder 🤯
When Do Bonds Do Well? 📈
Bonds do well in times of very serious geopolitical risk that causes investors to panic, recession risk, and financial-crisis risk.
They also did well at a time of pandemic risk.
However, bonds do not hold up well during periods of inflation 👎
There is one type of risk for which bonds are extraordinarily ill-suited, and that’s inflation.
And the one thing that is almost guaranteed in all of our lifetimes is that prices on goods and services will rise every year, so inflation is a given.
This means that over time, stocks will outperform bonds.
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Will The Fed Cut Rates This Year? ✂️
At least one rate cut is likely this year, with the first one likely to take place on September 12.
The economy is softening.
It isn’t collapsing, and there isn’t a recession, but inflation is also softening.
Commodity prices are off their highs.
After an initial cut in September, we may get another one in December.
We could see more in 2025 📅
The long-term federal-funds rate should be somewhere between 3% and 3.5% compared to 5.25-5.5% now.
People talk about the Fed cutting rates by a quarter-point (0.25 of a percentage point) each time, but the Fed could cut rates by half a percentage point.
If we see any slowdown, the Fed will want to get to a 3%-3.5% level as soon as it can 🏛️
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