We have advised our clients to expect an increase in volatility for some time. It has arrived. We have also advised that it is not time to panic. That is because a great deal of money remains unspent, both by our government and the private sector, including personal savings.
The greatest threat is to companies that have no earnings. When rates rise, the relative value of companies that make no money and pay no dividends is far worse than for the boring traditional companies that we like to own. So far this year, the "hopes and dreams" stocks of last year are those that are getting hit very badly now.
The concerns are obvious. The Federal Reserve (Fed) is about to raise interest rates. They are also reducing the value of securities that they are buying on the open market. Remember, when the Fed buys assets, a process called quantitative easing, it is putting money into the economy and creating a shortage of securities. If the Fed buys a bond from you, you now have cash and the Fed has a bond. This supports the price of assets and stimulates the economy. You have cash now, what are you going to buy? Multiply that by billions and you can see how quantitative easing stimulates buying and inflation.
At this point, the Fed is only reducing purchases. Eventually, they will stop buying completely. They may allow bonds (or mortgages) to mature, moving cash out of the private sector and increasing the amount of cash that the Fed holds. We think that private-sector spending and government spending, for example the giant infrastructure bill, will replace a lot of the Fed stimulus. The economy is likely to continue to grow this year.
We also have the prospect of war in Ukraine and threats by the Chinese Communist Party against Taiwan. These fears, combined with stimulus-driven inflation, cause volatility. We are not completely discounting the possibility that we will bumble our way into war due to an unforeseen event. The Archduke Franz Ferdinand and his wife Sophie died at the hands of a drunken anarchist when their driver took a wrong turn in their open car. So started World War I.
We doubt that this will happen. If it does, and if panic ensues, we shall keep our heads and try to profit from the imprudence of others.