Tennis Anyone?

I recently acquired an app for my Apple iPhone and iPad called Swing Vision to help my son up his tennis game. It is an amazing little tool that turns your Apple device into an analytical tool for tennis. Using the phone’s camera it will record video of the match, keep score, show where each shot lands, and calculate the percentage of shots that are in, deep, number of rallies above eight shots, number of shots in longest rally, average shot speed, number of forehands/backhands that land in…you get the idea. After a match, it is a lot of data.

My son is less interested in the data than processing the outcome of the match. After a recent match, he queried: “How much information is too much?”

As an investor, I find myself asking that question almost every day. You can’t—and shouldn’t—take action on every scrap of data. We have to choose the information that helps us make the best long-term investment.

Last week Federal Reserve Chairman Jerome Powell pointed to the same challenge. There’s no shortage of information available to the Fed. Yet in answering a question about potential future rate hikes, Powell said the Fed would continue to focus on inflation … and more data would be needed to determine the future path of rates.

Last Week’s Fed decision

At last week’s meeting, the Fed announced a Federal Funds rate increase of another quarter-percentage point, to target the 5.25%-5.50% range.

The market isn’t sure whether there will be more hikes, and the probability in the futures market is mixed. Our view is that whether rates go up another quarter point or three-quarters of a point, we know we are nearer the end of the hiking cycle. More important than the top level is how long will interest rates remain elevated.

Bond buying

While higher rates make it difficult for borrowers, as investors, we are glad to be buying bonds on behalf of clients with yields in the 5-7% range. For those willing to take on additional credit risk, higher yields are available.

Inflation isn’t just one number; it exists in different parts of the economy and is unique to each. Energy inflation, the price of oil and gasoline, isn’t the same as the inflation in the price of cardboard for a shipping company or the price of butter (have you seen the price of butter!) at the grocery store.

As a result, while inflation has come down in some areas it has been persistently high in others. This makes the Fed’s job more difficult and may lead to elevated interest rates for a longer period of time. Good news if you’re providing credit; not so much if you need it.

Because the outcome for interest rates is still uncertain, we like the idea of buying bonds with maturities in the middle of the yield curve, 3-7 years as an example.

New data

In the day following the Fed’s meeting, we received a lot of new information about how the economy is performing.

• First, the economy grew at a purported 2.4% annual rate during the second quarter. While not great, it certainly doesn’t look like a recession either. The report indicates that both businesses and consumers continued spending. Businesses spent on improving productivity and consumers are traveling!
• Second, we learned that the Fed’s favorite measure of inflation, the personal consumptions expenditure (PCE) index, was up 2.6% after rising over 4% in the first quarter. That’s an important data point in determining the Fed’s future path for rates.
• Third, durable goods orders were reportedly up 4.7%. A strong rebound for the goods part of the economy.
• Fourth, jobless claims—that is, people who have lost a job and are filing a claim—fell. Weakness in this number provides some information about the health of the job market. With consumption above two-thirds of the economy its health is an important measure to watch.

Putting information to use as investors

All this new data suggests that we are experiencing the best of all possible worlds as investors. The economy is doing well enough to support corporate earnings growth and higher stock prices. Higher interest rates provide a better return on our bond portfolios and those higher rates haven’t cut into returns in other areas like real estate just yet.

“Just yet.” There’s the rub. Much of the good news we’re seeing is still an economic recovery from the negative effects of the pandemic. To the extent that these remain in place for longer, the Fed will be forced to keep rates high, and perhaps higher than they are today. Ultimately, we all bear the increased cost of debt. For government debt, that’s higher taxes; for corporate debt, that’s either lower profit margins or higher prices; for consumer debt, it’s a higher default rate when the labor market softens.

Just like that Swing Vision app, we have to analyze a lot of data, then choose the information that helps us make the best long-term investment decisions. We want to account for the plans of our clients, their time horizons and success before the analysis. Then, like watching my son play, sometimes you just have to enjoy the game.