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Month: July 2023

State of the Economy

Big question: how’s the economy doing?

With the year more than half over and markets on a spree, it’s an important question to consider.

Let’s dig into the latest data and find out.

Inflation continues its downward spiral.

The latest data for June shows that inflation fell for the 12th month in a row to an annual rate of 3%.1

That’s a significant improvement from June of last year when inflation soared to 9.1%.

It also puts the Federal Reserve in the difficult position of deciding whether or not to raise rates again after pausing in June.

The odds are good that the Fed will hike rates again at least once more this year, though if inflation continues to decline, policymakers might choose to hold off.2

The economy continues to shrug off recession worries.

Despite concerns about how rising interest rates could eat away at economic growth, it doesn’t look like a recession is imminent.

Obviously, that could change.

However, a July 10 Federal Reserve model projects that the economy grew 2.3% in Q2.3

The job market is still robust, even in sectors sensitive to high interest rates.4

All told, the economy has added 1.67 million jobs in 2023 so far.5

That’s significantly less than the 2.67 million jobs added in the first half of 2022 but it shows that the labor market still has legs.

However, job growth may be cooling in the private sector, which could be a warning sign of a slowing economy.6

Market psychology has been trending toward optimism (and greed).7

The stock market generally tends to reflect expectations about the economy and business performance.

While economic data seems to support the optimistic view, markets might be a little overheated.

That means pullbacks and corrections are likely, even if we’re already in the early stages of a bull market.

Here’s some good news: They happen pretty regularly, as the chart below shows.8

You can see by the red dots that even years with strong market performance experienced some pretty big drops.

That’s normal and not a reason to worry.

So, what happens next in markets?

We see the potential for volatility ahead.

While the rally seems to have spread beyond tech stocks, sentiment could easily swing the other way.

Bottom line: We’re watching markets, we’re reading reports, and we’ll be in touch with our clients as needed.


Questions You Were Afraid to Ask #9

In our last writing, we broke down some of the most common terms associated with bonds and what they mean.  But there was one term we left unexplained – and often, it’s the one you hear the most about in the media.  We’re referring to a bond’s yield.  So, without further ado, let’s answer:

Questions You Were Afraid to Ask #9:
What are bond yields and why do they matter?

Super-quick refresher on four of the terms we defined last time, because they’ll play a role here, too:

Par Value: This is the amount that must be returned to the investor when the bond matures – essentially, the original investor’s principal. (Many bonds are issued at a par value of $1,000.)

Coupon Rate: This is the bond’s interest rate, paid by the issuer at specific intervals. For instance, let’s say you owned a $1,000 bond with a 10% annual coupon rate. The issuer would then pay you $100 in interest each year until maturity.  

Maturity: This is the amount of time until the bond is due to be repaid. A 10-year Treasury bond, for instance, matures 10 years from the date it was issued.

Price: This is the amount for which the bond is traded in the secondary market. Sometimes, bonds trade at their par value, but they don’t have to. For instance, imagine Fred bought a bond from the issuer for $1000, but trades it to Fran for only $950. The bond’s par value is still $1000.  The price, though, is $950, and is said to be traded at a discount. On the other hand, if Fred trades it for $1,050, then Fran would be buying it at a premium.  And if Fran buys it for the same price that Fred originally paid – $1000 – she would be buying it at par.   

Financial terminology can be slippery and hard to remember.  (It’s like mental soap.)  But keeping all these terms in mind, the definition of a bond’s yield is this: The return – or amount – an investor expects to gain until the bond matures. 

Simple, right?  Now we can wrap this up and go about our day.

Except, not quite.  While that may be the definition, the actual ramifications of yield go a bit deeper.  To understand this, we first need to understand the most basic way yield is calculated. 

A bond’s current yield can be found by dividing the bond’s annual interest rate payment (coupon rate) by its price.  For example, imagine Fran buys a bond with a 10% coupon rate for its original $1000 price.  The bond’s yield would be 10%, too. 

Now imagine that Frank buys that same bond from Fran a year later – but for $75 more. Since the bond is being traded for more than its par value – in this case, $1,075 – the yield would go down to 9.3%. After all, if Frank pays more than Fran for the same level of interest rate, he’s getting a lower return on his investment than Fran did, who paid less. However, if the bond trades for less than par – say, $975 – then the yield goes up to 10.25%. 

In other words, yields and bond prices are inversely related.  If the price of a bond goes up, its yield will go down. If the price goes down, the yield goes up.  Make sense?    

Essentially, by comparing the current yield of different bonds, you can see which bonds are expected to give more or less of a return on your investment. The higher the yield, the better the expected return. 

Now, that doesn’t mean an investor should just look for bonds with the highest yields and call it a day. That’s because high-yield bonds tend to come with more risk than low-yield bonds do. As we covered previously, issuers with lower credit ratings will often pay higher interest rates, since there is some risk they won’t be able to repay the principal by the time the bond matures. Investors must always balance risk versus reward when choosing where to put their money, and that holds true for bonds, too.

So, that’s yield in a nutshell. Now, you may be wondering, “Why do I hear so much about bond yields in the media?” Well, many analysts and economists use yields to project which direction interest rates will move in the future…and by extension, the overall economy. You see, when interest rates are expected to rise, bond prices tend to go down.  (That’s because an existing bond’s coupon rate will no longer be as attractive as that of a new bond, meaning the owner would need to sell the bond at a discount.) And when interest rates are expected to fall, bond prices rise. For that reason, when yields rise across the entire bond market, analysts often see it as a signal that interest rates may rise soon, too. (Furthermore, when the yield on short-term bonds rises above that of long-term bonds, this can indicate that investors are concerned about a possible recession.)         

Now, here’s the truly important thing:

We covered a lot of concepts in a very short amount of time.  Hopefully, it all made sense.  To be honest, we’re just barely scratching the surface of this topic – but this is precisely why we started writing this series on “Questions You Were Afraid to Ask.” 

The world of investing can be a complicated one.  Sometimes, it’s more complicated than it needs to be.  You will often see terms like “yield” thrown about in the media without any explanation or context. Many investors, even experienced ones, can find all this lingo to be confusing, even intimidating.  That’s not how investing should be! You don’t need a PhD to understand this stuff.  You just need to break it down and translate it into plain English.  Everyone, regardless of their level of education or experience, has the right to invest with confidence in their own future.  (Furthermore, smart investors don’t actually need to think about terms like “yield-to-worst” that much.  Far more important is understanding what you want to accomplish, and what steps you need to take to get there.

Next time, we’re going to move away from bonds and answer some questions many investors have regarding modern investing trends.  In the meantime, have a great day!