Are the markets weird right now?

November 6, 2023   |   Investing

Zak Lutz here, Partner and Chief Investment Officer at LifeGuide.

I was talking to a client the other day about how stocks and bonds are both going down right now, making this an unusually challenging investing environment. And they asked me, “The markets seem really weird right now…why are things going down if the economy is actually so good?”

So, in today’s post, I’d like to do two things:

1. Explain that what’s going on is more math than weird or mysterious
2. Share why the future of the markets is brighter than it may seem right now

Ready? Let’s go!

Note: This video was originally produced for our monthly client newsletter, Guidepost.

Making sense of the markets: Is it math or mystery?

What’s going on with these markets? Is it actually mysterious?

On the one hand, the client who said these markets are weird isn’t entirely wrong. Stocks and bonds don’t usually go down at the same time. But what’s going on here isn’t as mysterious as it seems. In fact, I bet you can guess the culprit.

On the count of three, say it with me. Ready?

One, two, three…

INFLATION.

Ugh.

I know.

“Inflation!”

We’re all sick of hearing and talking about it! It’s nothing new at this point. But the truth is that inflation is still the primary driver of what’s going on with the markets right now—even with the conflict in the Middle East and China’s slowing economy.

What is new, however, is that longer-term bond yields (as in, the amount of interest or income an investor receives) have significantly jumped up recently. In fact, the yield on 10-Year Treasury Bonds recently broke 5%. You have to go back to before 2008 to find yields that high.

Until now, short-term rates have shot up, but longer-term rates have stayed lower.

That has now changed.

Stocks? Down. Bonds? Down. Why??

So, how do higher long-term bond yields explain why stocks and bonds are both going down?

It boils down to simple math.

For stocks, one reason is that in the past, when bonds weren’t paying much, people would assume the risk of investing in stocks to try and make a decent return. Now, those same people can switch to bonds—taking on less risk while still making a decent return. People are picking bonds over stocks because they are getting higher bond yields now compared to the smaller dividends on stocks. This is decreasing demand for stocks, bringing down their value.

And what about longer-term bond values? Again, it’s a simple math equation. A bond’s price has to go down when the bond’s yield needs to go up.

Allow me to illustrate with a simplified example.  Let’s say a bond pays $100 in interest, and everyone was happy with that $100 representing 4% of the bond price last year.  That bond is still paying $100 in interest this year, but that $100 now must be 5% of the bond price because rates have increased.

So, last year, when rates were 4%, you would have divided $100 by 4% (100/0.04), equaling a bond price of $2,500.  With rates being 5% this year, you would take $100 divided by 5% (100/0.05), equaling a bond price of only $2,000.

Again, at its core, there is nothing weird about this. It’s simply a math equation.

You can think of stock and bond prices “resetting” as we transition from the ultra-low rate environment we have been in for nearly two decades since the Great Recession to a more historically normal rate environment.

There are many reasons for optimism right now!

While this reset can be difficult, there is good news and reasons for optimism about the future! Here’s why:

1. Higher long-term yields will aid the Fed in the fight against inflation because they won’t have to raise short-term rates as much.
2. The Fed now has a greater ability to stimulate the economy during the next recession (whenever that may be) because they have more room to lower rates.
3. The long-term prospects of stocks have improved as price-to-earnings ratios (“PE ratios”) for many stocks have come down. The long-term prospects of bonds have also improved because they are now paying more. Lower PE ratios and higher yields mean stocks and bonds have room to move up over time, especially if rates go back down.
4. These market conditions are bringing a return to more sustainable, balanced economic conditions, which is necessary for the economy’s long-term health. Why? Because higher rates bring saving and borrowing into balance! Think about it this way: There isn’t much reason to save if you aren’t going to earn anything, and there isn’t a deterrent to borrowing if it doesn’t cost you anything. All of that has now changed. Look at recent CD rates and credit card, car loan, and mortgage rates. With higher rates, people are rewarded for saving, and it costs something to borrow. Simple math, right?

Some closing thoughts

“Trust in the Provider, not in the provision.”

I’m not saying this “reset” will be easy. However, the restored balance between savings and borrowing can bring long-term stability to the markets. I hope sharing this with you today takes some of the mystery out of the markets and helps you feel more optimistic about the future.

I want to leave you with a final word of encouragement because, ultimately, we would be doing you a disservice if we convinced you to put more trust in your wealth.

As 1 Timothy 6:17 reminds us, wealth is a lousy place to put our hope. It is just too uncertain. Instead, I want to encourage you to chew on Andy Stanley’s paraphrase of verse 17: “I will not trust in riches but in Him who richly provides.”

Said another way, “Trust in the Provider, not in the provision.”