Keeping Steady Amid Rising Inflation

Contributed by Geoff Blyth, portfolio manager, senior vice president and chief investment officer for Tompkins Financial Advisors, Western New York

News of rapidly rising interest rates and spiking inflation have overwhelmed the financial markets during much of 2022. With the cost of everyday items skyrocketing, investors might feel tempted to revise their investment strategies to combat these fiscal pressures and secure their funds for the future. Before making any emotional (and drastic) decisions, they should take a deep breath and review what’s actually driving much of the market downturn.

On the Rise

Factors currently influencing negative market sentiment are ongoing pandemic concerns, higher interest rates, increased inflation and the war in Ukraine.  Primary among these are Interest rates and inflation. For example, the average fixed 30-year mortgage rate was sitting around 3% during the start of the COVID-19 pandemic in 2020, encouraging first-time homebuyers and refinancing by existing homeowners. As of October 2022, rates have more than doubled, significantly eroding activity in the housing market. Nonetheless, from an historical perspective, this near-term jump still pales in contrast to double digit rates in the 1990s. With this rate shift in real estate, the rental market has also seen a significant jump, showing a year-over-year increase of over 13% in the rent prices of a single-family home. And, along with the housing market, our economy is also experiencing rapid increases in the cost of other daily necessities like food and gasoline.

Not so Steady

Another, infrequent, victim of the current market downturn is fixed income, or bond investments. Bonds are the stable component of an investment portfolio, purchased to offset the expected volatility of stocks. They are the steadying force in the allocation. This year, however, bonds have suffered right along with stocks, losing double-digit value due to the speed and magnitude of rising interest rates. As rates rise, bonds lose principal value, and for every 1% rates increase, a bond will lose value approximately equal to its duration. With rates having gone up almost 3x their beginning year values, most intermediate term (3-7 years) bonds are down 15-20%, a condition not seen in fifty years. Now, those same bonds are now yielding 3-4% per year, a considerable increase year-over-year, and a benefit to fixed income investors they haven’t enjoyed in more than a decade. That being said, it will take some time to recoup all of the principal loss of the past nine months. The good news for bond investors is that they are finally receiving a strong income flow from their fixed income investments.

Forget the Flux

While these increases are jarring, it’s important to remember that the markets have gone through similar cycles before. The economy expands, and then contracts. Whether it’s international conflict or economic recession, markets have proven to be resilient. It’s also important to remember the saying “this too shall pass” when contemplating an impulsive change to an investment plan. History repeats itself and it’s usually the direst just before the correction. Remaining invested in an investment strategy that makes sense for your financial situation and time horizon is still the only proven way to compound wealth. It just doesn’t seem like it when you’re in the midst of a market storm. Those who react and make irrational market-timing moves will almost assuredly suffer more and diminish their retirement nest eggs. The tortoise does win the race, again.