Newsletter

NEWS

What Happened Last Week

US job growth showed 256,000 new non-farm payrolls in December, far above the estimates of around 165,000.

The unemployment rate dropped to 4.1% in December from 4.2% in November.

Average earnings, average hours worked, and therefore average purchasing power for workers as a whole have all increased in December.

Mortgage rates rose due to renewed expectations of 3%+ inflation for longer. The average 30-year mortgage surpassed 7% again.

Investor sentiment is fearful at the moment, and has trended fearful for the last month, according to the AAII Investor Sentiment Survey and Fear and Greed Index.

Both the S&P 500 and the MSCI World are below their 50-day moving average, but the 50-day moving average remains above the 200-day moving average.

How I See It

There is a lot of uncertainty and fear in markets right now, mainly due to the fear of higher interest rates for longer.

But while there are tradeoffs, I believe the best course forward is exactly that: higher rates for longer.

While inflation has many drivers, the largest among them is money supply. If the Federal Reserve attempts to reduce interest rates too quickly through purchasing up US Treasuries this year, that risks increasing money supply (M2) fast enough to push inflation rates back up in 2026 and potentially beyond.

That’s a bit oversimplified, because not all money goes into circulation (what we call M1) or even potential circulation (M2), but an environment that favors lending certainly encourages it.

High inflation, if it becomes the norm, is extremely difficult to slow down.

So the Fed has to make a decision. They have a dual mandate: to keep inflation low and maintain full employment.

Right now, the employment side of things appears to be easily thriving in this high interest rate environment.

High interest rates can cause difficulty in the long-run for companies which rely heavily on loans. They can also affect expected earnings many years into the future, which affect growth stocks more than value stocks. But they aren’t the only contributor, so there is usually an initial overreaction in stocks when interest rate expectations change suddenly.

Interestingly, the long-term rates turned higher than short-term rates in the past month (as measured by US Treasury yields). This was the first time this has happened in two years.

These higher long rates incentivize bank loans now as opposed to later, because they can potentially get some of the highest return on investment during this window of time. The average interest paid on bank savings accounts is less than 0.5% annually. Think about how much the bank makes by borrowing at 0.5% and lending at 7%!

Bottom line: we can still experience reasonably good economic growth with high interest rates.

The fact is, we had a lot of economic news this past week that would be considered good news under other circumstances. But it was interpreted more like bad news. That’s usually a good sign for the likelihood of a positive 12 months ahead.

I think there is a healthy fear in the markets right now, and the markets are taking a breather.

As I mentioned on December 9, I think this year could be one in which we experience a correction (down 10%-20% over a few months before continuing upward). Right now, the S&P 500 is down close to 5% from its high back on December 6 , which would be considered a pullback.

That said, I think a likely scenario is that we’re looking at a single-digit return by the end of the year. But that return is still essential to capture when investing with long-term goals in mind. And that means riding through pullbacks and corrections if necessary.

Covered call option strategies can be particularly attractive in an environment that expects smaller, but still positive, returns. For those who are less inclined to take the risk, those covered call options could help pay for put options on the downside, which act as a type of insurance against market loss beyond a certain threshold.

Options strategies can be risky if one doesn’t have full knowledge of how to execute them. But there are also ETFs that allow access to professional managers who do this for you, particularly Defined Outcome ETFs.