Over these last few weeks, the Stock Market has been dropping pretty steadily, and it’s not showing any signs of slowing down. What does this mean? Is it time to just pack up and leave?
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Right, now let’s talk Stocks.
Most stocks took a hit, especially most of the interesting growth and spec stocks out there. Three big examples from my own portfolio would be NIO (which is currently at $38.11 in comparison to its $62.84 in early February), Tesla ($598, down from over 860 early February), Apple ($121, down from $136 in Feb.).
Why is this happening to the stock market?
To put it simply – because we aren’t the only people on the market. Every little action that every investor takes affects the overall situation. And so, with the bond yields going up, the market trying to correct itself, and all of this talk of inflation, people are going to be worried. To top it all off, Federal Reserve chairman Jerome Powell recently announced that they will not be raising interest rates.
What did people take away from his statement? “Inflation is coming. Time to panic!”
But here’s the thing – we’ve been seeing inflation all around the Market for the last year. And, if you’re into real estate, you know that it’s been happening there as well.
Alright, but why now?
For inflation to really kick in, money needs to move around fast. In the financial world, this is called “velocity of money”, and it comes with its own fancy formula, backed up by a ton of data and theories.
And what do we have right now? Lockdowns, that’s what.
People are discouraged from going out and spending their money because a ton of stuff is just not available or overly difficult to do. Think restaurants, vacations, movie theatres, concerts … Since people can’t spend their money where they want, they’re just saving it. And J.P. Morgan confirms this by pointing out that US household savings have gone up by over 1.5 trillion dollars for last year alone.
But what will happen once we finally put all of this lockdown stuff behind us?
Well, people are obviously going to go out and do what they’ve been wanting to do. And, since they’ve had to wait for more than a year, they’re going to want to do them fast. This means that a lot of money is going to change hands really fast.
Then, there’s also the whole stimulus thing that’s happening over in the US, where over 1.9 trillion dollars will hit the economy. And by “hit”, I mean inject another 1.9 trillion into it.
So, the lockdowns are, in a way, keeping the inflation bay, for now, at least. Of course, I’m not saying that lockdowns are a “good thing” because they are also one of the main reasons we even got to this situation in the first place.
Lately, there’s been a lot of talk about loosening restrictions and potentially returning to normal by the end of the year. But while people are looking forward to going back to living their lives like they want to and businesses are planning to finally get back on track, investors are getting increasingly worried.
In 2020, both the real estate and the Stock Market managed to hit record highs, not just because people were scared, but also because they … didn’t have anything else to do with their money. And we’ve already seen inflation in both of these fields, so, even if you haven’t thought about the bigger picture, it’s only natural to expect that it will spread over to the rest of the economy.
Bonds & inflation
Bonds serve as a sort of a “warranty”. One-point-five percent bond yields mean that after you buy, you are guaranteed to get a 1.5% return on your investment every year. But if investors are worried about inflation, 1.5% just doesn’t cut it. If the inflation is higher than the bond percentage, people will lose value on their money over time, and, well, nobody wants that. So, nobody buys bonds.
But if nobody buys bonds, the yield goes up (supply & demand, basic stuff).
Here’s how it works:
- Investors worry about inflation.
- Investors stop buying bonds.
- Bond yields go up.
- Investors start buying bonds again.
Bond yields are directly tied to inflation projections. The higher inflation people expect, the more bonds need to yield. If you take a look at the history books, you’ll also notice this pattern (back in 1981, when inflation was at about 12.5%, bond yields managed to hit 15.30%).
Why is this affecting the stock market?
If bonds go up to, let’s say, 10%, people would get a guaranteed 10% return on their money by making a risk-free investment. But the money put into bonds is money that’s not put into the stock market. So, the stock market directly suffers as a result of people buying bonds.
- Inflation (projections) goes up.
- The price of bonds goes up.
- People pull their money off the Stock Market to put it into bonds.
- The Stock Market suffers.
Additionally, there’s a ton of people out there who are 100% convinced that the ten-year yield (Treasury Yield 10 Years (^TNX)) leads the Federal Reserve’s interest rates. When they see the bond yields going up, they automatically assume that the Fed will raise their interest rate.
Remember how I mentioned that the Fed’s chairman said how they’re not going to raise interest? Well, this same announcement made the bond yields go up, and the market go down even more.
How do Interest Rates affect the Stock Market?
Don’t stocks “love” low-interest rates? Well, yes, but also no. In general, low-interest rates are good for investors because money is a lot more “accessible”. But this accessibility also speeds up inflation.
The real estate market is hitting record highs precisely due to the low-interest rates.
- Low-interest rates cause more inflation.
- Inflation makes bond yields go up.
- Bond yields going up makes the market go down.
So, what does this mean for the Stock Market?
If the interest rates stay low, the market suffers. If the interest rates go up, the market suffers. Does this mean that the Stock Market is finished?
Of course not.
The market had a fantastic run, and now it’s time for a correction. This is all normal. And no matter what the Fed chairman said, the stock market was going to react poorly.
What am I doing now?
I’m doing exactly what I always advise people to do – I’m keeping an eye on the prices and waiting for good opportunities to buy. I will continue with my strategy for as long as I still believe in the companies. If I lose faith in them, I will find new, better investment targets.
Of course, I’m being careful. I don’t like being overly aggressive with my purchases, even in the best of times, and I want to see some really good deals before I start buying more aggressively. Besides, I strongly believe that every long-term investor should hold on to a solid cash position. Throwing everything you have into the Stock Market is all sorts of silly and will only lead to problems down the line. If you have been following my channel for some time, you’ve probably heard me talk about this over and over, but I’ll leave a couple of links for you down in the description, just in case you missed it.
Wrapping it all up
So, let’s wrap things up for today with a short summary:
Stocks are not just some arbitrary numbers in your spreadsheet. Every stock on the market represents a real business, staffed and ran by real people. When the price goes down, the valuation for the entire company goes with it. When the valuation goes down, they need to produce fewer earnings to meet their price-to-earnings ratio. When the stock goes higher, the business needs to perform much better to justify the price.
- No, it’s not “over” for the Stock Market.
- Yes, there is inflation, and it’s reasonable to expect even more inflation down the line.
- Yes, inflation will mess with the bonds and the Stock Market.
- No, there is no reason to panic.
- Yes, I expect more dips.
- No, I am not buying aggressively.
- Investing is safer when stocks are cheaper.
- Investing is riskier when they’re more expensive.
Keeping cash on hand allows you to take advantage of the big dips when they happen.
The market is correcting itself right now. The bond yields are going up, and there is a lot of talk about inflation. And while you guys might not be too worried about it, the average investor will be.
Something that I often bring up in our Private Investing Group is that we need to remember that the market moves based on everyone’s actions. The average investor isn’t some super-specialized sixty-plus-year-of-experience genius with five different financial degrees. There’s a massive influx of new people on the market, but even those who have been around for a while will still make mistakes and give in to media hype or fear.
And, when every other week, we get a new big “situation” that’s touted as scary or problematic for the market, tons of people fall for it.
But we, as long-term investors, cannot afford to fall for these distractions. We need to keep a cool head and look at the future.
And so, I advise my group members to do just that:
Do your research. Think before you buy and do it in increments. Don’t be overly aggressive with your purchases unless the situation really calls for it.
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If you like this sort of content and you’d like to get more of it faster, then I suggest checking out our Private investing. You’ll get instant access to a ton of exclusive Stock blogs, a couple of courses (that you won’t find anywhere else), and the ability to get in touch with me in real-time. Links are in the description below.
Thank you all for reading, and until next time.
Recommended books for further reading:
- A Beginner’s Guide to the Stock Market: Everything You Need to Start Making Money Today
- How to Make Money in Stocks: A Winning System In Good Times And Bad
- How to Day Trade for a Living: A Beginner’s Guide to Trading Tools and Tactics, Money Management, Discipline and Trading Psychology
- The Warren Buffett Way
- Warren Buffett and the Interpretation of Financial Statements: The Search for the Company with a Durable Competitive Advantage