Rising Interest Rates and Their Collateral Damage: What To Know

See what’s next for banks, inflation, company buybacks, alternative investing and more

How are you feeling these days? Well, probably pretty pessimistic. Well, you're not alone. People are more pessimistic about the financial markets than they were even at the start of the pandemic, even more so than during the 2008 credit crisis. It's understandable why there's so much pessimism. Fund managers expect the Fed to raise rates seven times this year. Some expect 12 rate increases. Inflation has been rising at the fastest pace since 1981. And you would think that with all the pessimism, people would not want to own stocks and bonds, mutual funds, or ETFs; people are selling all those assets. They're taking that money and throwing it into bank accounts. Banks don't want your money. They've already got $9 trillion in cash. That's more than they have in outstanding loans. This is why bank savings accounts and CD rates are so low because the banks don't want your money. Their attitude is: go somewhere else, let them have your deposit.

What caused our economic stagnation?

Over the past couple of years, the federal government gave out $1200 stimulus checks. They gave out $600 a week unemployment checks. They gave $300 a month child tax credits. And the government's not done. Not just at the federal level where they're talking about $10,000 student loan forgiveness, in California, they're getting ready to give everybody in the state a $400 gas debit card. There are 11 million jobs open in America; two for every person who's employable but not working. But why should you get a job when the government is throwing so much money at you since there aren't enough people willing to look for work? Employment levels are still below that of 2019, and this is a challenge for the economy because if employers can't hire the workers, they can't make the products, they can't sell their services. And there is that much less for people to buy. And we have economic stagnation coupled with inflation. Here's the crazy thing. 

Even though US consumers are pessimistic about the economy in the first quarter of this year, credit card spending was up 28% compared to a year ago. And by the way, it's not just your debt that's an issue. It's federal debt. Federal debt is now $24 trillion and 30% of that money are US Treasuries that mature within the next 12 months. Now what happens when the federal government has a US Treasury that matures? They have to replace it with a brand new US Treasury.

Rising interest rates will change everything

The problem is that interest rates are much higher today than they were 12 months ago, and that means the government is going to have to start spending more money than ever on the interest on the national debt. In fact, interest on the national debt is the fastest growing part of the entire federal budget. Oh, my goodness gracious. You can see the challenge. And in the middle of all this we have I-bonds. I-bonds are really a wonderful thing. I've talked about them often here on the show. They're paying over 9.5%. Somebody somewhere please explain to me why we allow the government to issue bonds that are paying an interest rate that is 3 to 4 times higher than anybody anywhere else in the country is paying. All we're doing is exacerbating the federal debt problem and the cost on the interest on that debt. 

Meanwhile, so far this year, bonds have lost more than 10%. 30-year treasuries are down 20% this year. I warned you about this back in January. I warned you that we were going to have a very terrible year for bonds because as interest rates go up, the price of bonds goes down. And we are seeing the worst year ever. Prior to this, the worst year for bonds in the United States was 1842.

It's bad and it's going to get worse as interest rates keep going up, the price of bonds keeps going down. And all bonds are affected by this, including mortgage backed securities. They're in turmoil because of the hot housing market. Last year, there were $4 trillion of mortgage backed securities issued. The Federal Reserve bought most of them. Investors had to buy only $300 billion worth of those bonds. But this year, the Fed isn't buying so much. They're not supporting the economy the way they did during the pandemic. And therefore, the amount of these bonds that investors have to buy has doubled to $600 billion. Think about that. If there's twice the supply, what does that do to demand? Demand isn't twice as strong. And that means you can expect further price declines in mortgage-backed securities. 

Companies are buying back more of their own stock

So what do you buy when you want to buy stocks? Well, if you're the corporate CEO and you're sitting on hundreds of millions of dollars, billions of dollars in some cases, what do you do with all that cash? So what are corporate CEOs doing? They're buying stock of their own company. They're called corporate buybacks. And corporate executives are buying back $1 trillion worth of their own shares this year. Now, on the one hand, you could argue that this is their way of saying we think our stocks are oversold, that the prices are too low, and they are a great bargain right now.

But keep this statistic in mind. The last time we hit a high of corporate buybacks was in 2000, right before the .com bubble and 2007, right before the 2008 credit crisis. This is, in fact, the worst start to a year, the first several months ever. For the Nasdaq, it's down 21%. The S&P has fallen for six, seven consecutive weeks. We have seen massive losses in individual stocks. Netflix fell 35% in a single day, 49% in a single month. It's down 71% from its high. Nvidia fell 32% in a single day. PayPal down 24% in a single day. Amazon down 14% in a single day. And the FAANG stocks - Facebook, Apple, Amazon, Netflix and Google, collectively, they've lost more than $1 trillion in a single month. I kind of love it when people tell me that Bitcoin is volatile. Invesco is no longer recommending a 60/40 portfolio. They're now recommending a 50/30/20 portfolio, 50% stocks, 30% bonds, 20% alternatives. 

The rise of “alternatives” and thematic investing

Alternatives. That's a new word. A word you need to get familiar with. New York City's comptroller manages the city's $500 billion pension plan and retirement assets for police officers, firefighters, schoolteachers and other government workers. And he now wants permission to invest in alternative investments such as foreign stocks or private equity bonds that are high yield debt, meaning junk bonds. Alternatives, they say, are key in times of market volatility.

Texas gave its state pension plans permission to invest in alternatives, so did Georgia. Other states and cities are revising their rules as well. Hedge funds, non-traded real estate and yes, crypto all in the alternative space. Related to all of this is thematic investing. Thematic investments have tripled their share of the global investment market over the past decade. Now, 3% of all stock funds are thematic funds. $800 billion in total assets. 

I invented one of the first thematic funds, the iShares Exponential Technologies ETF. The symbol is XT. I invented this back in 2015. That fund now holds $3.5 billion in assets and has a wonderful track record of above average returns and below average risks. It's an exact example of thematic investing. There are now dozens of ETFs available with a similar theme in the area of exponential technologies. You have a whole bunch of fund companies, including Global X and Invesco, that offer a wide array of thematic funds, recognizing that these categorize as alternatives to traditional investment management. So as you are trying to evaluate your investment strategy, recognize that you probably have a traditional portfolio 60/40 or maybe it's 65/35 or maybe it's 50/50. The time might be now for you to consider adding alternatives to your portfolio. And yes, in the world of alternatives, that's where you'll find crypto.