April Storm? - April Allocation

Welcome to April and to another positive month!  We are once again at an inflection point in the market and in our economy.  We have weathered a storm with the collapse of Silicon Valley Bank and Credit Suisse, but we may not have faced the storm yet.  As a result, the main driver of returns over the past decade, the Federal Funds Rate, is once again up for debate. 

On one hand, we still have high inflation in the US, Europe, and most of the world, but on the other hand, the increase in interest rates is putting pressure on smaller banks, and more banks failures could cause weakness in our economy-through a self-fulfilling prophecy. 

What happened - Banks dutifully bought cheaper bonds during quantitative easing, and now, they have to take a write down as those bonds have lost value with the rise in interest rates.  As a result, they must increase their holdings to maintain their solvency.  Bank failures happen; no company lasts forever, so in the case of these two banks, I think the handwriting was on the wall, especially considering the management issues they have had over the years. These banks were weak and could not survive the added pressures.  How many more weak banks are out there is unknown, but the Federal Reserve has stepped in to allow for lower interest loans to prop up their books.

So back to the driver of the market – Federal Funds Rate.  It is all about pricing in, or better said, guessing, future interest rate hikes.  If investors believe the rate hikes are at an end, then they will be more likely to move from bonds back to the stock market. Additionally, if rate increases are expected, and investors have guessed how many, how much, and their models are accurate, then investors will also shift from bonds to stocks.  Conversely, if the market thinks more rate hikes are coming, and they are not priced in, then they will remain in bonds and stocks will suffer.

I am of the belief that rates will be hiked twice this year, given current economic indicators-inflation, unemployment, and GDP.  The one-time hike is priced in; the second is not. 

The recent OPEC+ announcement to cut oil production could maintain the current inflation level despite another interest rate hike, making the second hike inevitable.  However, I will be cautious in the coming months if OPEC+’s production cut is somehow a prescient move to weather a coming economic downturn.

Until we know if the banking crisis was the storm and the certainty around interest rates solidifies, I’m in the I Fund.  Keep investing!