Stock Talk - Higher Interest Rates: A Threat or Opportunity for Retirement?

Starting point is 00:00:00 Welcome everyone to this special Oak Carbush Roundtable on higher interest rates and what they could mean for your investments and your retirement plan. I'm Chris Paris, and Troy and Charles and I looked at one issue that reaches almost every part of your financial life. We started with a simple idea. Higher interest rates can lower the value of future cash flows, but they can also create better income opportunities for savers and retirees. If you missed our full discussion on higher interest rates, this is the short version. this is for you. The ideas we think matter most for retirees and near retirees in our roundtable, the Oak Carvest team spent 90 minutes looking at how higher interest rates move through stocks, bonds, real estate, commodities, annuities, and your retirement plan. The biggest takeaways were

Starting point is 00:00:45 surprisingly simple. Higher rates can hurt the price of assets you already own while improving the income you may earn on new money. We also talked about why earnings and productivity can sometimes overpower rising interest rates just as they did during parts of the 1990s technology boom. Finally, we broke down the 10-year Treasury to show why a rise caused by real interest rates can mean something very different from a rise caused by inflation expectations. Eric and I have pulled together the strongest moments from our discussion and tied them back to one question. Or higher interest rates, a roadblock for your retirement plan, or a new set of opportunities.

Starting point is 00:01:21 We hope you find our discussion educational and entertaining. Who controls interest rates? We hear all the time on television that the Fed is going to raise rates, but that's short-term rates. So tell us who really controls interest rates and how that's all determined. Thanks, Troy. So outside of times of crisis where the government in the Treasury and the Fed will step in and try to control and manipulate long-term rates, they set short-term rates, right? They set the rate that banks borrow from the Fed at. They moved to, you know, it up last week for the first time, and I think it was three years, they had not hiked rates. They hiked rates by 25 basis points. I think the Fed funds rate went from three and three

Starting point is 00:02:05 quarters, four percent, something right around there, only 25 basis points. That said, if you look historically, the Fed really follows the bond market. There's been a bunch of studies done that they tend to follow the two-year treasury with a lag. So right now, you know, they raised rates. the short end, but long-term rates have been trending up now for upwards of five years. I think we were looking at this right before we came in. 2020 and COVID was pretty close to the secular low for long-term rates. We will be talking about the U.S. Treasury market, because that's the benchmark rate, regardless of whether it's three months or 30 years.

Starting point is 00:02:48 All other fixed-income products, whether that's corporate bonds or municipal bonds, are based off of that benchmark rate. So that's why it's so important. Yeah, and the whole premise for this episode when I was thinking about what we wanted to do is because you turned on the TV the last week and financial news is more or less in hysteria that the Fed raised rates for the first time in three years.

Starting point is 00:03:13 And it's not a positive or 100% negative, right? There's some good things about them raising rates. You know, if they're raising rates for the right reasons, economic growth, you know, accelerating, real growth being okay. You know, that's actually beneficial for some kind of assets. You know, it's not great for your, if you're going to look at buying your first house, but, you know, a lot of retirees and pre-retirees have already refinanced their mortgages, you know, in 2020, 2022, and mortgage rates for three and a half, four percent. So the higher rates to them, you know, don't really mean anything, right? It actually means that if you

Starting point is 00:03:52 you didn't lock in a 10-year treasury at 1% at the COVID lows. You probably have some cash that you can invest at higher rates, whether it's in the stock market or in the bond market or annuities or whatever tool you need in your retirement plan. Well, yeah. So, okay, so we have some other good questions here. Just, I want to kind of rapid fire these and just try to answer quickly so we can get to the giveaway.

Starting point is 00:04:17 Do we see, where did it go here? Okay, so Ronald Joe just simply says, where do we see inflation going? So just a brief talk on inflation because I think one, coming up in a couple of weeks here, October 14th, I believe. We get the Social Security COLA information. I'm going to do a video on that once it comes out. But just generally, look, my personal opinion is a quarter point rate hike isn't going to do much to curb inflation. But what is your opinion, guys? It depends.

Starting point is 00:04:52 I'll let Chris give the definitive answer. No, there's no, I mean, there's no, there's under the bus there, pal. Yeah, it's okay. I mean, let's talk about it where it matters. There's like 100 components in inflation or something. But where it matters for people watching this in retirement, approaching retirement, the goods and services that they're expected to buy over the next six to 12 months. I'll give the academic answer and then I'll give the, you know, financial advisor answer.

Starting point is 00:05:19 So inflation is, you know, it's above 2%, right? It's running probably 3%. And it had been coming down. There's a couple websites out there. One's called Truflation, which does a great job at marking to market housing prices, which are coming down in most locations. But the way the Fed looks at it, it takes a year before it comes into their data. And they also overweight rental prices?

Starting point is 00:05:48 rental prices, they include investment management fees, they include memory prices for computers, a host of things are in there that make it look probably higher than most people realize. But it's running, say, over 3%. And I hear a lot of complaints. I've heard it for the last couple years. And I have to smile at times because I've never once heard anyone come in. a client or a potential client and look at their portfolio and say, my 15% returns in stocks are too high. And I'm like, well, that's inflationary. You just like it, right? Or your housing.

Starting point is 00:06:31 You know, housing prices are up since 2020 in some markets, 20%. Most retirees already own their house, right? And they've been a beneficiary of that massive inflation in that asset they own. So, you know, the egg prices have gone, you know, from $2 to $3. But that... Meanwhile, your Exxon has gone from... Your portfolio has gone up hundreds of thousands of dollars. So, you know, I just, I implore people who are in retirement or near retirement to look at the big, big picture in, you know, if you do have assets in the stock market or have homes and assets, you know, step back and look for a little bit how lucky you've been to be in an environment that the returns. have been really good to offset a lot of that short-term inflation that we're getting the last

Starting point is 00:07:19 five years with all this money printing and givingaways and spending that's going on by the government. We'd like to talk about stocks. Definitely more than bonds most of the time. So, I mean, so. I thought the discussion on bonds tonight has actually been quite interesting. It is for two old bond guys. You see how many people are still tuned in.

Starting point is 00:07:39 Okay, yeah, we're staying steady. So, yeah, stock prices. So, you know, a stock is the net present, you know, any asset, right, is the net present value of the cash flow it generates over, the free cash flow generates over time. So you discount that at a rate. The higher the interest rate, the lower the net present value. That's pretty simple economics equation. You can do it on your calculator. Makes sense, right?

Starting point is 00:08:08 with the stock market, that is historically the case. And it's been going on now in our current stock market for almost 18 months. The multiple on the overall S&P 500 has come down to about three points. Three turns, yeah. Three. From around 23 to 20 times earnings, while earnings are actually getting much better this last quarter. When you strip out one-time gains, it was the high 20s, 28, 29 percent.

Starting point is 00:08:37 Correct. something like that. So, you know, and the S&P 500, your to date is up 12, 12 and a half percent, somewhere around there. So, you know, if interest rates had stayed flat with earnings being up, you know, 28, 29 percent, you would have thought, hey, the S&P 500 might be up 28, 29 percent. That higher interest rate, I always look at the 10-year interest rate for stocks, you know, is compressing the multiple sum. Right now, it's essentially five percent. you know, which is essentially 20 times earnings. I just flip the interest rate and kind of get the multiple.

Starting point is 00:09:15 So in short, a higher interest rate puts pressure on stock prices. It's a headwind. It's a headwind. Earnings have gone up. A lot. Earnings have gone up, but the stock market has not gone up quite as much. Typically, if we have, let's say it's a 15 multiple on earnings in the market. So when we talk about a multiple, if you have $1 in earnings, a 15 multiple,

Starting point is 00:09:37 you'd have 15 times one, a price of $15. Earnings have gone up. They've done tremendously well this year, but because interest rates have increased, it's put pressure on stock prices. So even though we look in our accounts and everything is increased in value, if it weren't for interest rates being higher,

Starting point is 00:09:58 stock prices would be much higher. Yes, I mean, and looking even more granular, the 10-year treasury since the war in Iran started, the end of March is up 100 basis points. It's gone from 4% to 5%. Right. So that's essentially taken the multiple of the S&P 500, you know, a 4% 10-year treasury.

Starting point is 00:10:19 You could say, I'm going to pay 25 times. You know, now it's a 5% 10-year treasury. It's 20 times. So that's what's been the headwind is the multiple and rising interest rates. And you can see it in real time almost daily nowadays, depending on where oil goes and how the negotiations in Iran are going or how the war is going. You know, the last couple days, there's been optimism that it was going to stop.

Starting point is 00:10:47 And oil is down, I think, $10 a barrel the last two or three days. Longer-term interest rates fell, like 10 basis points. And as soon as they start falling, you can see the S&P 500 overall start rallying pretty considerably because there are computers that will trade this to the, you know, one basis point every day. A lot of retirees and pre-retirees own real estate, right? And so, you know, how do higher interest rates affect your real estate holdings, whether you're renting real estate or whether you own it and you're looking to sell it? And it, I mean, that's pretty easy in that, you know, higher interest rates lead to higher mortgage rates generally, which means the buyer of your

Starting point is 00:11:28 property is going to probably pay less, even though you might think it's worth more given the economy and everything else, someone else isn't going to be able to pay as much just because their financing costs are going up. So, you know, it's real estate over long periods of time, rental properties can be inflationary hedges, you know, right? Because you can raise your rental rates, right? But your house itself that you're living in, a little different. You can't raise your own rent. So, you know, if you're looking to sell now, you might be looking. at, you know, lower prices than six months ago. And a lot of that might just be because mortgage rates are now over 7%, I think,

Starting point is 00:12:11 seven and a quarter percent for a jumbo. So definitely a major headwin for real estate purchases. Okay, so let's transition, though, because most of our clients, they own their home. It's almost paid off. It is paid off. What about investing in real estate? How does it impact investing in real estate? So we have two different types, right?

Starting point is 00:12:32 So you can invest in real estate through the public markets where you buy a reet. You can invest in the private market. And technically there's two types of private markets, right? Maybe not private markets, but private investments. You can do it through a pooled investment vehicle, like a limited partnership or a private reit and you get a K1 and you are hands off. You don't get the tax benefits. But you get some income and some price appreciation potential.

Starting point is 00:12:59 Or you can do it yourself, right? where you are out there investing privately? Yeah, the only thing I want to say on interest rates is connecting it back to the stock market and stock market cycles. And I want to say, and I'll put some of these slides out probably in future stock talks. But historically, so when the Fed raises rates, right,

Starting point is 00:13:23 if they're raising it for the right reasons, growth is good, it usually doesn't kill a bull market. Now, historically, it can slow it down for the first three months. And if there's going to be a pullback in the market, historically, and the Fed raises rates, it'll come in the first three months. You know, and historically, it's, I mean, it's been as little as, you know, 5% and as much as 12 to 15 when things get really rough. I'm probably not expecting that in the fourth quarter, but something that extreme. If we are going to get a move down in the market caused by the Fed, it should come relatively early

Starting point is 00:14:06 because the economy is doing well and earnings are doing well. So usually on the other side, you know, if it's not an inflation blowout and the Fed says, this is a cycle we're going to raise rates five times, you get the earnings continuing to improve and you get investors exhaling. And historically, the market has very good positive returns over the coming 12 months. The only time they've really, I'd say, kind of blown up a bull market cycle was during dot com when they raised rates and raised rates and kept raising rates in 2000 when the economy was already slowing down.

Starting point is 00:14:48 And they, you know, they went too far in that one and did create a problem for the stock market. That was one of the lone times that's happened. Thank you for tuning into Stock Talk. The Oak Harvest team hopes you have a great weekend. All content contained with an Oak Harvest podcast expresses the views of the speaker and is for informational purposes only. It is based on information believed to be reliable when created, but any cited data, indicators, statistics, or other sources are not guaranteed.

Starting point is 00:15:18 The views and opinions expressed herein may change without notice. Strategies and ideas discussed may not be right for you, and nothing in this podcast should be considered as personalized investment, tax or legal advice, or an offer or solicitation to buy or sell securities. Indexes such as the S&P 500 are not available for direct investment, and your investment results may differ when compared to an index. Specific portfolio actions or strategies discussed will not apply to all client portfolios. Investing involves the risk of loss, and past performance is not indicative of future

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Stock Talk - Higher Interest Rates: A Threat or Opportunity for Retirement?

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