Investor Essentials Daily

Bonds are still the way to go

January 22, 2024

The year started with unexpected economic data, impacting the Federal Reserve’s strategy. 

Unemployment rates were lower than expected and inflation showed resilience. These trends have dampened investor optimism, making early interest rate cuts by the Fed less likely. 

The strong job market poses a challenge for the Fed, while high interest rates have led to a significant rise in corporate bankruptcies. 

This situation has caused uncertainty in the stock market, making bonds more attractive due to its lower risk and higher interest rates—the highest in 15 years. 

Stocks have very little reason to keep rising because of the market’s expectation of rate cuts and the possibility of a continued high-rates. 

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The year commenced with a surprising twist in economic indicators, challenging the Fed’s strategic balance. 

Job numbers exceeded expectations, keeping unemployment at a low of 3.7%, defying the Fed’s targeted range. The recalibration of October’s unemployment figures to 3.8% further cements this trend. 

Meanwhile, inflation, a pivotal factor in economic planning, displayed tenacity. After a brief pause at 3.1% in November, it rebounded to 3.4% in December, complicating the Fed’s pathway.

This evolving scenario casts shadows over investor optimism. The anticipation of the Fed cutting interest rates as early as March is now much lower. 

Each month’s delay in policy shift exerts additional strain, threatening the possibility of a soft landing for the economy. 

Furthermore, the robust job market, typically a symbol of economic health, now presents a paradox—indicating resilience yet complicating the Fed’s maneuvers.

Another crucial aspect to consider is the impact of low rates on struggling corporations, potentially averting a bankruptcy wave. 

The Fed faces a delicate balance. Premature rate cuts could fuel a new cycle of high inflation, a scenario arguably worse than a brief recession.

The corporate sphere is already reeling from last year’s rapid rate hikes, evident in a staggering increase in major bankruptcies by 108%. 

Take a look…

This trend sets a grim backdrop as we begin the year. 

Bankruptcies trigger a domino effect—job losses, diminished investor confidence, tightened lending conditions—affecting not just a few, but the broader business ecosystem.

With the market’s flat start this year, the narrowing window for rate cuts adds to investor unease. 

If interest rates remain high, coupled with the already visible strain in the corporate sector, the stock market is going to have to pull back as a result.

In contrast, as more companies refinance their debt at higher rates, bonds are starting to look like a more reliable option.

As long as a company doesn’t go bankrupt, it has to pay back its bonds. That means investors have lower risk than they do investing in the stock market.

And today, bond interest rates are higher than they’ve been in 15 years.

On the flipside, stocks have very little reason to keep rising. 

As we have covered, the market already expects the Fed to start easing rates as soon as March. If that happens, it’s not likely to make the market rally… since it’s already expected.

But if the Fed ends up keeping rates higher for longer, that could start a major market pullback.

Best regards,

Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research

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