Bear Market Bounces

Investopedia describes a bear market rally as follows: “…a period inside of a bear market in which prices of stocks temporarily increase, sometimes quite sharply, before returning to new lows. This rise in prices is typically a short-lived increase, sometimes lasting anywhere from days to months, amidst an overall long-term downward trend in the market.”

In the sharp decline from February 2020 into April 2020, there were several sizable rallies (red arrows) of at least 6% over as little as one day. Each time, the bear market resumed and headed lower until finally hitting bottom on March 23. The point is that you don’t see quick 6% to 9% rallies in a bull market, but those snap backs are typical of a bear market. Eventually a bottom is reached, but these rallies on the way down will tend to drag people into the market at just the wrong time. We always caution that it is extremely difficult to time markets and this is yet another example. Keep your portfolios and brains balanced.


Scraping the Bottom of the Barrel

Financial news is non-stop talk about inflation, expected interest rate hikes, and the effects on markets and the economy. Undeniably, this is a massive economic problem, but we’d like to add one further complication that isn’t being discussed much – interest expense. The Committee for a Responsible Federal Budget (CRFB.org) estimated that in 2021, with interest rates at record lows, the Federal government spent roughly $300 billion on interest payments on the national debt. This is the equivalent of nearly 9% of all Federal revenue collected and over $2,400 per household. What happens if rates really do rise?

The CRFB also estimated that each 1% increase in interest rates would increase interest expense by $225 billion. (That estimate doesn’t include the impact of the American Rescue Plan and substantial additional debt issued due to COVID response. If the CRFB made a new estimate today, it’s a fair bet that number would be higher.)

In this post-COVID world, $225 billion may not sound like much when we have been throwing around numbers in the trillions like it was nothing, but let’s put some perspective around that number.

The chart below shows Federal outlays in 2019, before all the extraordinary COVID spending (which hopefully won’t be repeated). Most of the spending is mandatory, as depicted by the dark blue section of the outer circle. Mandatory means that the spending is from continuing programs and are automatically and permanently built in to the budget. The light blue side of the circle is discretionary spending, which is broken down into defense and non-defense categories. The gray portion is interest expense.

 

Although Federal debt levels have risen sharply, interest expense has remained fairly low because interest rates have been so low. With the low-rate trend now beginning to be reversed, the outlook is for interest expense to account for a larger and larger slice of the pie. That trend is shown on the chart below. (The alternative scenario assumes that policymakers extend most expiring tax cuts.)

 

 

The concern isn’t just that interest expense is rising. Without additional revenue (taxes) that increased interest can squeeze out the discretionary portion of the budget and we can argue that defense is only marginally discretionary. Based on the CRFB estimate, if interest rates go up 2% more than 2/3 of the nondefense discretionary budget would need to be eliminated to pay for the additional interest expense OR we would need to raise hundreds of billions of dollars in additional taxes to make up the difference. Here are the primary items at risk in the ‘discretionary’ budget.

  • Veteran and Military Retirement …………….. $200 Billion
  • Transportation ……………………………………. $157 billion
  • Disability Insurance ……………………………… $145 Billion
  • Food Stamps ………………………………………. $132 Billion
  • Housing ………………………………………………. $81 Billion
  • K-12 Education ……………………………………… $70 Billion
  • Social Security ………………………………………. $57 Billion
  • Higher Education ………………………………….. $36 Billion
  • Science, Space & Technology …………………… $35 Billion

It is very clear that discretionary is not so discretionary and tough choices lie ahead. There Is always the option to just add debt to maintain spending, but that just makes the problem worse in the long run. If you get the feeling we are approaching a self-reinforcing debt vortex, you may well be correct.


What We’re Reading

Commodities Are The Most Underused Inflation Hedge

U.S. Jobs Surge Defies Omicron, Puts More Pressure on Fed

Are Target-Date Funds Flawed?

How many robots does it take to run a grocery store? (5 min video – WOW!)

How the Biden administration misread the inflation threat

Black unemployment rate dips, labor force participation rises in January

How to Read the Jobs Report (6 min video)

Here’s why your tax return may be flagged by the IRS

The curious case of rising stocks in the night-time

 

 

Disclosures:
Palumbo Wealth Management (PWM) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where PWM and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at www.palumbowm.com
Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this newsletter, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio.
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
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By: thinkhouse