Join Bob Fraser and Ben Fraser as they uncover the surprising data showing investors expectations on rates have historically been wrong. Learn about why this is and what it means for making investment decisions.
Wall Street Journal article – https://www.wsj.com/finance/investing/investors-fed-interest-rates-a842073c
Connect with Bob Fraser on LinkedIn https://www.linkedin.com/in/bob-fraser-22469312/
Connect with Ben Fraser on LinkedIn https://www.linkedin.com/in/benwfraser/
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Transcription
Introduction
Bob Fraser: Hello, listeners. Today, we’re going to talk about the surprising way that nearly all investors are wrong.
Ben Fraser: What could it be? What are they wrong about? Stay tuned. We’re going to chat about it today. This is our top of mind segment on the show. These are fun, quick hitters on a topic that’s interesting and hopefully illuminating for our listeners.
So we’re reading this article today, and when you see this chart, I’m going to share my screen here. So if you’re watching a video, you can see it because it just tells one picture is worth a thousand words, right? And What’s been so interesting, and it’s all about investors being wrong about the Fed.
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The Role of the Fed in Investment Decisions
Ben Fraser: It’s so interesting that the Fed has become the focal point of the discussion of all investors over the past two years, really because of these interest rate increases and what the Fed is going to do, and what their perspective is going to be on inflation.
And it’s interesting because. As investors, we like to think we’re very rational, right? But there’s a lot of books that are about this, right? They were predictably irrational. And I’ve heard it said one way that people and humans make decisions emotionally and then justify them with logic, right? And we actually think we are.
Make decisions rationally and then have emotions that follow it. It’s usually the inverse and so much of that plays into investing and how we as investors make decisions.
Understanding Market Expectations vs Reality
Ben Fraser: And so you can see this chart here and this is the Fed funds rate and then it’s showing the market expectations versus what actually happened.
And so you can see this chart, this is over the past 20 years. You can see.
Bob Fraser: Describe it for just those people who are, who are listening.
Ben Fraser: Yeah. So we have two different lines here. We have the, on this chart, a black line that is the actual effective interest rate at that point in time. But as you may know, there is a yield curve, right?
Which is the market expectations of what interest rates are going to do at some point in the future. And so then they overlaid at that point in time, what were the expectations of the fed funds rate at that point in time and on an ongoing basis, and so you can see. The overlay of those expectations on what actually happens. And in almost every circumstance.
Bob Fraser: The investors are wrong. Investors are wrong about what is gonna happen with interest rates.
Ben Fraser: And it’s, if you see this chart, it’s not just a little bit it’s pretty it directionally, totally incorrect. And so if you go back to the last recession, oh 8, 0 9, we had a big increase in rates.
And the interesting thing was the rates were actually expected to stay flat and hold for a longer period of time. But then there was a recession and they dropped them effectively to zero pretty quickly. Going against investors expectations. And then for the next probably 10 years or so, the expectation was yields were going to go up at some point, and they did it, they kept them low.
Yeah, and a pretty aggressive expectation and you fast forward to now and what we’ve been saying all along is The Fed is going to go from what they’ve been saying and what they’ve been showing so far. They’re going to be deliberate. They’re going to be slow in making these kinds of rapid decisions and changes of their perspective.
And they’ve been pretty clear from the outset, right? They’ve not changed the tune for really the past eight months.
Bob Fraser: So they’re clear that they’re not going to lower rates soon or quickly or until inflation meets their targets. They’re And it’s consistently beating their targets and yet the market continues to say, Oh, the rate, they’re going to cut rates.
They’re going to cover anything. The chart shows this as rates are steadily rising, the expectations, Oh, they’re going to drop. Oh they’re up now, but they’re going to drop again. And Oh, now they’re going to drop. And then maybe they’re going to drop now, and no, they keep going up.
Ben Fraser: Yeah. You can see here, as they’ve got up it’s not just say we’re going to hold it up. It’s they’re going to peak and they’re going to drop right away. And they’re pretty aggressive drops. And it’s interesting to just hearing some of the expectations from different economists, and there’s one big thing I think I referenced last week that is expecting up to six rate cuts this year, and it’s just pretty hard to believe that’s anywhere in the realm of reality, given what we’re seeing, we talked about GDP, we talked about unemployment numbers last week, inflation was just.
The Impact of Inflation on Investment Decisions
Ben Fraser: Released this week and it is, surprise, higher than expected and it’s remaining stubborn, right? And that’s what we didn’t say for a long time.
Bob Fraser: The headline is inflation at 3. 1 percent reflects stubborn pricing pressure, which is what we have been saying all along, that inflation is not going to go down easily or quickly from here.
And for a couple of reasons and there it is, and then, and the fed has been, if you actually read the fed statements, and I think a lot of market participants don’t read the fed statements, they have not shifted. They have said, we are going to, we’re not going to stop until we get our 2 percent goal.
And even then they’re going to wait until it stabilizes, right? The rates and or the, yeah, the inflation rates, they’re going to wait until it’s stable. So they’re not quick to want to cut. What if they cut and all of a sudden inflation pressure starts ticking up again, right? They don’t want to get in that situation.
They want to be absolutely convinced that inflation is dead, right? They want to make sure there’s no more heartbeat on inflation. Yeah, then they will cut. So there’ve been a hundred percent clear about this, and added by the way, putting this election year in, in, in play, what’s going to, they’re going to any scrutiny on reducing rates, it’s going to be incredible amount of scrutiny, now Powell is a Republican, but he is, he’s on both sides.
He maintains relationships on both sides of the aisle. And he’s going to want it to be a hundred percent data driven. He’s not going to want to be accused of, yeah you tried to put Biden in the office or you tried to keep Biden out of office. He’s going to want to make it a hundred percent data driven.
And
The Emotional Aspect of Investing
Ben Fraser: Yeah, I think the learning here is going back to what I said at the beginning, as investors, as human beings, we’re wired to. Want to believe something will happen. And I think what’s been so interesting in this is because it’s been the fastest rise in interest rates in history, we don’t know how to react, right?
We were, we got so used to cheap money and the market wants it to go back to what it was. It’s hard to say this is a new normal because we don’t know exactly where it’s going to stabilize, but. Higher rates than zero is very likely going to be the new normal. And so the market is still trying to digest this.
It wants things to go back to normal because the longer that it stays high, the more things it’s going to break. And we’ve seen, the stock market continues to just go up and up and up, right? But if expectations all of a sudden are not what reality is, I think there’s going to be some challenges there in the markets.
The Importance of Being Data-Driven Investors
Bob Fraser: And back to your point, the opening point you made is that Really, humans are emotional beings primarily, and we don’t think we are, right? We think they’re rational. But it just goes to the point of being data driven investors that it’s very important to be data driven investors, and I remember, I used to run a hedge fund and I remember my best indicator was my mom, the mom indicator. And she would call me, literally happening multiple times. She’d call me and say, ah, this is, we got to back up the truck. This is the time to go all in, in the stock market.
This is it. And of course, and literally that was the time to sell and I, and she was my best timing indicator. And then, or she’d be, Oh, we got to exit the markets. It’s all going bad from here. It’s. Everything’s going down and she was, she pinged the bottom market and I used her as my, I would say, yeah, you’re so right, mom, I’m doing the exact opposite.
And I could throw mom under the bus here but it’s just, it’s the truth is we’re all that way, right?
Ben Fraser: It’s the herd mentality, right? So she was hearing from what they’re saying, talking heads on TV at that point. It’s usually too late.
Bob Fraser: Yeah. And yeah, you both want to be, you want to be afraid when no one else is afraid and you want to be fearless when everyone else is afraid but it just shows how we are emotional beings and everybody wants this, to go back to normal, but what if this is normal?
Actually, historically interest rates don’t stay at zero. Okay. So there’s a time value of money. And. And actually I have a 800 page book on the history of interest rates. And you know what, interest rates historically have been for thousands of years around 6%.
So money has time value and that’s the range. So maybe this is normal.
Ben Fraser: Yeah.
Applying Lessons to Investment Strategies
Ben Fraser: And I think this going, how do we apply this to the best team? I think it’s important, right? If you’re looking at different investments. What are the expectations for how much of the value of the returns are being driven from, positive changes in the interest rates or the market or cap rates, it’s very important.
I think you have to be really cautious right now because there is probably a new normal and it’s much higher than what we experienced in the past. You need to use discipline, you need to use caution and you need to. Make sure that you’re thinking what if this continues this way, right? How do we actually mitigate risks in a new normal environment with interest rates where they’re at?
So just some interesting things, right?
Conclusion: Becoming a Better Investor
Ben Fraser: We always try to bring as much value as we can, not just on the data, but also helping investors become better investors and emotions can have a big impact on this as well as expectations. Hopefully I will enjoy this. If you are, we appreciate it if you leave a review and share it with a friend.
So you don’t miss two episodes and appreciate y’all listening. If you have other topics you want to suggest for us to react to, or do more content on. Please go to our website, https://www.thebillionairepodcast.com/ and click the ask anything button. And we’ll see those responses. So appreciate you all and hope you enjoy it.
