The year seemed very strange to me. The news was dominated by:
- Politics – Brexit in the United Kingdom and the U.S. Election
- Conflict and Tragedy – Numerous shootings and terrorist attacks
- Awards – Bob Dylan winning the Nobel Prize for Literature
- Business – EpiPen prices, the Wells Fargo scandal
- Sports – Chicago Cubs win baseballs World Series
- Social Behavior – Pokémon Go
- Celebrity Deaths – Prince, John Glenn, Fidel Castro, and many more
But then again, it’s been a strange decade in global economics. Extremely low interest rates and inflation caused economists to coin the term “the new normal.” Based on Brexit and the results of the U.S. election, it looks like we may have to adapt again from what we have been calling “the new normal” back to what was “normal” in the economy before the market crash of 2008.
It appears that the more than 30-year bull market in bonds (characterized by declining interest rates and increasing value of bonds) is about to change. This month the Federal Reserve increased interest rates 0.25%. They did the same thing last December. They also signaled that there may be three additional increases in 2017. Rising interest rates, if done too often and too fast, can cause a bear market in bonds (characterized by rising interest rates and falling bond values).
While the transition back to more normal interest rates will cause some short-term volatility (due to declining bond prices), in the long run it’s what the economy really needs. In a normal economy when a financial advisor designs an asset allocation to mitigate risk, they can expect stocks to return about 10% annually, bonds to return 4% to 6% annually, and cash to return 2% to 3% annually over the long-term. Since 2008, cash has returned close to zero which effectively eliminated one of the important tools a portfolio manager could use to reduce portfolio risk. Returning to a “normal” economy will eventually return the cash tool back to the portfolio managers toolbox.
In the meantime, we will continue to adapt during the transition from “the new normal” back to “normal,” which won’t happen overnight. It will be a multi-year process, and we will navigate through this process carefully and deliberately as we have before with other transitions.
On behalf of our entire staff, we wish you a Happy, Healthy New Year, filled with family, friends and joy.