Bob’s Journal for 3/2/23

Why Interest Rates Haven’t Peaked

Investment markets indicated investors thought interest rates peaked in late 2022.

The yield on the 10-year treasury bond reached 3.96% in October 2022 and began falling. By late January 2023, the yield was below 3.50%.

Throughout that period, futures markets prices indicated investors believed interest rates would decline steadily for the next few years.

That interest rate outlook was based on the belief that inflation had peaked and would decline fairly quickly. Declining inflation would cause the Federal Reserve to return to an easy monetary policy by mid-2023.

The optimism about inflation probably was wrong, as demonstrated by last week’s return of the 10-year yield to 3.96%.

But more than inflation is keeping interest rates elevated. Basic supply and demand factors mean interest rates aren’t likely to return to their 2021 levels, absent a financial crisis.

The Federal Reserve was buying most U.S. government debt during the pandemic period. But the Fed slowed its asset purchases in late 2021. Since then, it has cut the size of its balance sheet by reducing purchases and allowing some bonds and mortgages it holds to mature without replacing them.

At the same time, the federal government’s debt level is increasing. Of course, there are the annual budget deficits. While lower than during the peak pandemic years, the annual deficits still are substantial.

In addition, interest rates are much higher than they were a year ago. As treasury debt matures, the government must issue replacement debt and find new buyers for it, because the Fed no longer is buying all federal debt.

The treasury has to compete with other investments. Cash-like investments now pay yields of around 5%, so the new government debt must pay much higher yields than the older debt. Simply rolling over debt increases federal spending and the deficit because of the higher interest rates that must be paid on the new debt.

This liquidity gap in the markets is likely to keep a floor under interest rates until the Fed is convinced that inflation is headed down to its target rate of 2% and resumes buying most new treasury debt.

Fresh Insights from Warren Buffett

The annual shareholder letter from Warren Buffett of Berkshire-Hathaway was posted over the weekend. As usual, investors would benefit from reading it.

Early in the letter, Buffett makes a couple of key points.

He begins with a tribute to the company’s long-term shareholders. Buffett says that these investors accumulated a lot of wealth simply by buying and holding the company’s stock.

But most of them haven’t used that wealth to buy what he calls “look-at-me assets” or limited the benefits of the wealth to their families. Instead, many end up contributing a significant portion of their Berkshire gains to charities that use it to improve the lives of others. Buffett said he’s proud to work for such shareholders.

A little later, in an uncharacteristically modest turn, Buffett says most of his decisions have been “no better than so-so” and he’s made a lot of mistakes. Buffett and his shareholders also benefitted from “very large doses of luck.”

He also describes his “secret sauce” and how it applies to Berkshire’s long-term positions in Coca-Cola and American Express.

Buffett defends stock repurchases by companies and calls “disgusting” actions companies take to manipulate earnings to beat market expectations. He criticizes the analysts and reporters who embrace those practices.

The letter also discusses taxes, reproduces aphorisms from his partner Charlie Munger, and more.

Blockchain Technology Isn’t the Same as Cryptocurrencies

Often, investors and the media believe blockchain technology and cryptocurrencies are the same. That’s a big mistake.

Cryptocurrencies were all the rage a couple of years ago. More recently, most investors have been fleeing the cryptocurrencies because of falling prices and widely reported bankruptcies, thefts and frauds.

Investors should know that blockchain technology is what makes bitcoin and other cryptocurrencies possible, but blockchain is a lot more than digital currencies.

Sophisticated investors and large companies realize this. That’s why they’re expanding investments in the technology even as headlines lump it with crypto frauds and risks.

This article from Forbes explains the difference between blockchain technology and cryptocurrencies. It also discusses different ways that blockchain is being used by large companies such as Mastercard, Goldman Sachs and others.

In addition, the article discusses companies that tried to integrate blockchain technology in their businesses but abandoned those efforts.

Over time, blockchain technology is going to replace a lot of current technology, especially in financial businesses. Investors might want to ignore cryptocurrencies and focus on different ways blockchain technology can be used by businesses.

The Data

The Fed’s preferred measure of inflation, the Personal Consumption Expenditure (PCE) Price Index, increased 0.6% in January after rising 0.2% in December. In the past 12 months, the PCE Price Index increased 5.4% as of January, up from 5.3% in December.

The Core PCE Price Index, which excludes food and energy, increased 0.6% in January after rising 0.4% in December. For the past 12 months, the Core PCE Price Index increased 4.7% through January, which is up from 4.6% through December.

Personal income increased by 0.6% in January, building on the revised 0.3% jump in December.

Personal spending increased 1.8% in January after declining 0.1% in December. January had the largest monthly increase in spending since March 2021.

After adjusting for inflation, real personal spending increased 1.1% in January after declining 0.3% in December.

The Consumer Sentiment Index from the University of Michigan increased to 67 in February from 64.9 in January and 66.4 in the mid-February flash estimate. February’s final reading was the highest since January 2022.

Consumer expectations were higher than in mid-February and the end of January. Assessments of current conditions were higher than at the end of January but lower than in mid-February.

New home sales increased 7.2% in January, which follows the same increase in December. But sales in January were 19.4% lower than 12 months earlier.

The median sales price of new homes in January was $427,500, and the average sales price was $474,400. The median price was 0.7% lower than 12 months earlier, and the average price was 5.3% lower than 12 months earlier.

Pending home sales increased 8.1% in January after increasing 1.1% in December. Pending home sales in January were 24.1% lower than 12 months earlier.

Home prices declined again in December, falling 0.9% for the month, according to the S&P Corelogic Case-Shiller Home Price Index. The index had declined 0.8% in November. December was the sixth consecutive month the index declined.

Over 12 months, the index increased 4.6% in December, which is down from 6.8% in November. December is the lowest 12-month growth rate for the index since July 2020.

The House Price Index from the Federal Housing Finance Agency (FHFA) declined 0.1% in December, the same drop as in November. Over 12 months, the index is up 6.6% as of December, compared to 8.2% as of November.

The manufacturing sector of the economy improved a little in February but still is contracting, according to two surveys.

The ISM Manufacturing Index improved to 47.7 in February from 47.4 in January. January’s level was the lowest since May 2020. February was the fourth consecutive month that the index was below 50.0, which indicates the sector is contracting.

The PMI Manufacturing Index was 47.3 at the end of February, that’s down from 47.8 at mid-February but higher than the 46.9 recorded at the end of January. February is the fourth consecutive month this index was below 50.0, indicating a contraction in manufacturing.

The Consumer Confidence Index from The Conference Board tumbled to 102.9 in February from 107.1 in January.

Consumers’ assessments of current business and labor market conditions improved a little.

But consumers’ expectations for the future declined sharply. The Expectations Index has been below 80 for 11 of the last 12 months. A recession usually follows within a year after the Expectations Index falls below 80.

The Kansas City Fed Manufacturing Index declined to negative 9 in February from negative 4 in January.

The Dallas Fed’s general business activity index for manufacturing declined to negative 13.5 in February from negative 8.4 in January. That’s the 10th consecutive month the index showed a contraction in activity.

The Richmond Fed Manufacturing Index fell to negative 16 in February after being negative 11 in January.

Durable goods orders fell 4.5% in January after increasing 5.1% in December. That’s the largest decline since December 2020.

But after excluding aircraft and defense, which is considered a good proxy for business investment, orders increased 0.8% in January after declining 0.3% in December.

The second estimate of gross domestic product (GDP) growth for the fourth quarter was that the economy rose at an annualized rate of 2.7%. That’s down from the first estimate of 3.2%.

New unemployment claims declined by 3,000 to 192,000 in the latest week.

Continuing claims, which lag a week behind new claims, decreased to 1.654 million from 1.691 million.

The Markets

The S&P 500 lost 0.71% for the week ended with Tuesday’s close. The Dow Jones Industrial Average fell 1.41%. The Russell 2000 gained 0.40%. The All-Country World Index (excluding U.S. stocks) retreated 1.66%. Emerging market equities tumbled 2.42%.

Long-term treasuries gained 1.31% for the week. Investment-grade bonds rose 0.38%. Treasury Inflation-Protected Securities (TIPS) added 0.20%. High-yield bonds gained 1.53%.

In the currency arena, the U.S. dollar increased 0.85%.

Energy-based commodities lost 0.34%. Broader-based commodities fell 1.10%. Gold declined 0.49%.

Bob’s News & Updates

My new book is officially published: “Retirement Watch: The Essential Guide to Retiring in the 2020s.” Learn more and order by clicking here and here, respectively. You can be among the first to write a review.

My previous book, “Where’s My Money: Secrets to Getting the Most out of Your Social Security,” is receiving mostly five-star reviews on Amazon for telling you clearly what your benefit options are in different situations and how to determine the best choice for you. You can find it on Amazon.com or Regnery.com.

The number of regular viewers for my Retirement Watch Spotlight Series continues to increase. You should sign up because I make in-depth presentations of key retirement finance topics. You can watch these online seminars from the comfort of your home or office at times you choose. To learn more about my new Spotlight Series, click here.

A recent five-star review of my book, “The New Rules of Retirement” on Amazon.com said, “A complete retirement guide! One of the best books on this topic!” Click for more details about the revised edition of “The New Rules of Retirement.”

If you’re interested in my books, check my Amazon.com author’s page.

I’m a senior contributor to the Forbes.com blog. You can view my contributor page here.