The cost of living is sky-high, and Jerome H. Powell, the chair of the Federal Reserve, says that battling it is his highest priority. He has raised interest rates to damp down inflation, which hit its highest point in 40 years. Financial markets don’t know quite how to react.
Something similar happened the last time inflation was out of control. Paul A. Volcker was the Fed chair then. He wrung inflation out of the economy, but at a great cost — hurling the nation into not just one recession, but two. Unemployment soared, stocks fell repeatedly, interest rates oscillated and, for a while, bonds looked shaky, too.
It’s worth looking at his era for guidance.
First, because it had multiple, severe downturns, the Volcker era was disastrous for anyone who traded actively and bet wrong on the direction of the markets. Short-term trading is especially dangerous when the market’s currents are opaque and treacherously strong, as they were back then and may be now.
But, second, the Volcker era was wonderful for those with the patience and resources to ride it out. While Mr. Volcker’s stern treatment of the economy was deliberately disruptive, it ushered in awesome bull markets, in both stocks and bonds.
When Mr. Volcker became Fed chair in 1979, inflation was running above 11 percent annually, and the unemployment rate was almost 6 percent. A bull market in stocks had started in 1974 and it continued months more, even though the Volcker Fed had begun to tighten monetary policy.
On Saturday, Oct. 6, 1979, Mr. Volcker announced that, “No longer would the Federal Reserve set interest rates to guide policy,” Jeremy J. Siegel, the University of Pennsylvania economist, wrote in the book “Stocks for the Long Run.” “Instead, it would exercise control over the supply of money without regard to interest rate movements.”
By reducing the money supply, and letting short-term interest rates float, the Fed was, effectively, letting rates spiral upward.
“Stocks went into a tailspin, falling almost 8 percent on record volume in the 2½ days following the announcement,” Professor Siegel wrote. “Stockholders shuddered at the prospect of sharply higher interest rates that would be necessary to tame inflation.”
By March 1980, the Fed funds rate was an astonishing 17 percent, compared with just 2.5 percent today. It would exceed 19 percent the following year.
The economy slowed so much that it fell into a recession from January through July 1980.
But it wasn’t until Nov. 28, 1980, that a bear market in stocks began.
The S& P 500 lost more than 27 percent during a miserable 20-month period that ended in August 1982. If you were on the wrong side of that move, you lost a ton of money. The second Volcker recession began in July 1981 and lasted until November 1982.
If you hung in during the entire Volcker era, you experienced turmoil but went on to enormous gains in both stocks and bonds. From the day Mr. Volcker took office until the day he left in 1987, shares in the Vanguard S& P 500 stock index fund — the first lowcost broad index fund available to ordinary investors — would have gained 215 percent, according to FactSet data.
An index of the broad bond market, now known as the Bloomberg U.S. Aggregate, would have gained 143 percent in that period. And on the day Mr. Volcker started as Fed chair, the 30-year U.S. Treasury bond provided a yield of more than 9 percent — a guaranteed doubling of your money every eight years, if you had just held onto it. Even better, you could have bought a Treasury bond in September 1981 that paid a guaranteed 15.19 percent for 30 years.
There were big ups and downs in shorter stretches. They scared me away from stocks for a while.
What we’ve been experiencing over the last year is frightening, too. It’s not clear whether the July rally in the stock market was more like an early sucker’s rally in the Volcker era (leading to a recession and bear market) or like the second big rally — the one that became a great bull market. Or, perhaps, it’s another variation.
No one knows. But remember that those long-term bets on stocks and bonds paid off, even in that era of market turmoil.
- Jeff Sommer, New York Times (via Honolulu Star-Advertiser, 8/14/22)
No comments:
Post a Comment