Stocks and Bonds Are Both Falling. Here’s Why.
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If you thought stocks and bonds usually move independently, you're not wrong. It's one of the reasons they complement each other in financial portfolios — bonds can provide stability and balance out the volatility of stocks.
And yet, that's not happening right now. Year-to-date, the S&P 500 is down more 1,000 points as of Dec. 22, 2022.
Here's why experts think this is happening and what consumers should do to weather the storm.
Inflation and rising interest rates affect stocks and bonds
Many factors affect stock and bond markets. Economist Anessa Custovic, chief investment officer for Cardinal Retirement Planning, suggests when we see correlations between assets — meaning when stocks, bonds, gold, real estate or other investments move in the same direction — it's due to related economic trends.
In this case, Custovic — based out of Chapel Hill, North Carolina — says consumers feel the pain of top-down macroeconomic forces such as a lingering pandemic, supply-chain issues and geopolitical crises. Not to mention, the United States is experiencing inflation highs not seen for 40 years.
The U.S. central bank, known as the Federal Reserve, wants to get inflation under control, and one of the tools they have to do that is interest rates. By raising interest rates, the Federal Reserve is making borrowing more costly, which could slow down economic growth and rein in inflation.
This may feel different and uncomfortable because it is.
"Usually, we don't have rate hikes while financial conditions are already tightening and uncertainty is happening," says Custovic.
How interest rate hikes influence stock prices
A direct side effect of raising interest rates is falling stock and bond prices.
For stocks, interest rates can affect the capital and earnings of a company in a myriad of ways, says Damian Pardo, a certified financial planner and regional director of wealth management for First Horizon Advisors in Coral Gables, Florida.
First, companies make less. In a rising interest rate environment, the cost of a company's debt may become more expensive, eating into earnings. And with earnings lower, their share price could fall.
Second, people have less. If consumers have less money available due to inflation, says Pardo, "earnings are probably going to get hit because [consumers] may not be buying your product the way they were buying it the year before." This could look like consumers putting off the next tire, phone, fridge or vacation purchase because each paycheck is buying less than it did before.
Third, bad news can feed off itself. As financial analysts report on decreased consumer spending and the increasing cost of capital, word spreads, stock expectations change and some people rush to sell.
"All of that puts pressure on the price of stock," says Pardo.
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Why rising interest rates push bond prices down, too
Rising interest rates also affect bond prices. Bond interest rates are usually set upon purchasing a bond. When rates rise, new bonds are issued with higher rates, becoming more desirable than bonds with lower rates. As a result, the value of the bonds people already own with lower rates will fall. This is of most immediate concern to bond owners looking to sell in the short term.
However, Pardo stresses that it's essential not to panic. If you own high-quality bonds and hold them to maturity, he says, you will likely still receive your principal and yield.
But if you must sell sooner rather than later, keep the following strategies in mind.
How to manage your portfolio during a downturn
Bear markets and falling prices don't last forever. All are different, and one thing remains true: Selling when the market is down means locking in your losses, so it's best to avoid it if you can.
In the meantime, consider the following four strategies for adjusting your financial plan and mindset during tough times.
1. Reflect on whether your financial goal has any flexibility.
Do you need to access this money? If you don't need the money right now, sit tight.
If you intend on retiring soon, you may be retiring into a recession, "probably one of the worst-case scenarios in terms of making your money last for retirement," says Custovic.
While working another year to ride out the downturn is an option for some pre-retirees, it's understandably out of reach for many others. So if you can't because you depend on your investments for income, have a disability or have no other choice, that's normal and valid too.
2. Lean on excess cash reserves first if you have them.
A cash reserve is an essential component of any financial portfolio; it's a way to hold resources in an easy-to-access spot in an emergency.
If you have it, says Pardo, dipping into it is an option. For example, if your emergency fund contains more than six months' worth of living expenses, perhaps you could use three months of emergency funds while conserving the rest.
Spending a limited amount of cash in a way that still preserves your emergency fund overall can make strategic sense. Using cash first, instead of selling off other assets, will allow you to remain invested, ideally long enough to benefit from an eventual recovery.
3. As a last resort, strategically consider what assets to cash out first.
"The way you take your money out of the portfolio, and when, makes a huge difference on how long this money is going to last," says Custovic. "If you need to withdraw funds, pull them first from the assets that have a positive return or have lost the least amount of money."
4. Ask for help. If this feels complicated, that's because it is.
A certified financial planner or advisor can help you weigh your values, timeline and goals and create a financial plan that works for you.