Investors Are Almost Always Wrong About Rates | Top of Mind Series

Hello, listeners. Today we're going to talk about the surprising way that nearly all investors are wrong.

What could it be? What are they wrong about? Well, 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 the other day, 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 about investors being wrong about the Fed.

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It's so interesting that the Fed has become the focal point of the discussion of all investors over the past 2 years, really because of these interest rate increases and what's the Fed going to do? What's their perspective 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 about this, right? That we're predictably irrational. And I've heard it said one way that people and humans make decisions emotionally and then justify with logic, right? We actually think we make decisions rationally and then have emotions that follow. And it's usually the inverse. And so much of that plays into investing and how we as investors make decisions. 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 know, can see this chart, this is over the past 20 years. You can see— describe it for just those people who are, who are listening. Yeah. So we have, we have two different lines here. We have 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 kind of on an ongoing basis. And so you can see the overlay of those expectations on what actually happened. And in almost every circumstance, the investors are wrong.

Investors are wrong about what is going to happen with interest rates.

And it's— if you see this chart, it's not just a little bit, it's, it's pretty like directionally totally incorrect. And so if you go back to the last recession, '08-'09, you know, we had a big, you 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. You know, and they did it.

They kept them low.

Yeah. And a pretty aggressive expectation. And you kind of fast forward to now and what we've been kind of 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, these kind of rapid decision changes of their perspective. And they've been pretty clear from the outset, right? They've, they've not changed the, the tune for really the past 8 years.

Clear that they're not going to lower rates soon or quickly or until inflation meets their targets, and it's consistently meeting their targets. And yet the market continues to say, oh, the rate— they're going to cut rates, they're going to cut. And the chart shows this as rates are steadily rising, the expectations, oh, they're going to drop. Oh, well, they're up now, but they're going to drop again. And oh, they're— now they're going to drop. And then, well, maybe they're going to drop now, you know, and no, they keep going up.

Yeah, you can see here the— as they've gone up, it's, it's not just say we're going to hold it up. It's like they're going to peak and they're going to drop right away. And they're pretty aggressive drops. And it's interesting, too, just hearing some of the expectations from different economists, you know, and there's one thing I think I referenced last week that is expecting up to 6 rate cuts this year. And it's, it's just pretty hard to believe that 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 released this week and it is— surprise— higher than expected. And it's just remaining stubborn. Right. And that's what we've been saying for a long time.

The headline is inflation at 3.1% 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, you know, 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% goal. And even then they're going to wait until, until it stabilizes. Right. The rates and—

or the—

yeah, the inflation rates, they're going to wait until it stabilizes. So they're not quick to want to cut. What if they cut and all of a sudden inflation pressures start 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— they want to— they want to make sure there's no more heartbeat on inflation. Yeah. And then they will cut. So they've been 100% clear about this. You know, and added, by the way, you know, putting this election year in, in play, you know, what's going to, you know, they're going to any, any scrutiny on reducing rates. I mean, it's going to be incredible amount of scrutiny. You know, now Powell is a Republican, you know, but he is, he's on both sides. He is, he's maintained relationships on both sides of the aisle and he is going to want it to be 100% data-driven. He is not going to want to be accused of Yeah, you, you tried to put Biden in the office or you tried to keep Biden out of office.

Right.

You know, so he's, he's going to want to make it 100% data-driven. And so, you know, yeah.

And I think like the learning here is going back to what I said at the beginning, as investors, as human beings, we're wired to, you know, want to believe something to 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— we don't know how to react, right? We got so used to cheap, you know, money and the market wants it to go back to what it was. But, you know, 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 it wants things to go back to normal because it's the longer that it stays high, the more things it's going to break. And we've seen— I mean, the stock market continues to just go up and up and up and up. Right. But if expectations all of a sudden, you know, are not what reality is, I think there's going to be some challenges there in the markets.

And back to your point, you know, the opening point you made is that really, you know, humans are emotional beings primarily. You know, and we don't think we are, right? We think we're rational. But it just goes to the point of, you know, being data-driven investors, that it's very, very important to be data-driven investors, you know? And I remember, you know, I used to run a hedge fund, and I remember my best indicator was my mom, you know, the mom indicator. And she would call me, literally happened multiple times, she'd call me and say, Bob, this is— 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, 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, going bad from here. You know, it's— everything's going down. And she was— she pinged the bottom market. I used her as my— I would say, yeah, you're so right, Mom. I would do the exact opposite. And, you know, and I could throw mom under the bus here, but, but it's just, you know, it's the truth is we're all that way, right?

It's, it's, it was the herd mentality, right? So she was hearing from what they were saying, talking heads on TV at that point. You know, it's usually too late. Yeah.

And so, yeah, you want to be, you want to be afraid when no one else is afraid and you want, you want to be fearless when everyone else is, is, is afraid and But it just shows how we are emotional beings. And, you know, everybody wants this, you know, to go back to normal. But what if this is normal? Actually, you know, historically, interest rates don't stay at zero. Okay. So there's a time value of money. And, and actually, I have a, I have a, you know, 800-page book on the history of interest rates. And you know what? You know what interest rates historically have been for, for thousands of years? Around 6%. So money has time value and that's, that's kind of the range. So maybe this is normal.

Yeah. And I think this going— how do we apply this to investing? 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 you know, positive changes in, in the interest rates or the market or cap rates, you know, it's very important. I think you got 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, well, 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? We always try to bring as much value as we can, not just on the data, but also helping investors become better investors. And, you know, emotions can have a big impact in this as well and expectations. So hopefully enjoy this. If you are, we appreciate if you leave a review, share with a friend, subscribe so you don't miss the episodes and appreciate all this. If you have other topics you want to suggest for us to react to or do more content on, please go to our website, TheBillionairePodcast.com, and click the Ask Anything button and we'll see those responses. So appreciate you all. Hope you enjoy.