By Jonathan Caplan

In recent months I have been alternating my screeds between investment topics and general interest topics. And each month I receive constructive feedback from readers. Some prefer that I “stay in my lane” and focus on investing and the financial markets. Others prefer the human interest stories.

Last month I penned a human interest piece regarding the convergence of Shavuot and Memorial Day and related a story about a Jewish-American hero, Carl Goldman. The response was overwhelmingly favorable. But my son Adam quipped: “It was a great article but perhaps your column should be in another section of the Jewish Link.” So, before you surmise from the title that the recent passing of singer Tina Turner will be the topic of choice, my focus will be that TINA (“there is no alternative”) is an investment imperative of the past.

Mixed Signals

There are periods of time when I feel that my judgment regarding the macroeconomic outlook and market risk is spot on. Back in late 2021, I warned about the risks investors could face entering 2022. The Nov. 25, 2021 column included these cautionary words:

“With regard to bond investments, sustained inflationary pressures could cause the Federal Reserve to act with more alacrity on its path to normalization of interest rates. Bonds with long-dated maturities and many highly priced growth stocks could fall victim to an accelerated pace of interest rate increases. While we are not suggesting that these asset classes should necessarily be avoided completely, one should consider alternatives that are better suited for the evolving macroeconomic environment.”

My level of conviction at that time was rather high. More recently, I have found it increasingly difficult to understand current market trends. As my colleague Joseph knows quite well, I have been pacing up and down the office on some days, speculating on a variety of potential reasons for the financial market machinations.

What is clear is that the Federal Reserve has not finished tightening monetary conditions and will likely maintain a restrictive policy for some time. The reaction of the financial markets has me scratching my head. The stock market has been rising in the first half of 2023. While the market is still recovering losses from last year, the steady ascent in the face of tightening monetary conditions is mystifying. The message seems to be that the Federal Reserve is destined to vanquish inflation without the economy necessarily entering a recession.

Conversely, after its historically poor performance in 2022, the bond market seems to be signaling that the economy will be going into recession. While short-term interest rates have been rising, yields on longer dated bonds have been generally declining since peaking in the fall of 2022. Moreover, short-term interest rates are now significantly higher than long-term interest rates. The overnight Federal Funds rate is over 5% while the interest rate on 10-year and 30-year Treasurys are comfortably below 4%. This unusual phenomenon, known as an inverted yield curve, often portends recession. As Alliance Bernstein Co-Head of Fixed Income Gershon Distenfeld said on Bloomberg TV on May 16: “The fact that it (the yield curve) is so inverted is saying that it’s likely that something bad is going to happen.”

Clearly, the equity and fixed income markets seem to be sending contradictory messages. The equity markets suggest that any slowdown in the economy will be shallow and/or short-lived at worst. The bond market suggests that the economy is headed for trouble and that the Federal Reserve will be cutting interest rates in the not-too-distant future. Ultimately, one of those signals will prove false and the markets will correct accordingly.

There Is an Alternative

While we tend to always invest prudently and conservatively, we are especially cautious when we cannot formulate a convincing narrative, given conflicting signals. But there is one investment that we find quite compelling given the risks and uncertainties: short-term Treasurys.

When the Federal Reserve maintained its “near zero interest rate policy” for most of the past 15 years, heavily investing in short-term Treasurys proved to be a fool’s errand. Real short-term interest rates (nominal interest rates less the inflation rate) were negative for nearly the entire period. Thus, investors were incentivized to avoid the short-term fixed income market, which guaranteed the loss of purchasing power.

Real interest rates have now turned the corner. As inflation has been easing and short-term interest rates have been rising, one can now easily earn a positive real rate of return on short-term Treasurys. One can invest in Treasury Bills directly with the Treasury Department or purchase a short-term Treasury ETF (exchange traded fund) that affords the investor great liquidity.

What if Recession Is Around the Corner?

One of the potential pitfalls of investing in short-term fixed income securities is when interest rates are generally declining. At each maturity, one’s income potential on reinvested principal will move steadily lower. This is known as reinvestment risk. That said, we do not expect a major decline in short-term interest rates any time soon. Moreover, we do not envision any scenario where the Federal Reserve lowers interest rates below the inflation rate for perhaps many years into the future. So, even if one misses a rally in stocks or bonds by investing in short-term Treasurys, one would not be facing the loss of purchasing power.

Final Thoughts

When interest rates were hovering near zero, it made little difference whether one left cash in a checking account or an interest-bearing vehicle. Now that short-term interest rates are hovering near 5%, leaving large amounts of cash in one’s checking account is essentially handing the bank a gift. For example, if one regularly keeps an average of $50,000 in one’s checking account, one is foregoing the opportunity to generate $2,500 in essentially risk-free annual income. In this case, the local bank is the beneficiary of one’s lack of action. By proactively taking action and investing those non-interest bearing checking account balances in short-term Treasurys and/or other safe short-term fixed income investment vehicles, one (or many worthy tzedakahs of one’s choice) could certainly benefit greatly.

The views presented are those of the authors and should not be construed as personal investment advice or a solicitation to purchase or sell securities referenced in this market commentary. The authors or clients may own stock or sectors discussed. All economic and performance information is historical and not indicative of future results. Any investment involves risk. You should not assume that any discussion or information provided here serves as the receipt of, or as a substitute for, personalized investment advice. All information is obtained from sources believed to be reliable. However, we do not guarantee the accuracy, adequacy or completeness of any information and are not responsible for any errors or omissions or from the results obtained from the use of such information.

Jonathan D. Caplan, a former Wall Street executive, is president and founder of wealth management firm Caplan Capital Management, Inc., with offices in Highland Park and Hackensack. He holds a bachelor’s degree from Yeshiva University and an MBA in finance from New York University Stern School of Business. You can find other recent investment articles by Jonathan at www.caplancapital.com/blog.