Scott Kahan On Inflation & The Roaring Twenties

Scott Kahan On Inflation & The Roaring Twenties

 Why are we seeing inflation creeping back?

You have to look at the recent past. Remember we are coming off pandemic lows in stock prices, GDP and jobs. As the economy rebounds, we have to expect jumps in the same places and ultimately in consumer prices. Which is why the Consumer Price Index has been trending up every month since January.

 Is it transitory or something more?

People should be reminded that some inflation growth beyond where it has been in recent years is not a bad thing. It wasn’t long ago that Chair Powell was talking about keeping interest rates low even if inflation ticked above the Fed’s two percent target. Specifically, because it had been low for so long. Remember when people were worried about negative interest rates and deflation?

True inflation, the kind that presents genuine concern for economists and markets, is when you see rapid wage growth. We’re not seeing that now. There are still seven million less people working today than before the pandemic. It’s difficult, in my view, to make a case for impending wage inflation when you still have so many people out of work.

We should be prepared for higher inflation than we’ve had but it is likely to stabilize in the target two percent range. Which is good.

So, what’s going on with prices?

The economy is experiencing supply chain issues. Demand is rising and supply is not so prices are going up. Producers are trying to catch up to rising demand as the country and the economy opens up as the pandemic recedes. They need more workers. And workers may be slow to return to work due to COVID fears.

Demand is high because, let’s face it, people who work in professional and corporate jobs who have been working at home and zoom conferencing throughout the pandemic, have more money in their pockets. You hear it all the time. Consumer spending for office personnel working remotely is down dramatically on transportation, restaurants, travel, dry cleaning, clothing you name it.

And many people are refinancing mortgages. That’s freeing up money for spending, too.

You mentioned the Roaring Twenties – would you like to elaborate?

People say this decade is going to be like the roaring twenties when there was tremendous pent-up demand as the world rebounded from both the first world war and the 1918 pandemic. Obviously, the pandemic comparison is intriguing. And it is worth mentioning that the US savings rate which was just over seven percent pre-pandemic has averaged twice that level since. Even in February of this year it still stood at 13.6%. So, pent-up demand could be with us for some time. Even after people return to the office.

Of course, the Roaring Twenties resulted in the stock market crash and the Great Depression ten years later.  But I don’t see that happening here because we know how to manage the economy better now.

What do you mean by “don’t play the inflation trade?

What’s done well in the last six months are value and small cap stocks while growth stocks have cooled off. Remember value stocks, which historically outperform growth, have not done well in a long time. This could be seen as part of a natural rotation. It may or may not continue, but it’s good to see growth in other parts of the market.

Likewise, the real estate market has been a seller’s market. The reassessing of city living during the pandemic is part of it. But the big drivers are low interest rates and pent-up demand. And remember the housing market crashed and burned in 2008 and has barely recovered since. So, this was overdue, too.

Let’s talk about the fixed income side…

Fixed income is more problematic. There is little yield out there and there hasn’t been for a while. And if you are buying longer term bonds, they are more susceptible to rising interest rates than shorter maturities.

Powell indicated that the Fed is likely to raise rates in 2023 to slow down the economy. If the economy picks up faster, it may come sooner. When interest rates rise bond-prices fall. Longer-term maturities fall further. We recommend staying short to intermediate term. That is anything from under one to up to 10 years. In this environment, shorter is better though.  If you are in a high tax bracket, we recommend municipal bonds in the same maturities

What about dividend stocks?

People buy dividend stocks for extra yield. Be careful and remember if the stock market goes down ten percent and your dividend is four percent you just lost six percent. Same with preferred stocks or high yield corporate bonds. If you chase yield, you’re just adding risk to your portfolio.

Income needs when yields are low can be filled when you rebalance your portfolio. In the very short term of course you should always cover yourself with at least six months expenses in cash.

So, what are your clients doing?

Some of our people see the market going up and are wanting to buy into it. They may have 50/50 allocations and want to boost their equity allocations. I ask them, what’s changed in your financial plans? You shouldn’t change your allocations based on market conditions but on changes in your financial plans. Rebalance yes – change allocations independent of changes in your financial plans to time the market no.

In practical terms this means when your 50/50 portfolio becomes 57/43, then you want to sell. And put that money in fixed income or hold it in cash.

Where are you on the 60/40 debate?

Our clients have a variety of portfolio mixes based on what they need to reach their financial goals and their appetite for risk. They don’t all have the same 60/40 on stocks and bonds. We have clients from 50/50 to 80/20 and even some young people at one hundred percent equities.

If you set our portfolio to reach your financial goals while not exceeding your risk appetite it makes it easier to weather those ten to fifteen percent market corrections which happen all the time.

Financial Asset Management Corporation has provided fee-only financial planning and investment management services for individuals and small businesses in the Tri-State area since 1986. They serve 175 clients and manage over 325 million dollars in assets. (26 South Greeley Avenue, Chappaqua, NY, (914) 238-8900; www.famcorporation.com )

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