inflation

“Fed” Up With Inflation

photo shows a $1 bill inflated like a pillow

Recent weeks and months have been tumultuous in the stock market, and if you listen to market commentary, you will see one word come up over and over: inflation.

The funny thing is, market commentators cannot seem to decide whether we have too much or not enough. Many commodities started dropping a few months ago, driven by fears that inflationary prices would lead to a recession. When it looked like inflation was starting to level off, the same commodities dropped more. And then the Federal Reserve said it was satisfied with the way inflation was leveling off. Investors started worrying that the Fed was too complacent about the possibility of further inflation.

So guess what happened? Commodities dropped further still.

The moral of the story seems to be that the markets will do what they want in the short run and that market commentators will find excuses for it.

But we do believe that inflation will have a noticeable impact in the long run, and this poses many risks and opportunities for all of us.

With all the government stimulus money floating around, it might seem like inflation is inevitable. But the supply of money is only one side of the equation: money’s value depends on the supply of money versus the supply of all the things we want to spend it on.

For now the supply of money is up (due to the stimulus), and the supply of stuff we want is down (due largely to last year’s shutdowns and disruptions). The government’s hope is that as the next normal arrives, the supply of stuff will catch up to the supply of money—and inflation will settle back down.

Maybe that happens, maybe not. But we are less interested in what inflation does in the next year or two than we are in what it does in the decades ahead.

Everyone wants to build a bigger, brighter future. We are seeing an unprecedented demand for raw materials to make that happen, on top of the equipment and expertise to transform those materials into useful products. Whether we have a little inflation or a lot of inflation, this position strikes us as a good time to be in business for the companies producing raw materials and the ones manufacturing finished goods from them.

We do not know with certainty when or if this will play out. It may take years or decades. Even then, it may not come to pass the way we’re imagining.

But we think these big-picture trends will be more important in the long term than what the Fed announces this week or the next.

Clients, would you like to talk about this or anything else? Write or call.


The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.


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That ’70s Post

photo shows a close-up of the 1970s LOVE postage stamp for 8 cents

A TV sitcom from the turn of the millennium, That ‘70s Show was the story of teenage friends in the late 1970s. A period piece, the trappings of the show remind me how dramatically the life of the American consumer has changed—and yet the ’70s might come around again.

No, we are not going back to a time when the great new retail products included patented suitcases with wheels, Mr. Coffee automatic coffee makers, and Pong games. But for certain economic trends, That ’70s Show might seem more relevant once again.

Back then, inflation and interest rates were at multidecade peaks, up in the teens. Commodity prices were roaring higher, and shortages emerged. For forty years now, interest rates and inflation have been sliding: rates for each have been near zero for years.

Perhaps, finally, the trend is changing. Inflation rates and interest rates may rise again—perhaps persistently, for a period of years. No one knows for certain.

Inflation means rising prices. Just consider the changes you might have noticed recently with houses and cars and lumber, even our groceries and gasoline. Seems prices are on their way up, quickly in some places.

These things have major effects on the investment markets. Bonds and other fixed income investments may struggle if interest rates move higher; commodity producers may benefit from rising prices. Keep in mind that winners and losers emerge when things change.

We may be getting that ’70s feeling in some ways, but it’s a good reminder that history has provided a solid foundation for our work here with you.

Clients, if you would like to talk about this (or simply reminisce about the ’70s), email us or call.


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Odd Couple (of Goals)

Surveys indicate the public’s trust in the Federal Reserve has been declining over time. We totally understand this result.

The Federal Reserve, like other central banks around the world, plays a significant role in setting monetary policy. It operates under mandates written in law to promote full employment and price stability. Presumably, most people would be in favor of these worthy objects.

In practice, however, it seeks to raise the cost of living by 2% every year: that’s the actual effect of the goal we typically hear about, to hit an “inflation target of 2%.” That term is a less clear way of saying “raise the cost of living.” How many of us actually want that?

Now add in Federal Reserve policy on interest rates: keep them near zero for the next few years. So if the cost of living is rising and we earn next to nothing on our savings, then we are really going backward in purchasing power. A dollar of savings today plus zero interest for the next year and we will be short by 2 cents to buy the same amount of goods a year from now. That is a risk to our financial position.

This really is an odd couple of goals. It is rough on savers and people on fixed incomes.

The Federal Reserve has its rationale for all this, of course. It believes that a little inflation is good for the economy and that we are prone to have our spending manipulated by its policies for the short-term benefit of the economy. A better economy means more jobs, which is generally good for each of us.

We have our doubts about the logic. Fortunately, we can try to invest to take advantage of the opportunities these policies present. If we are willing to live with fluctuations in value, we may still be able to earn returns.

We believe it was simpler when savings had positive returns, but we are here to make the most of it.

Clients, if you would like to talk about the risks and rewards of investing and saving, please email us or call.


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Too Close to the Sun

© Can Stock Photo / Paha_L

In Greek mythology, Daedalus constructs wings of feathers and wax so he and his son Icarus may escape from the island of Crete. Although warned against flying too close to the sun, Icarus becomes giddy with the sensation of flight. His wings melt when he gets too close to the sun, and he crashes into the sea and drowns.

This tale of hubris is perhaps mimicked in our time by central bankers around the world. Central banks including our Federal Reserve Bank are charged with conducting monetary policy to achieve stability of prices and favorable economic results. The stresses of the last global recession induced some of these authorities to adopt unprecedented policies.

Among these ideas, the most unusual might be negative interest rates. If we think of the rate of interest as a price – the price of money – then the concept of negative rates seems insane. If bananas had negative prices, producers would have to pay you to take them.

There are practical problems, too, for savers and investors. Imagine having $100,000 in the bank today. After a year of -1% interest, you would have, say, $99,000. “Money in the bank” would no longer be like money in the bank.

Why would central bankers consider such a policy? Like Icarus with his wings, they seem intoxicated by their apparent power to manipulate the economy. Negative interest rates would be a strong incentive to reduce savings and increase spending. This could theoretically boost the economy.

The unintended consequences of their actions could create real problems. Average folks trying to save for the future were severely disadvantaged by the zero interest policy of the last decade. Negative rates would make that even worse.
The Federal Reserve has not yet gone below zero. But a research paper published by a Fed official earlier this year concluded that “negative interest rates might be a useful tool…”1

Clients, our concern over this trend in Fed thinking bolsters our conviction about the investments we hold that would potentially benefit from the unintended consequences. No guarantees: we wish central bankers would simply avoid flying too close to the sun, so to speak.

Clients, if you would like to talk about this or anything else, please email us or call.

Notes & References

1. “How Much Could Negative Rates Have Helped the Recovery?”, Federal Reserve Bank of San Francisco. https://www.frbsf.org/economic-research/publications/economic-letter/2019/february/how-much-could-negative-rates-have-helped-recovery/. Accessed June 25th, 2019.


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Easy Money, Hard Truths

© Can Stock Photo / alexskopje

If you follow market commentary, you may have noticed a lot of attention being placed on Federal Reserve Chairman Jerome Powell. After a series of interest rate hikes, the Fed has started pumping the brakes and some market watchers—the President among them—are hoping for interest rates to go back down, or even a return to the Fed’s “quantitative easing” policy.

It is easy to understand the appeal of easy monetary policy. Being able to borrow money cheaply helps fuel economic growth. Corporations, individuals, and governments all benefit from being able to take out lower interest loans.

That growth comes with strings attached. The cheaper it is to borrow money, the more borrowed money accumulates on balance sheets. In moderation, borrowing money allows people and companies to accomplish things their own money could not. But those debts eventually come due, and not all of them always pay off. Too much debt can have catastrophic results.

We do not need to look far into the past to get a glimpse of the consequences that overly easy monetary policy can have. Not even 10 years ago there was widespread panic about the possibility of Greece’s national debt dragging the whole Eurozone down with it.

How did this happen? Greece was a developing country with a growing economy, but Euro monetary policy was dominated by larger countries with slower economies that wanted looser money to fuel their own growth. For Greece, that loose money just wound up inflating their debts into an unsustainable bubble.

We have been concerned for some time about signs that corporate and government debt in the U.S. may be growing into a massive debt bubble, and we are not alone. In our opinion, the last thing that the economy needs is even more debt. We hope that cooler heads prevail and the Fed agrees with us.

Clients, if you have any questions or concerns, please give us a call.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Four Trends for Fall, 2018

© Can Stock Photo / Elenathewise

The gap between consensus expectations and reality as it unfolds is where we think profit potential lives. This is why we put so much effort into studying trends, and the ramifications for investors.

One year ago, we wrote about four trends. The next energy revolution (solar + batteries), long range prospects for the world’s most populous democracy, the airline industry, and rising interest rates continue to play roles in our thoughts and portfolios.

Other ideas are also in play.

1. Thinking about the next few years, our highest conviction idea is inflation will exceed consensus expectations. Some of the ways we act on this belief may provide some counterweight to other portfolio holdings, since inflation hurts some industries while it helps others.

2. As the economic expansion lengthens toward record territory, the desire to extend our lifespan tends to be insensitive to the business cycle. Biopharmaceutical companies, working on cures for everything from Alzheimers to various forms of cancer, seem attractively priced.

3. The trend toward rising interest rates, noted last year, may have an effect on weaker and more leveraged companies. We are looking to avoid the second-order and third-order effects that higher rates may have on some borrowers.

4. US stocks have become popular relative to international equities, with dramatic outperformance over the past decade. At some point the trend changes, and better value usually wins out.

One of the difficult things about being contrarian–going against the crowd–is that we sometimes look silly. When everybody else is having more success in the short run while we search for bargains, it can be tough. But that is what we do. We’re excited about the continuing evolution of your holdings as the future unfolds.

We can offer no guarantees except that we will continue to put our best effort into the endeavor. Clients, if you have any questions or comments or insights to add, please email us or call.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

 

Wishing For A Gold Mine?

© Can Stock Photo / snokid

We know a fellow who built a gold mine. Whenever we mention this, people usually ask what it was. The answer is…a gold mine. This client worked as a construction superintendent for a very large contractor. He had built coal mines and a gold mine among many other large projects.

This anecdote comes to mind as we prepare to tell you our latest thoughts on investment tactics. We invest time every week looking for the best bargains, trying to figure out emerging trends, thinking about the economy and the markets. In a recent research meeting, Greg Leibman posed the question, “What can we own that might benefit from rising inflation?”

We humans tend to think that recent conditions or trends will persist. This makes it hard to realize the long spell of very low inflation might come to an end, with inflation outpacing expectations.

One way to weather periods of rising inflation is to invest in companies that own things: land, buildings, factories, raw materials, and so on. An oil company already owns the oil in their reserves and the wells to pump it; when prices go up, they get to sell it for more profit but most of their capital expenses have already been baked in.

Miners similarly benefit when the prices of their existing mineral reserves go up. Like oil companies, their stock price tends to move in correlation with natural resource prices, making them a potential inflation hedge. Some mining companies have exposure to the gold market, which some people may see as a particularly important hedge against inflation.

We have had raw material companies on our radar for some time now: they tend to be big cyclical movers, and we have been bullish about the current cycle so far. But we believe that this same sentiment may have created buying opportunities in the mining sector.

We look for potential gaps between expectations and the unfolding reality. That is where profit lives, in our opinion. When Greg posed the question, we put our heads together and started looking at potential opportunities. To summarize,

• Inflation may exceed expectations in the years ahead.
• We believe that some companies within the mining sector are at bargain levels.

There are no guarantees. What we think of as bargains sometimes have the dismaying tendency to get cheaper after we buy them. But we think we have identified potential investment opportunities that may be appropriate for some portfolios. Clients, if you would like to talk about this or anything else, please email us or call.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.

Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

The Inflation Powder Keg

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A few weeks ago, the Federal Reserve issued a policy statement greenlighting more interest rate hikes despite fears of inflation.1 For years the Fed has struggled to keep inflation up to its target rate of 2%, and now that it is there, it looks likely to us that the Fed may overshoot the target entirely.

Interest rates and inflation tend to go hand in hand. When interest rates are high, borrowers can earn more money to spend, creating upward price pressures. When inflation is high, lenders try to raise rates to keep ahead of inflation. As rates continue to rise, you can often expect inflation to do the same.

Worse, there are other pressures looming on the horizon that we think may contribute even more to inflation. A strong economic cycle and robust jobs market may often bring higher inflation. As unemployment drops, workers become harder to find. Many companies might have to offer higher wages to get the employees they need, forcing them to raise prices—at the same time that workers have more money to spend from higher wages. Rising prices and rising wages equals inflation.

We also expect more price pressure to arrive from overseas. The trade war that the current administration seems bent on fighting shows no signs of cooling off. When you raise taxes on a product, such as a tariff on imports, inevitably the price may go up to pay for the taxes.

Tariffs create knock-on effects, as well. Many products manufactured inside the U.S. use materials imported from overseas that are subject to tariffs, so domestic products may also face rising prices. And domestic companies that are fortunate enough to dodge the tariffs entirely may still raise their prices opportunistically: with the prices of other goods rising, they have an opportunity to increase prices and profits without hurting themselves as much competitively.

Once again, where you have rising prices, you have inflation. Put it all together and the economy may be sitting on a powder keg of explosive inflation pressure. We do not know when or if the powder may exploded, but we cannot afford to ignore it.

We have gotten so used to low inflation rates in the past decade that it is easy to pretend they will last forever. Sooner or later, we expect some investors to be burned by this mindset. We want to do what we can to avoid being among them. Clients, if you have any concerns about how inflation may affect your portfolio or investment strategy please call us.

Notes and References

1:Press Release, Board of Governors of the Federal Reserve: https://www.federalreserve.gov/newsevents/pressreleases/monetary20180613a.htm. Accessed June 28, 2018.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

 

Burning Up Money

© Can Stock Photo / ancientimages

No doubt you probably noticed the turmoil in the stock market over the past several weeks. You might have assumed, if you watched the stock indexes hit a low of more than 10% below their peak, that some particularly ugly piece of news had hit the market.

If so, you would probably be surprised to hear that the biggest news stories leading to the correction were that the economy was booming and unemployment was at record lows. So why were investors panicking at this seemingly positive news? The answer is inflation.

You see, as the economy grows, increasing wealth leads to increasing demand. This means higher prices–or, in economic terms, inflation. This creates a couple of problems for the stock market. In the long term, rising prices make it harder to maintain economic growth and may contribute to an eventual crash. In the short term, both economic growth and inflation increase the pressure on the Federal Reserve to raise interest rates, making bonds and other interest-driven investments more attractive relative to stocks.

We are deeply skeptical of this short-term rationale. While bond investors may salivate at the prospect of higher interest rates in the future, we think this is short-sighted. Tomorrow’s higher interest bonds may sound attractive, but you would be foolish to buy them if the interest rate is going to be even higher the day after. On February 5th, when the stock market was posting headline-grabbing declines fueled by interest rate paranoia, investors were actually buying up bonds–bonds that stood to lose purchasing power as soon as better, higher interest bonds started being issued!

The longer term concern, that inflation may spell the beginning of the end of the current economic boom, is a bigger threat. We have warned for a long time that the Federal Reserve was likely to wind up overshooting the mark on its 2% inflation rate target. We think this is even more likely now that the government has passed a very stimulus-minded tax package. Cutting taxes during the middle of a boom is likely just throwing gasoline on the fire: it is possible we may see some explosive growth, so in the short run we are excited about the market, but in the long run the economy may just burn out that much faster.

Clients, many of you have been in business with us long enough to remember the roller-coaster years we saw around 2007. The dip at the start of February may potentially be forgotten as the market forges on ahead, but it will not be the last one. The roller coaster is coming back, and although we look forward to the ride we will keep a mindful eye for the day we may need to think about getting off. Call us if you have any questions about the market and the broader economic outlook.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.