The Times They Are a Changin’

Inflation was just beginning in 1963 when Bob Dylan wrote the song “The Times They Are A-Changin’”. Prices increased as wages grew and the demand for raw materials increased faster than supply. In the late 1960s, government spending for the Great Society and Vietnam War also drove up prices. By the early 1970s, when the oil crisis hit, inflation was well underway and headed higher. That was then. This is now.

It’s Back!

For the last five years, I have been warning my readers to prepare for inflation. I have been saying the secular bull market would most likely end not with another Great Recession, but with high inflation.

It has been 40 years since the last great bout of inflation, and most of the general population is experiencing it for the first time. Most people measure inflation by the cost of gasoline and groceries. Most do not understand what an increase in the Fed Funds rates means, whether it is a quarter point or one full point. Most people do not understand what it means when the Fed is deleveraging their balance sheet. What most people see is the rocket-and-feather impact of inflation: “prices go up like a rocket and come down like a feather”.

It’s true that the Fed is raising interest rates and deleveraging their balance sheet. That will probably reduce inflation for a few years. However, wages are rising at their most rapid rate in decades, and the price of raw materials is adding to the cost push inflation.

The danger for investors is that it can take years for the stock market (as measured by the DOW) to catch up with inflation. Last time ‘round, the market took 32 years to catch up. It could be worse this time. Consider that the DOW almost hit 1,000 in 1966, just as inflation was taking off. For the next 16 years, it would sell off 20%, rise again to 1,000 only to sell off 30%. Then it would rise again to 1,000 only to sell off 40%, rise again to 1,000 only to sell off 20%. Only in 1979 did it begin to rise and in August 1982 pass 1,000 to continue up to over 10,000 by the end of the century.

That was the DOW. But not all stocks followed that pattern.

Prices as measured by the CPI (consumer price index) rose sixfold between 1961 and 1993. The DOW took those 32 years to catch up with a sixfold increase from its level in 1961.Put another way, the purchasing power of the dollar lost 70% of its value between 1961 and 1981. Groceries that cost $1 in 1961 cost $3 by 1979. The average price of a gallon of gas was $0.31 in 1961 and $1.31 in 1981. The average price of a loaf of bread was $0.21 but by 1981 was $0.83.

For me, it spells danger for the individual investors and financial advisors using index funds. Index funds did not exist in the 1960s-70s as they do today. Today, they own 18.7% of all companies in the S&P 500, 22.8% of the mid-cap S&P 500, and 28.2% of the small cap S&P 600.1

The general stock market in the 1960s and 1970s was not a safe place to preserve or grow capital. I doubt index funds will be now. Index funds could very well see the ramifications of the DOW not recovering the full purchasing power until the 2050s.

The bond market also sold off during the ‘60s and ‘70s; yields on bonds were increasing, meaning bond prices were caving in.

While inflation was not kind to the stock market as measured by the DOW or S&P, there were companies whose stock prices soared during those times. Advanced Micro Devices, for example, dropped in value from about $30 per share to $10 per share in 1972, and then climbed to over $1,750 (adjusted for stock splits) during the mid-1980s. Advanced Micro Devices was not an outlier. There were dozens of stocks that grew portfolios: Eastman Kodak, IBM, Revlon, Merck, Gillette, Pfizer, Eli Lilly, Coca-Cola, Pepsi, McDonalds, Disney, and Baxter Labs increased 71-fold during the inflation times. $10,000 invested in of those stocks would have been worth $710,000 at their peak. $10,000 invested in Polaroid increased to $940,000! Of course, investing at the absolute bottom and selling at the absolute top is next to impossible.

Those are household names to us today, but in the 1960s, they were up-and-coming. McDonalds did not come public until 1966. Pfizer developed a way to produce industrial quantities of penicillin during World War II, and that gave rise to the pharmaceutical industry; Merck, Pfizer, Eli Lilly, and Baxter Labs were young companies in the 1960s. Computers were new, and IBM rode the computer wave. Disney built Disney Land in Anaheim in the late 1950s. These were the disruptive companies of that time. While the general stock market struggled, these companies soared.

The times they are a changin’, as Dylan wrote. The secular bull market that began at the end of the Great Recession seems to be coming to an end, and the beginning of the new high inflation times seems to be on its way. Those strategies that worked satisfactorily in the secular bull market may become obsolete as we enter this new period.

For our team at AFC, we have begun to make incremental portfolio changes in anticipation of inflation. The changes will be incremental because we acknowledge that we could be wrong. The Fed may engineer a soft landing and keep inflation at low levels while at the same time reawakening the secular bull for another decade. At AFC, we want to be prepared either way.

1. Wigglesworth, Robin. “The Power of Twelve: The Financial Industry’s New Emperors.” Financial Times, June 17, 2022. https://www.ft.com/content/cb818afb-4ac3-430b-8e17-2de9129f5ac7?desktop=true&segmentId=7c8f09b9-9b61-4fbb-9430-9208a9e233c8#myft:notification:daily-email:content.