Her husband died in February 1978. She sat down with a financial adviser and did some planning; the FA believed she would be financially stable. Her late husband’s life insurance was enough to replace his income at the interest rates prevailing in 1978. Their stockbroker bought a couple dividend stocks for growth and bonds for income. It seemed the widow would be set for the remaining years of her life… BUT!

By the summer of 1986, the bonds had matured, and the replacement bonds were paying half as much. What she could buy with her income had been beaten down another 50% by inflation. In essence, the funds that she thought would get her through the remaining years of her life was just 25% of what she would really need. She was worried about running out of money.

In those nine years, the price of a postage stamp had risen from 13 cents to 22 cents (69%), a loaf of bread from 32 cents to 56 cents (75%), a gallon of milk from $0.83 to $1.08 (30%), and a Big Mac from McDonalds from $0.64 to $2.59 (304%). That was the impact of inflation upon purchasing power in just the eight years from 1978 to 1986.

By 1986, the Fed has been successful in reducing inflation and interest rates had been pushed back down. The higher prices did not decrease. It was a double whammy for the widow. Her effective purchasing power had tumbled 75% in just eight years.

In the last  six years I have been writing and sharing on the radio that the most probable end of the secular bull market would be a bout of high inflation. One which, I believe, could rival or surpass the inflation of the 1960s and 1970s. Our objective at AFC has been to build a margin of safety into the value of our portfolios. We hope to grow portfolios to a level of perhaps twice or more of what would be needed to live without experiencing a lifestyle upset like that experienced by the widow.

Inflation raged for 16 years, from 1966 through 1981. The stock market did not keep up with the increasing consumer price index. Four separate times, the DOW tumbled as much as 40% during those years. Oil prices shot up because OPEC had control and oil demand was increasing. In the 2020s, however, alternative energy may soften the blow of increased oil prices.

Inflation may be here to stay for a long time. An article in the Economist highlighted why inflation has such sticking power. Monetary policy has been very loose and there was a significant worldwide printing of money by central banks to combat the pandemic. Unemployment is low worldwide and wages are increasing faster than productivity. As always, this is a perception market, and people’s outlooks for prices and wages impact consumption.1

It is no surprise the stock market is down in 2022. That was typical in the ‘60s and 70’s as well. There were recoveries during those years only for the market to sell off again. Selling into cash resulted in a significant loss in purchasing power. Holding a highly diversified portfolio did not work then, either, as the DOW did not gain, and the S&P 500 grew at an average compounded rate of only 2.4%. That is significantly less than the 6.8% compounded growth in the consumer price index. There was little, if any, financial planning during those days. My guess is that the normal financial planning would have failed to keep up with purchasing power.

It was the stock pickers who did well during the last inflationary market. If history is any guide, I suspect we shall see the same for the 2020s. That is the value AFC brings to our clients. We know there will be periodic losses, setbacks, and unexpected occurrences. Calamitous drops will not scare us out of the market. Historically, riding through those times, although scary, have yielded returns that have done better than the market over the longer-term. We believe that history does not repeat but it does rhyme.

When the widow came to AFC to open an account, I built a portfolio that I hoped would not only do better than the S&P 500 but would furnish the income she needed without drawing down the principal. She lived for 24 more years, to age 90, without having to degrade her quality of life. The account did fluctuate quite a bit, but even with those fluctuations she did not run out of money.

 

Mike Adams

NOTES

1. Dettmer, Otto. “Why Inflation Refuses to Go Away.” The Economist. The Economist Newspaper, October 19, 2022. https://www.economist.com/finance-and-economics/2022/10/19/why-inflation-refuses-to-go-away.