Most prognosticators are, I believe, looking backward to predict the future. But we live in a time when things that have never happened before are happening all the time. I refer not only to social and political changes like the Great Recession, COVID, and the Russian invasion of the Ukraine, but also of economic upheavals like we saw with companies like Theranos, WeWork, FTX, and Silicon Valley Bank.
The Federal Reserve began to raise interest rates a year ago to tame inflation. It is Personal Consumption Expenditures (PCE) that the Fed tracks to measure inflation, not the Consumer Price Index. PCE has been five percent (5%), plus or minus, for well over a year, and it does not seem to be abating. My guess is that it will be years before we see it decrease again. Half of the PCE is related to wages, and wages are increasing at five percent (5%) per year, and likewise that increase does not seem to be slowing.
Coming out of the Great Recession, the Obama administration made job creation a major priority. It worked. The Trump and Biden administrations also made job creation a priority. They have all been so successful there are between five and six million more open jobs than there are workers to fill them. In addition, 200,000 or so jobs are created every month; contrast this with the fewer than a net 100,000 new workers which entered the workforce during the same period. The situation is getting worse rather than better. Job openings are so plentiful that 47 million people changed jobs in 2022. Most probably moved because the new job paid more than the old one.
Usually, when the Fed raises interest rates, people begin to worry about losing their jobs and reduce spending on nonessentials like clothes, restaurants, cars, and appliances. But this time is different. Consumers coming out of COVID received stimulus checks and had nothing on which to spend them because they were sheltering in place. As COVID has died down and jobs remain competitive, consumers have bought cars and durable items, are eating in restaurants and buying clothes, and are taking vacations. They are earning more and accepting the price increases.
The Taylor Principle says that in order to defeat inflation, central banks (the Federal Reserve in the United States) need to push and keep interest rates above the rate of inflation. The Fed is continuing to raise rates and, in my opinion, will continue to raise until they reach 5.5% or even 6% just to keep inflation in check. Instead of defeating inflation, it will keep PCE inflation in check but not get it back to the target 2%. At least not until job creation slows.
None of this should be a surprise if you have been reading my newsletters, listening to my radio program, or seeing my Money Show presentations. I have been saying since 2016 that we would see a bout of high inflation that would last for years. That time is now.
This means that the recession economists, business leaders, and Wall Street are expecting could be years down the road. Consumers are continuing to consume. Unless congress moves forward on an immigration act which would add workers from beyond our borders, it will very probably be automation and robotics that bring the number of jobs and workers into balance. But that second scenario will take years, during that time we will learn to live with high inflation.
Wall Street has been wrong about the 2022 recession and they will very probably be wrong about the Fed lowering interest rates. That did happen once before in 1972 and the result was surging inflation. That surging inflation lasted until the Fed again began raising interest rates which hit a high of 20% in 1980. Unemployment to hit 10%. The Fed economists are aware of what lowering interest rates in the early 1970s did and it is unlikely they will make the same mistake again.
We are also living in a time of market chaos. Sam Bankman-Fried went from a net worth of $18 billion on a Monday a complete loss and bankruptcy by Friday. The most popular startup bank in Silicon Valley faced so many demands for withdrawal by depositors that in one day they lost $42 billion, and an additional $100 billion later, when regulators shut down the bank. A 19-year-old Stanford dropout, Elizabeth Holmes, convinced some of the wealthiest and most powerful people in the US to be part of a company that was built on failed science. Adam Neumann convinced investors to dump billions into the real estate company WeWork, which he advertised as a tech company.
We will likely continue to see these types of chaotic events over the next few years. It will probably be difficult to tell the difference between real innovation and a lie masquerading as one.
Things that have never happened before happen all the time. It is something we will have to get used to.
There is, however, a lesson to be learned from past bouts of inflation. Inflation today is running at five percent (5%), which does not seem that destructive to portfolios and purchasing power. The inflation of 1960 – 1980 averaged 6.8% annually. That is not that much different from today.
What that meant for the consumer was that the dollar from 1960 to 1980 lost 70% of its purchasing power. On the average what cost $1 to buy in 1960 cost $3 to buy in 1980. In 1960, a first class stamp was 4 cents, a Coke was 10 cents, a dozen eggs 57 cents, and a gallon of milk was 49 cents. By 1980, the first-class stamp was 15 cents, a Coke was 35 cents, a dozen eggs were 91 cents, and a gallon of milk was $2.16. That was the result of 6.8% annual inflation, not that different from today’s inflation rate.
How did the stock market do? In 1966, the DOW hit 1,000 for the first time, and it would not pass that 1,000 again until August 1982, 16 years later. From 1966, the DOW sold off 20%, before rising again to 1,000. Then it sold off 30% before rising again to 1,000. Then the DOW sold off 40% before recovering to 1,000. Finally, it sold off 20% before passing the 1,000 mark in 1982.
It took 32 years for the stock market, as measured by the S&P 500 with dividends reinvested, to reach the same purchasing power as the consumer pricing index.
During good times, prior to COVID, the average return for financial advisors with their financial planning and asset allocation models was just over five percent (5%).1 But that was during a time when the S&P 500 with dividends reinvested was increasing at 17% per year. The average financial advisor was trailing the stock market by a whopping 12%! During that time, incidentally, Adams Financial Concepts was doing better than the S&P 500 with dividends reinvested (see our real returns, net of fees, on our website www.adamsfinancialconcepts.com). If that was what the average financial advisor was returning during a secular bull market, what will they be able to return for their clients during years of high inflation and disruptions?
At Adams Financial Concepts, we have been anticipating this time for almost a decade. We have experienced a drawdown in our client accounts, but we expect approximately a 20% increase in the first quarter of 2023, beating the S&P 500 with dividends reinvested by 15% or so. We stand on our 18-year track record. And while past performance is no guarantee of future performance, we strive to continue to improve.
We want our clients to do better than inflation and to continue to build a margin of safety. We do not want our clients to run out of money.
1. Anderson, J. (n.d.). Coach through biases – yours and your clients’. SEI. Retrieved December 22, 2021, from https://seic.com/knowledge-center/coach-through-biases-yours-and-your-clients.
