“It’s the end of the world as we know it… And I feel fine.” R.E.M., 1987
This thirty-five-year-old lyric could be sung by the S&P 500 today, which feels fine regardless of the seemingly fragile state of the world. While worries abound about everything from the latest COVID-19 variant to supply chain ‘bottlenecks,’ climate change to the death of TV icon Betty White, the stock index of five hundred ‘important’ US companies nonetheless blasted expectations in 2021 by rising an extraordinary twenty-eight-point-seven percent! Many other stock markets, but not all, fared reasonably well, too.
What keeps driving markets higher and higher? There are, as always, many possibilities. One is that stock markets do well when people think that the economy is going to do well in the future, so the market could be ‘telling’ us that the outlook is bright, at least for corporate profits (and thus shareholders). Another reason could be that the economy is doing well right now, even if many people don’t seem to feel or express it. The data, however, show it - unemployment is at very low levels; interest rates remain low, profits are solid and moderate growth looks like it is back. This sounds like a good, if not perfect ‘goldilocks’ economy.
Another possibility is that the stock market is pricing in future inflation, now. Inflation?! Yes. The dreaded I word made a big comeback in 2021, as there were some historically high readings on inflation. Questions abound around inflation such as: How ‘bad’ are the numbers? Is it permanent? and, how do you (or we) preserve/protect capital during periods of higher-than-normal inflation?
Let’s start with how bad are the numbers? They are very bad if they stick around, which could lead to ‘hyperinflation.’ This is what we really fear when we talk about inflation being scary, but this scenario remains highly unlikely to happen. For the past decade or so, inflation has been relatively muted, and this recent spike may simply be a ‘reversion to the mean.’ Recall that we really do ‘want’ inflation. In fact, the stated goal of the Federal Reserve is to maintain a long-term constant inflation rate in the broad economy. However, this is impossible to achieve on a linear path, so don’t panic! Number two: Is this permanent or ‘transitory’? The answer is both. While outsized readings of CPI came through last fall, it was a perfect storm. The trifecta of high oil prices, abnormally and temporarily elevated building material costs, and pandemic-induced elevated prices on items like used cars all conspired to create a late 1970s type inflation number (+6.8% in November). Some of these increases have already abated and the CPI number will not continue at this rate, meaning a piece of this is ‘transitory.’ On the other hand, labor costs have risen in the US and input costs are up so some portion of this is indeed permanent. Lastly, how do we protect and preserve capital in these environments. This is what portfolio management is about. Investing in assets that rise with inflation expectations before, during or after inflation hits your pocketbook is a primary goal of our investing activities. Asset allocation continues to work as intended.
If you ever want to discuss your portfolio or anything in your financial situation, then please do not hesitate to call or email. In the meantime, we wish you a healthy and happy new year and great things for 2022!
Scott Lasky, CFP™
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