Since the dawn of time, people have wanted two things: Power and control.
Power over other people. Power over land. Power over our technologies. And so on.
And it’s not hard to imagine that since currencies were created, people have wanted more. More money to trade with, buy supplies, and eventually negotiate with. Obviously, when you have a lot of a valuable resource, you find it’s easier to dictate or influence many outcomes in your favor.
So, part of inflation comes from the mere fact that people want to make more money.
Without inflation, we become stagnant. Innovation is stifled because “if I can live just fine on $25 a year, why would I ever change what I’m doing?” Hence why there’d be no need to save. Which means no banking. No banking means no borrowing. No borrowing means … Which means … You get the picture.
Understand, part of inflation comes from our own ambitions.
Another reason why we need inflation is that it creates demand immediately. For example, if you expect prices to be higher in the future, you’ll buy today.
However, the opposite is true as well. If you expect prices to be lower tomorrow, you won’t buy today. Demand eventually comes to a halt. Jobs get cut. Wages fall. Bankruptcies rise. Economies fall.
Clearly, these consequences have a more dire downward spiraling effect. Frankly, deflation actually might be much worse than inflation.
On the bright side, where are we seeing an example of that recently?
More and more home sellers are dropping prices.
“Buyers, who earlier this year had to race to beat the competition, can now take their time touring homes and perhaps even wait to see if sellers drop the price,” said our Chief Economist @FairweatherPhD. #realestate pic.twitter.com/wtFmq9xBLW
— Redfin (@Redfin) August 6, 2022
As of today, most of the conversation has surrounded the negatives of raising rates. But, truthfully, I think we’re just in the middle of a mean reversion with some hiccups along the way, and I think some good will come from the Fed fighting inflation. This is how to best handle this volatile market and how to reorient our perspective on interest rates.
Why Inflation is[n’t so bad] Good
Fed chairman Powell and co. are trying to keep this inflation from running any hotter.
Even though it was stagnant from June to July – where we thought inflation had peaked – August came in at 8.3%. A little higher than expected. But to be fair, summer is almost over, the kids are returning back to school, and most workers are getting back into full swing, which might have played a factor in the unexpected rise.
But please don’t look at the Fed’s recent moves as trying to kill jobs or destroy the economy. Why would they want to do that? Instead, what the Fed is trying to do is reduce its balance sheet by selling securities to the public to reduce the money supply in circulation – a key driver to demand and wage growth. How? By finally offering attractive interest rates on treasuries in exchange for your cash today.
The good news is that we are now being rewarded for being savers rather than being punished.
Considering where high-yield saving account yields started at the beginning of this year, look at this table from NerdWallet. Showing that you can get a pretty impressive 2% yield on your idle cash alone.
Dirt-cheap borrowing is gone. So, if saving was an issue for you in the past because you were getting next to nothing on your savings, now is the perfect time to be a saver. Now is the time to save for the house a few years down the road, the wedding, the big vacation. You name it.
Additionally, the chart below shows various current fixed-income yields. The 1-year Treasury rate, or risk-free money, is spitting off as much as 4% now.
We know that bonds typically act as the anti-stocks in a downturn. However, for most of this year, bonds haven’t helped us at all with the losses from stocks. Actually, in many cases, bonds only exacerbated them.
To add to that, in Ben Carlson’s case for owning bonds right now, at least two things remain accurate: the Fed is continuing to tighten and interest rates could go higher. Ben did mention that “bonds could continue to get clobbered if interest rates continue to rise at their current trajectory.”
We know the Fed will continue to hike rates throughout the end of this year. To what extent, we don’t know. Depends on where core CPI, the housing and job market, and so on land.
You may want to react. You may think that you can wait to buy the dip. Whatever it is. But we don’t know where the market will go from here.
The point of all this is, if you’re looking for something to do about it, maybe the right thing is to do nothing. Maybe not making any drastic changes on the investment front and strengthening your cash positions is the best way to play this environment. In fact, Denise Chisholm, Director of Quantitative Market Strategy at Fidelity, would support this when she said,
“… historically, two quarters in a row with negative GDP has been great news for the stock market: Every time since 1957 that GDP fell in two consecutive quarters, the S&P 500 advanced over the next nine months, with an average return of nearly 18%.”
Forget about the daily movements. If you have the time horizon for it and you’re not putting money to work, I think you’re going to regret missing an opportunity like this that may not come again for a long time. If not mine, then take Batnick’s word for it,
“You’re never going to buy the bottom, and you’re almost always going to regret it in the short term, but if you can stomach the pain, you’re usually rewarded over the long term.”
Who says we’re not in a recession?
To put this all into perspective, even across the pond, the UK is battling their highest inflation in years. They just raised rates by 75bps as well – but oddly enough are also lowering taxes. Nonetheless, I found it interesting that globally, we don’t even fall into the top ten worst offenders when it comes to combating higher prices. Venezuela is experiencing almost 1,200% inflation!
August’s headline inflation report came in just that much too high. Yet still, clearly not peaking as Wall Street expected. Which means the Federal Reserve will continue to be aggressive with tightening. This could explain the significant market decline that happened on the 13th.
The Fed will continue raising rates until inflation reaches a more reasonable level. But, despite the labor market holding up, two things are critical here: the yield curve has been inverted since July and it’s been two consecutive quarters of negative GDP.
So, unless you’ve been stalking the market, the good news is, it has been so mild that most people haven’t even noticed – even if we are/are not in a recession. Therefore I think the biggest takeaway is that we shouldn’t keep anchoring to old rates.
Understand that, yes, it sucks that the cost to own a home is becoming outrageous, but 6% interest rates on mortgages aren’t that unusual. When looking at the average mortgage rates for the last 60 years – roughly 7% – a six percent rate is actually about average. Maybe we are just anchoring to where rates were without considering where they could be (15-16%).
Yes, it sucks that jobs may soon suffer, but we have the best unemployment numbers on par with years like ’99-’00 and ’17-’19. Two important periods right before the contraction. More proof we may have seen the worst of it.
Not to mention that the median IPO valuations in the last three years alone were worth more than 2011 to 2016 combined. Maybe we’re finally reaching an equilibrium, rather than the Fed continuing to give us performance-enhancing drugs (rates).
As time goes on, people will continue to want the same thing: Control.
Control over our own autonomy. Control over our environment. Control over our automated technologies. Fill in the blank.
Make sure you know what you can and cannot control.