Turn on your TV these days and it seems like there’s a lot to be concerned about. How will the markets fare? Will the U.S. fall into a recession? What about the global economy? Economists and pundits are hinting that a recession could arrive soon, and everyone is pointing the finger at the same culprit – out of control inflation. Now, the Federal Reserve may be a bit too late in raising rates and potentially stifling growth. According to a survey of economists conducted by The Wall Street Journal, the risk of recession in the next twelve months is 28%, up from 18% just two months ago.
The International Monetary Fund (IMF) is also a bit bearish about the inflation outlook, cutting growth forecasts for 143 countries representing 86% of global GDP citing rising commodity prices and trade issues. These pressures globally could impact household spending, squeeze profit margins, and create a significant impact on food processing and supply.
The cumulative effects of inflation can sometimes go unrecognized. Inflation has spiked recently but hasn’t been discussed much for the last decade. While price changes are slight on a day-to-day basis, the effects can be great over time. Investing for retirement or being in retirement can last 20-30 years or more. In January 2022, inflation was 7.5%—the highest in 40 years. It can feel like sticker shock, as over the past 10 years, inflation has averaged only 2.1%. Some prices have increased well over 7.5%.
We may not have this kind of inflation for the foreseeable future, but it’s with us now. We can’t grasp the real impact of inflation without looking backwards a bit. By looking back 30 years, we may be able to gauge how much things would cost in the future. Just looking back from 2021 to 1991, we see the long-term impact of even mild inflation when we compare prices.
The real quandary here is most talking heads in the media are signaling recession, while at the same time some of those economists still expect inflation-adjusted U.S. GDP to go up by 2.6% in 2022! That level of GDP growth is higher than the average annual growth rate for the decade leading up to the pandemic. On one hand, people are talking and worrying a lot about an economy that is actually quite strong.
While the future is too uncertain to reliably predict what the economy will do, we do have some reasons for real optimism. The strong jobs market, rising wages, and consumer households in good financial shape should be plenty to help overcome inflationary pressures that are poised to relax in the second half of the year.
On the U.S. business side of the equation, S&P 500 companies have collectively reported profit margins of 12.18% over the past 12 months, which is significantly higher than historical profit margins. The figures for 2021 shattered records and also represent the highest after-tax corporate profits relative to GDP that have ever been recorded (since the 1940s). Some think that corporate profit margins have peaked, especially in this more challenging economic environment, but this strong profit outlook has led analysts and corporations to raise – not lower – earnings expectations for 2022.
Anytime we see ‘experts’ and the media in alignment on a common theme, we get a bit more skeptical about its outcome. The reality here is that the economy is strong, inflation is present, and fundamentals are still very robust despite inflationary and interest rate pressures. Markets move on expectations and realities. Right now, expectations are low so an upside surprise based on reality could be in order. Just yesterday evening we saw mixed results from two of the biggest tech titans, Microsoft and Google after a brutal day on Wall Street. Strong revenue and earnings that should surely set the tone in the equity markets for the near future.
Times like these can be unsettling. For clients and friends in retirement, inflation can stoke fear and anxiety. Goods and services cost more, and for those on a fixed income, they may have to withdraw a greater amount just to keep up. Worries about their income or growth from investments not keeping up with inflation or running out of money in retirement become overwhelming. It can make people anxious and insecure.
We invest for the future. We stay invested for the long term. In retirement, most people think it’s best to invest less in stocks and more into investments perceived as “safe,” such as bonds, CDs, cash. Why? Volatility and the effect it could have on their income. But…over the long-term, fixed-income investments (bonds) and cash investments (like CDs) have provided lower returns than stocks. While bonds offer significant diversification and have a place in most of our portfolios, they don’t like inflation or rising rate environments that we are currently experiencing.
For the last 30 years, stocks have significantly outpaced inflation. The outpacing occurred despite six bear markets (market drops of more than 20%). The average drop of the six bear markets was 37% and the biggest drop was 52%.
If you are still concerned about inflation and how it impacts your portfolio, we can help by reviewing your current strategy, risk tolerance, and investment objectives to determine the optimal mix of stocks, bonds, and cash. We also encourage the utilization of non-traditional assets like commodities, real estate, and other structures to help guard against inflation.
We can’t always control what happens around us but we will continue to provide our valued clients the best possible advice to accomplish their goals and objectives – in any market.
Thank you for your trust and support,
The RINA Wealth Management Team