We have been meeting with many of you over the past month, either in-person or online, discussing your 2020 “Half-Time” results, portfolio risk, and our outlook moving forward. If you have not scheduled your personal review this quarter, call or email us now to schedule a time, either online or in-person, that will best fit your schedule. This is a great time to update and review your overall personal financial planning and investment risk
We would expect continue volatility moving forward for the U.S. financial markets. We are seeing movements almost daily within the markets based on the current virus outlook and economic recovery. Couple that with the upcoming elections in November, continued swings in market movement can be expected until some of the current uncertainties are resolved. As of this writing, Congress is also negotiating another stimulus package, the HEALS Act, and some form of the bill is expected to eventually pass. Currently, the biggest issue causing delay is the extension of unemployment benefits. We will keep you posted.
Inflation Remains Front and Center Long Term
The Federal Reserve of the United States has discussed abandoning its inflation target of 2%. Instead, the Fed has implied that it would allow inflation to run higher in order to keep interest rates suppressed. Why does this matter? Well, we believe it shows a real possibility that inflation will begin ramping up from recent global actions by both governments and central banks. From an economic perspective, it creates problems. If you’re intending to make long-term investments but understand inflation could rise, usually your fear is that the Fed could ramp up interest rates to hold down inflation. Currently, however, the Fed is now giving the signal to individuals that investments can be made and the Fed will allow inflation to rise without much near-term meddling. This means asset prices can go higher. The idea is to invest now or risk paying increased prices in the future. Fast forward ten years from now, asset holders could benefit while those without assets may not. This move could escalate our concerns for a ramp up of inflation.
Back in the late 1980’s, the Economist magazine came up with an indicator that became known as the “Big Mac Index,” which is exactly what it sounds like. They took the price of a Big Mac worldwide to determine whether a currency was either overvalued or undervalued based on those prices. The Big Mac was chosen from its exposure to various cost categories such as transportation, dairy, meat, and other expenses that could reflect actual costs being realized. While the index was intended for global currency comparisons, we can also look at this data isolated just in the US. While most would say it solely reflects food prices, it does seem to tell a broader story, especially from a company focused on a low-cost option. McDonald’s would most likely attempt price compression to the best of its abilities. Over the last decade, the US has seen an increase in its domestic “Big Mac” prices of 4.4% per year. Compare this with overall food inflation reported a decade average right under 2% and inflation near 1.8%.
That’s quite a remarkable spread. As most clients understand the power of compounding returns from our planning sessions, it can quickly be seen how fast prices rise if actually increasing by over twice the stated rate. For example, it would take you $1.20 today to buy $1 of goods ten years ago at a 1.8% inflation rate. However, it would take you $1.54 at 4.4%. You need over $0.34 per dollar, or 34% more! Now, with the Fed potentially abandoning inflation fighting options in the future and holding interest rates at or near zero for the foreseeable future, it can be concluded that asset returns will be extremely meaningful over the next decade. Competitive returns could be difficult to achieve in fixed income/bond and cash-like assets.
What does this all mean? For most individuals here in the US, if the Fed is comfortable watching inflation rates trend over 2% it could mean much higher “real” prices. The previous example showed potentially how much higher inflation was by using the Big Mac Index rather than the stated rate of inflation (4.4% vs 1.8%). Already, stated food prices have seen a rise this year of 4.5%, significantly above the 2% average of food prices over the last ten years. We believe a continuation of higher inflation experienced by consumers could occur in the years ahead. We’ve continued to lean on publicly traded REITs (Real Estate Investment Trusts) and value stocks to help protect investors from rising inflation rates. Additionally, we will continue to hold inflation protected fixed income funds and are shifting our pro-risk bond stance towards more diverse bond holdings.
The pandemic is undoubtedly skewing the lens in the short term, not just for financial markets but for life in general. The same happened back during the financial crisis of 2008-2009. It was caused by the bust of a massive housing bubble. The Country was trending off unnaturally high housing prices. Most major cities’ housing prices have now eclipsed their housing bubble highs, but the crash in values made prices appear low for some time.
In the same way, the chaos caused by the pandemic has muddled supply chains and caused shockwaves in various industries, commodities, and markets. As previously discussed, some tech stock valuations have ballooned to unusually high prices, while some industries see price valuations near bankruptcy levels. Bankruptcies, particularly in the retail and service-related businesses have surged. The price of lumber has doubled since March and is up about 50% year to date. While suppliers were literally having to pay investors to take oil shipments, oil prices are still down roughly 33% this year. We believe it could take several years before normalcy is finally being seen in price levels so that we can have a clearer picture of inflation overall.
We cannot ignore the massive deficits and government debt issuance occurring today as well. But we’ll save the analysis for digging ourselves out of this massive fiscal hole for another day. As we’ve said before though, another favorite tool of the government is almost always inflation.
Virus Data Worldwide Mixed
While the data continues to bewilder us in some places, we believe that much of the worst in terms of fatalities is behind us, at least for America. The US saw a “second surge” that began on June 14th. The “first surge” from early March until June saw roughly 120,000 deaths with over 2.1m cases reported. The second surge observed nearly 2.7m cases reported with under 40,000 unfortunate deaths. Worldwide the data continues to be just as confusing. For example, Australia has seen a second wave like the US, although from significantly lower initial numbers (roughly 7,400 reported cases from first surge and currently another 11,000 from the second). The gap between the two “surges” was quite long as well. Spain appears to be observing another spike. India, Brazil, Argentina and Mexico seem to be reporting continuous rise in cases. Other countries continue to report cases but at suppressed numbers with no appearance of second surges, such as South Korea, Italy, Germany and the UK. (Worldometers.info)
In the beginning, we watched the virus surge through China and then curtail off. Most doubted the accuracy of this reporting however, we then saw the exact same happen in South Korea. Italy came next with undoubtable chaos, but the same pattern of cases slowly dropping along with deaths. It was at that point that there was an expectation to see it ripple through the US, which took much of the Northeast by storm, specifically New York and New Jersey. However, most other heavily populated states like California, Texas and Florida were almost untouched, which seemed extremely odd. It could possibly be explained by population density. Then, these states seemed to take off in case count starting around June 15th. Initially the new large case count appeared to be from a massive increase in testing, however these states also experienced increases in hospitalizations as well as deaths showing much more than just increased testing at play.
Fortunately, most of the “second surge” states have seen a peak in daily case counts, such as Arizona, California, Texas and Florida. Since most of these are high population states, this should continue bringing down the daily national numbers as well as seeing a peak in daily fatalities for the country as a whole in the coming weeks. Any fatality is a tragedy, however, it should be reiterated that throughout this entire pandemic the majority of these deaths, as with every country worldwide, are within the elderly population-specifically among nursing home and long-term care facilities. In the US as of June 17th, those over the age of 85 make up one third of COVID19 deaths. Those under 35 only comprising of 0.81% of fatalities, while those over 65 make up over 80%. This is no doubt this segment of the population that must be protected more than any other throughout this pandemic. This too shall pass!
We appreciated the privilege to serve all of you and please do not hesitate to call or email us at any time if you have any questions or concerns, or if we can be of further service in any way. Stay safe and well during these trying times.
Your TEAM at F.I.G. Financial Advisory Services, Inc.