Party Like It's 1979 - Welcome Back Inflation
My wife and I are both vaccinated, so we went home for Easter to Napoleon, Ohio. I got to talking with my parents and they reminisced about financial events in their lifetimes. Inflation was going through the roof and mortgage rates were nearly 10% when we moved to Napoleon in 1976. Rates continued to rise through the late ‘70’s until hitting a high of 16.6% in 1981. My parents borrowed on two mortgages during that time and my mom told of their maniacal effort to pay them down (although such efforts by my mom often are more about hating debt than they are about any specific rate)! From 1981 until the present day, mortgage rates have been on a steady decline, especially to the crazy low rates of the past 6 months. 30-year loan rates under 3% have been common.
Why did mortgage rates decline for 40 years? There is an inverse relationship between bonds and rates - rates decline when bonds increase. Bond prices have been rising and hit a 40 year high last year. After inflation was squashed in the early 80s, inflation was low, wage growth moderate, and the Federal Reserve was quick to move the Federal Funds rate up/down – all elements that kept us in a low interest rate world for a couple decades. And now with the economy improving, stimulus checks in people’s pockets, mortgage rates low, and the Federal Funds rate extremely low by historical standards, much is being written about the return of inflation. The prices of oil, lumber, and copper are all on the rise. The supply of new and used cars is extremely low, pushing prices up. P&G last week announced they will raise prices in the fall on a host of goods due to the rise in material costs. What does this all mean? It could be a short-term “re-opening” phenomenon. If, on the other hand, inflation is on its way up, we may see an environment much like the late 70’s and early 80’s. We might see a continued boom in construction, higher prices on everything, and eventually, interest rates will rise as bonds fall. The markets may go up for a while and in certain areas. Banks will do well if interest rates rise. Companies tied to construction may thrive. And real estate, commodities and farming will do well. Growth stocks may take a hit – think Google, Facebook, Tesla, Amazon.
The first quarter of the calendar year suggests the markets believe inflation is on its way. The Dow Jones Industrial Average far outpaced the broader stock market (S&P 500 and NASDAQ) indices. We prepared for this in our portfolios with the addition of financials in the fall (banks tend to earn more in a rising rate environment). We continue to look at moving toward value stocks while lowering our technology/growth weighting. We are also looking at opportunities to profit from inflation through commodities, land, or real estate.
The Shiller P/E ratio and the “Buffett Indicator” both continue to suggest the market is overvalued compared to historical norms. For perspective, the Buffet Indicator is at 204%, continuing at an all-time high, and the Shiller P/E is at 37.5, well into the overvalued zone. Bull markets rarely die due to over-valuation, but rather due to an event. It could be an interest rate spike, some sort of bubble popping from cryptocurrencies, or something no one anticipates. Overall, we remain invested since the market tends to move higher over time and we continue to prepare our portfolios for the changing economic environment.
For now, keep on keeping on. If you think we are headed back to a 70’s style disco party with bell-bottoms and leisure suits, get that mortgage locked in and be ready for higher prices and higher rates. Relatedly, we hear from many that you are holding significant cash in your savings accounts. If inflation is on the horizon, you may want that cash earning more than you can get in your bank savings account. Next time I will offer some thoughts on how to earn a return on that money given the super low bank rates.
Jared
Brian Kellett, brian@kellettschaffner.com. Phone 513-312-6067
Dave Bodnar, david@kellettschaffner.com. Phone 513-258-6973
Jared Kline, jared@kellettschaffner.com. Phone 513-768-2238
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