Stuck in the Middle With You

A year ago, we wrote an article titled “Party Like It’s 1979 – Welcome back inflation”. Unfortunately, as we all know, inflation is everywhere. The average sales price of houses sold in the US is up 36% since 2020. For perspective, since 1891, US home prices have increased 3.2% per year on average. The last two years have blown that average out of the water. My wife Corie has a furniture painting business and recently watched the nightstands she buys from Amazon spike from $140 apiece to $365, if she’s able to order them at all. And probably the example we most feel across the economy is gas prices. I paid $4.11/gallon this past week. A year ago the average price was $2.87.

As I type this on the last trading day in April, the S&P 500 is on pace for its worst start to a year since 1942. At the moment, the S&P is down 13% for the year. The Dow Jones is down 9% and small caps are down 17%.  From a sector perspective, Energy is up 39% and consumer staples (think Procter) is the next best performing sector at 3.5%. All other sectors are down for the year.

How did we get here? Let’s first talk about the Federal Reserve. The Federal Reserve has several goals: 1) Promote maximum employment; 2) Promote price stability; and 3) Moderate long term interest rates. In recent times, and in response to the global financial crisis in 2008 and the COVID pandemic, they bought mortgages and Treasury bonds. When they make those purchases, they are putting money into the economy. The idea was to add liquidity into the system to promote a functioning economy in a time of crisis. As you can see from the chart below, they went “all in” with a huge increase in liquidity starting in 2008.

In addition to this liquidity, 4 straight Presidents have passed stimulus bills, providing even more liquidity. “W” in 2008, Obama in 2009, Trump in 2020 and Biden in 2021. Was this necessary? The risk of deflation was viewed as being more dangerous. And frankly, we hadn’t experienced inflation for 40 years. For awhile, it seemed the risk of inflation was extremely low. But this money has to go somewhere, and it’s gone into all kinds of assets like real estate, cryptocurrencies and, more recently, spending on goods and services. All while supply is constrained. A big rebound in demand chasing a limited supply. Add in a war that has strained supplies of food and energy, an aging workforce that is working less and a declining immigration rate. And finally, sprinkle in a mess of a COVID situation in China that is disrupting supply chains. A perfect storm for….. Inflation.

The Federal Reserve has signaled an end to the liquidity although they’ve been very slow to act. They were still buying mortgages/Treasuries well into March. And while they have talked about raising interest rate aggressively, they raised by .25% in March, the first since 2018. If they raise rates by .5% next week, it will be the first hike of .5% in 22 years. It’s likely they will need to continue raising rates, balancing the risk of slowing the economy while getting ahold of inflation.

This is a long way of saying that the stock market is reacting to inflation, the likelihood of higher interest rates and the potential for a slowing economy. A similar series of events unfolded in 1973 and 1974. The stock market had enjoyed a long bull market. Money was pumped into the economy in the late 60’s and an oil crisis occurred in October of 1973. As you might have guessed, the market corrected, to the tune of about 40%.

We felt the market was headed in this direction, and we’ve accumulated cash in your accounts, more as the account moves down the risk curve from aggressive growth to conservative. For compliance reasons, we don’t quote returns in a newsletter like this. But suffice is to say as of this writing, accounts tend to be down far less than the market, and even far less than traditionally quoted stock/bond portfolios since we increased cash as a percentage of the assets. There will come a time where this will all wash itself out, and another bull market will commence.  Until then, in the words of the 1973 hit by the “Stealer’s Wheel”…. “Clowns to the left of me! Jokers to the Right! Here I am Stuck in the Middle with You”. If you have any questions, feel free to give us a call or email.

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

Kellett Schaffner Wealth Advisors LLC is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where Kellett Schaffner Wealth Advisors LLC and its representatives are properly licensed or exempt from licensure. This website is solely for informational purposes. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Kellett Schaffner Wealth Advisors LLC unless a client service agreement is in place.