Inflation: A Look Back Could Help as We Look Forward.
Since World War II it has been generally accepted that the primary cause of inflation is roughly 20% associated with the cost of energy, 20% associated with the cost of labor and 60% associated with consumption (both Personal Consumption Expenditures (PCE), our Sign number one of the Seven Signs of a Changing Economy, and government spending). (Source: J.P. Morgan Guide to the Markets, 9/30/2021)
I believe these inflation inputs are about the same percentages today. However, the one thing you don’t see much unless you go back and look at history, is the root cause. Meaning, how do people get the money to spend?
Back in 1969 President Nixon inherited a pretty nasty recession from Lyndon Johnson. We were finishing up the Vietnam war, which was very expensive, and unemployment was very high, i.e., 10%+.
When President Nixon ran for his re-election, he made a public statement that he would accept “inflation over unemployment” and he won 49 out of 50 states in a landslide victory.
Operating in the background was the United States Federal Reserve, which has a mandate to “promote growth without excessive inflation”. They were busy increasing the money supply and keeping interest rates artificially low to expand the economy and create jobs.
It took a few years but ultimately the U.S. dollar value started to drop against currencies as other countries around the world lost confidence in our ability to pay back our huge amounts of debt at the time. Back then the money supply was increased in the hundreds of billions of dollars versus today’s increase from $4 trillion in February 2020 to $21 trillion today. (Source: https://fred.stlouisfed.org/series/M1SL)
Today we are coming out of a few wars and, also the pandemic. There is also a like type of structure created by the Federal Reserve. They have Increased the money supply from $4 trillion to $21 trillion, more than 400% increase and much more than back in the 70’s. (Source: https://fred.stlouisfed.org/series/M1SL)
In the 1970’s the Organization of Petroleum Exporting Countries (OPEC) was increasing energy prices to the world. Energy prices today have increased dramatically as President Biden has kept his promise to shut down significant pipelines in the United States.
Labor costs have increased dramatically as people have been paid to stay home and earn money from government stipends versus going to work. Thus, causing labor cost increase dramatically. (Same or more demand and less labor analogy, Econ 101)
The increase in money supply combined with the increase in energy costs, increase in labor costs, and the incredible increase in consumer and government spending will likely have some similar results as the 1970’s. Just not tomorrow.
It’s kind of like smoking a cigarette, you can smoke a few cigs and “maybe” have no major health issues, but if you smoke your whole life you are likely to end up with life-threatening diseases.
It is the continuing of a bad habit that results in a poor outcome and in this example, continuing to have trillions of dollars of cheap money created out of the blue and maintaining low interest rates, will likely have a 1970’s level outcome, just not yet. Perhaps a year or two out.
I have been writing about this in both The WSG Weekly Update and The Seven Signs of a Changing Economy™ monthly update as well as discussing on our monthly conference call for almost 18 months. Our Wealth Strategies Group family is happy to know we have positioned our asset allocations to include inflation hedges as well as traditional growth investments, like ownership in Corporate America, which have historically been respectably good inflation hedges.
That being said, we all know market valuations can disconnect from great investments during certain periods, think 2000 through 2003, where overall our economy was quite good, yet the value of Corporate America dropped over 50%.
It is for that reason that we also have our “WSG Exit Strategy” up-to-date and willing to implement it if we should see the markets reverse the up trend that we are currently in. Keep in mind a 10% correction is normal, a 15% reduction in value is not out of the question and it’s really only after a 20% violation from the peak down that we would change the trend to a down trend and consider placing our WSG Exit Strategy into action.
For now, we expect a strong end to 2021. Our biggest holiday shopping season is right around the corner. Yet, with the above detail noted, next year could be a bit more choppy than the last ten!
I am interested in your questions, comments and observations. Please call, or email me, or just stop by the office and say Hi.
James O. Lunney, CFP®
CERTIFIED FINANCIAL PLANNER™ Professional
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.