We are good for now…
Key takeaways:
Growth stabilizing towards 4%
Rate of change in inflation nears peak
Our concerns about fed tapering into a slowdown
An overview of the current environment:
Firstly, Happy New Year! As we head into 2022, it is hard to believe that we have been living with Covid for over two years. I hope we are starting a new chapter in the Covid story. Inflation still does not seem to be the hot conversation topic for investment news. We believe that we have started to hit the peak cycle in the rate of change with respect to inflation. The rate of change of inflation will start to decline but the absolute numbers will be high; for example, inflation moving from 5% to 4% is a sizeable percentage drop but the ending outcome at a 4% inflation rate is still a relatively high rate. Especially, considering we have been at a roughly 2% inflation rate since even before the great financial crisis. We also believe that growth looks to stabilize specifically due to two factors: (i) a very strong labor market and (ii) supply chain catching up to demand.
Our investment process:
Fundamentally, our investment portfolios are built on BlackRock’s long-term asset allocation models coupled with our risk management framework. Our risk management process is built on growth, inflation, and policy decisions. Tracking these variables allows us to position assets with the highest risk-adjusted returns. Specifically, we are tracking the rate of change between GDP and inflation. Let’s dive into some of the data and take a deeper look at growth, inflation, and policy.
Looking at growth – The rate of change in growth per our model looks to have growth stabilizing towards 4% year over year. Stable growth is good for investments. Growth has been powered by the consumer spending capacity increasing as illustrated by an all-time high in ISM Services at 69.10. Job openings remain high and demand for qualified labor continues to grow. Because of this increased demand, wages continue to grow thereby increasing consumer discretionary spending. In addition, growth will continue given the resolution of covid related supply chain issues. We are starting to see a decrease in the time between invoices and fulfillment. Assuming these trends continue, we forecast that GDP numbers will remain strong throughout 2022.
Looking at inflation – We still believe inflation will continue to be a main theme going forward yet the rate of change has peaked, meaning things will still get more expensive, just not as fast. The 4th quarter 2021 numbers that are coming in now have already started to support our view. No one knows when the peak will occur, but we are fairly certain it is happening now. The largest components of inflation are shelter and wage growth. Although inflation associated with shelter and wages will continue to remain strong, central banks are looking towards policy rate increases to mitigate inflation supporting our view that inflation will continue albeit not as strong as in 2021. Lastly, there has been a drastic decline in commodity prices over the last several weeks that will lead to decrease cost for everything that is manufactured.
investments during infaltion
Looking at Policy – It is important to note that the Fed has created the conditions that we are in today by printing and creating more and more dollars, increasing the money supply in the economy. The increased money supply in turn raises prices for everything from bread to cars and equities to real estate. Low interest rates have also fueled a demand for assets which we believe will eventually result in asset bubbles. Further, low rates cause individuals to take on higher levels of leverage causing valuation bubbles in an over-heated market. If you look at the picture above, you will see the size of home mortgages have continually increased year over year. House values have skyrocketed and made owning a home in your current location very difficult or very expensive relative to 10 years ago. The Fed has stated multiple times that they are looking to exit the money printing business. but exactly how they do that is anyone’s guess.
The Big Risk
The ending of pandemic-related benefits is the biggest risk to growth in the coming year. And the fiscal math doesn’t add up. In 2022 in the second quarter when most of the benefits roll off, by using the CBO baseline projections, you will see a drop of 1.3 trillion dollars in federal spending. This is a big deal. No one knows how this will be navigated or if BBB comes back into the picture. But if the Fed has a misstep, they definitely have fewer tools than they did in years past. This could cause high-risk assets to suffer large losses as investors flee to safety.
Upcoming Changes
If you want to know how we are adjusting our portfolios to help our clients reach their goals, please reach out to us. We would be happy to review at no-cost your current portfolio. We outline key risk and different economic impacts to a portfolio and contrast it to economic data. Our hope is that you will see the quality work that we do and give us a chance to help your overall situation. If you are interested, please feel free to contact us at info@clientfirstcap.com or by filling out our contact form.
