Helpful miscellaneous articles
regarding our retirement plan and planning.
Like you, I review my retirement nestegg and plan from time to
time. Recently, I went though some continued
education for some credentials I maintain and it occurred to me that we all
could use a review about these issues.
So with your help, we will share and post articles and info that may be
helpful and of interest to many of you in this section.
Inflation Is Here! What Now?
January 2022
When I started my career in the early ’80s, many countries
around the world were infected with a miserable inflation disease. Diagnosing
the cause of double-digit inflation and administering a cure was the key
problem for economists and central bankers. Inflation was ultimately defeated
at a significant economic cost—two nasty recessions. Fast-forward the clock by
four decades, and inflation is rearing its ugly head again. Is it here to stay
and what should investors do about it?
Today’s inflation isn’t a surprise. Over the past two years, governments
have embraced Modern Monetary Theory (MMT) in practice, if not explicitly. To
cushion the economic pain inflicted by the pandemic, governments understandably
coordinated their fiscal and monetary policies to transfer newly created money
directly into bank accounts without raising tax receipts. As I predicted last
spring, deficits are ballooning, government debt is soaring, and inflation is
spiking.
Collectively across the G7 (United States, United Kingdom,
Germany, France, Canada, Japan, and Italy) total debt levels as a percentage of
GDP have doubled over the last 25 years, jumping from an average 80% in 1995 to
over 160% in 2020. Over the quarter-century span, the sharpest annual increase
in debt to GDP occurred in 2021, well outpacing the 14% surge during the
2008–2009 global financial crisis (GFC).
Deficits across the G7 have also exploded, surpassing the levels
experienced during the GFC. In the 25 years before 2020, the average general
government deficit among the G7 was −3% of GDP. In 2021, this ratio spiked more
than threefold to −10%, ranging from −4% in Germany to −15% in the United
States. “Inflation is political poison because it erodes the real purchasing
power of the income of the vast majority.”
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The situation today, as we begin 2022, is worse than the
preceding charts illustrate, because they exclude the huge deficits and massive
debt accumulation of 2021. As I explained at the outset of the pandemic policy
response, if money printing succeeds in maintaining the nominal value of
consumption spending, many more dollars will be chasing a smaller amount of
goods and services. The result is inflation.
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In the 12 months ended November 2021, US CPI rose 6.8%,
registering its sharpest increase since 1982, while inflation in the United
Kingdom surged above market forecasts to a 10-year high of 5.1%. Other advanced
economies experienced similar inflation highs over the same period. France’s
year-over-year inflation rate jumped 3.4%, a 13-year high, and Germany’s 5.2%
inflation rate marked a 30-year high. Japan remains an anomaly with a 0.6% year-over-year
2021 change in the CPI, although higher than in the recent past.
Inflation is political poison because it erodes the real
purchasing power of the income of the vast majority. Voters will pressure
governments to remedy inflation. What steps are governments likely to take?
Central banks will move to taper their financial asset purchases, but
quantitative easing (QE) is not solely responsible for inflation. QE is simply
shuffling bank reserves for government bonds on the balance sheets of banks.
Worse yet, removing QE could raise the risk of liquidity crises. Monetary
policy alone cannot restore price stability. Raising interest rates is the
traditional monetary tool, but central banks are constrained given today’s
elevated debt levels: the G7’s finances cannot afford nominal interest rates
above current inflation rates. To effectively tackle rapidly rising inflation,
governments must also raise taxes to drain excess demand, just as advocated by
MMT. Will legislators nimbly exercise their new responsibility to manage
inflation with tax policy? Sustained inflation may be the expedient political
path to diminish the real value of excessive public debt. “Sustained inflation
may be the expedient political path to diminish the real value of excessive
public debt.”
Given this likely scenario, how should investors reposition
their portfolios for today’s inflationary regime? Informed investors may begin
by paring back positions in mainstream stocks and bonds, particularly interest
rate–sensitive growth stocks, borrowing at long[1]term fixed rates, and diversifying into real assets such as real
estate, commodities, and resource stocks.
A simple building-block approach, such as the one we use in our
Asset Allocation Interactive tool, forecasts long-term buy-and-hold asset-class
returns as current yield plus real growth plus likely changes in valuation levels. Without relying on aggressive
valuation[1]reversion assumptions,
we are forecasting value stocks to deliver long-term real returns exceeding 6%
in the US market and in the 8–10% range for the Japanese, European, and
emerging markets. Not only are the long-term return prospects of value stocks
around the world attractive relative to the investment opportunity set, they
offer exposure to the cyclical sectors of the economy that tend to benefit from
reflation. Investors may also want to take advantage of below-zero real
interest rates to finance purchases of real assets, whose prices tend to rise
with inflation. “We are forecasting value stocksto deliverlong-term realreturns
exceeding 6% in the US market and in the 8–10% range forthe Japanese, European, and emerging markets.”
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Moreover, investors may wish to prepare for the possibility of
liquidity shocks that may accompany central banks’ tapering of QE and the
coming series of incremental increases in Fed-directed short-term interest
rates. Overpriced US assets—in particular, the speculative excesses
contributing to the very lofty prices of meme stocks, loss-making electric
vehicle companies, cryptocurrencies and non-fungible tokens, and mega-cap tech
companies—are most at risk in the current environment.
(As with any of these informative articles,
anyone who needs someone to talk to about
this
very subject contact me and I can direct you to a knowledgeable advisor).
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