Markets & Economics Commentary
©2022 Mark P Culver
1st Quarter: 2022 edition
S&P 500 Composite Index: 4530.42: 2022 YTD -4.6%
NASDAQ Composite Index: 14838.49: 2022 YTD -8.9%
Bloomberg Aggregate Bond: 2022 YTD -5.9%
After a more than one year hiatus while we were working out some kinks in our reporting software, I’m pleased to report that we are reintroducing the Epiqwest Culver Wealth Advisors, LLC Markets & Economics Commentary. It is our intent that this piece will be both informative in helping you understand how we are looking at the markets and the economy in the context of how we manage your accounts and be a little educational as well. And maybe, from time-to-time interweaving a bit of irony and humor.
Clearly, at the forefront of most everyone’s mind these days is inflation. And rightly so. Inflation hurts just about everyone, which is why it is the primary objective of virtually every central bank in the world to “defend the currency.” Of note, the Federal Reserve (the central bank for the US) is one of the few central banks in the world charged with a “dual mandate,” which also includes maximum employment.
It is important to understand that there are two distinctly different types of inflation. The first is known as Supply-Push Inflation. Supply-Push Inflation is most normally associated with insufficient supply of goods and/or services, that is, the scarcity of the same. That scarcity forces consumers to compete for the goods and services they want to buy and typically results in some form of a “bidding war.” Anyone who has been on either side of the real estate market lately is likely familiar with this concept. There simply are not enough homes for sale to satisfy the demand, thus prices must rise. If you extend that concept to the broad economy where supply chains have been completely disrupted from Covid-19, it’s easier to see how Supply-Push Inflation is a big factor in the broad inflation we are all seeing today.
The second type of inflation, and certainly the more common, is known as Demand-Pull Inflation. This type of inflation is typically caused by a strong economy and low unemployment where a lot of consumers have money and are in the mood to spend it. The “too much money chasing too few goods” scenario. However, this time, the Demand-Pull Inflation we see got its start from the Covid-19 pandemic, as well as the US’ monetary response to the pandemic. First, the pandemic forced the closure of much of the service sector of the US, as well as the global economy. Services such as travel (airlines, hotels, cruise ships), entertainment (movies, sporting events, live theatre), restaurants, retail, and in-person medical services all virtually shut down during the pandemic. That reality caused consumers to spend much more than they would have otherwise on the goods sectors of the economy, with the biggest beneficiaries being hard assets (stocks and real estate primarily), automobiles, but virtually every other good on the market as well.
Secondly, the coordinated Fiscal and Monetary efforts from governments around the world also contributed greatly to this type of inflation as it put untold billions (maybe trillions?) of dollars in consumer’s pockets. To be clear, I applauded the massive stimulus we saw as we would have likely seen Great Depression-type unemployment otherwise and a deflationary spiral that would have taken 20 years to unwind. However, to the surprise of almost nobody, we now find that we must deal with the aftermath of excessive liquidity and higher inflation rates.
So, to be clear, it is my contention that we are now dealing with a one-two inflationary punch from BOTH Cost-Push Inflation (not enough goods to satisfy demand) AND Demand-Pull Inflation (too much liquidity in the system).
Fortunately, the Federal Reserve in coordination with other central banks around the world, are very well equipped to absorb the excess liquidity in the system associated with the Demand-Pull phenomenon. As you are probably aware, the Federal Reserve recently raised the interest rate that they charge to banks (the Fed Funds Rate), which is a very short-term interest rate. In response banks raised the rates they charge to their borrowers, lenders charge more for 30-year mortgages, and so on through the system. That chain reaction has the effect of removing money from the system and contracting liquidity. That central banks have abandoned their “inflation is transitory” mantra is a good thing and should reign in this component of inflation quickly. The only questions on everyone’s mind in this regard is 1) how high do interest rates need to go to be effective, and 2) will the Fed overshoot with interest rates, as they are prone to do historically. My personal feeling is that the Fed will overshoot with interest rates, and we need to be on guard for a mild recession, perhaps in 2023.
On the other hand, in respect to the Covid-19 related Demand-Pull inflation, hopefully the Covid-19 pandemic will continue to abate, and the services sector will reopen. If that materializes, the pricing strain on the goods sector would abate as well and provide much needed relief to the supply chain problems we have seen. However, if another waive of the pandemic forces the service sector into hibernation again, we might wish the Fed had been slower in raising interest rates. So, my point is that it is difficult to know the right course of action as there are so many unknown variables.
Finally, revisiting the Cost-Push component, it’s important to understand that central banks and monetary policy really can’t move the needle much. The biggest factor that can help relieve supply chains is to keep Covid-19 contained so that the economy can self-heal by restoring the services sector. As consumers resume traveling, going to the theatre, and dining out, there will be less demand for the goods sector, which will slow the price inflation we’ve seen there.
As far as factoring in these thoughts to the management of your accounts with us, thus far we are staying fully invested. The US economy is still very strong, unemployment is low, and thus far, Q1 2022 earnings are good. We do not anticipate any big draw down in stock prices at this early juncture of the Feds rate tightening cycle. That is, holding higher cash levels is probably not worth the risk of missing higher prices associated with strong corporate earnings and still relatively low interest rates.
However, we are very cognizant of the complexity of the Feds endeavor to thread the needle of interest rates, inflation, and unemployment. As well as their historical failure at engineering the elusive “soft landing.” Particularly with so many variables at work that none of us have had to do deal with before. Consequently, our “tilt” would be towards a more conservative interpretation of the data as it comes and remain vigilant and nimble, just in case.
Please feel free to contact us if you have any questions or if you need to schedule an appointment to discuss your account or financial plan with us. This is particularly important if you have experienced a big change in your life recently (got married, retired, changed employment, bought/sold a business, etc.).
2022 Form ADV Notice and Offering – the firm’s 2022 Form ADV Part 1 & Part 2 filings with the Securities Exchange Commission was filed 03/01/2022. If you would like a copy of this important disclosure document, please contact us at (303) 442-3670 or [email protected] and we will be happy to deliver it to you at no charge.
Mark P. Culver