š Dancing with Inflation
Alex is up this week, where he somehow manages to relate the tension between inflation and interest rates to a traditional southern Italian folk dance and itā¦ kinda works? He also touches on the outlook for stocks and bonds and what to consider doing in your 401(k) and IRA.
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As I was thinking about what needs to happen to tame inflation, an episode of Anthony Bourdainās Parts Unknown randomly popped into my brain that turned out to be a decent analogy for the current environment.
In an episode set in southern Italy, Bourdain highlights the tarantella, an up-tempo Italian folk song. You may not know the name, but you know the melody:
Naturally, thereās much more to the story, which Bourdain spends a lot of time delving into. The short version is that the tarantella has roots in tarantism, the belief that one might begin a convulsive ādanceā after suffering a tarantula's bite and that music was the only way to draw it out. In the traditional arrangement, the dancers and the musicians try to dance longer or play faster until someone gets tired enough to quit. You can read more about the weird history here.
Given that context, the analogy seemed apt: the Fed - and central banks around the world - seem locked in a tarantella with inflation, trying to raise interest rates just enough to bring prices down without triggering a recession.
Itās a nearly impossible task.
The blistering pace1 of rate hikes ā from 0.08% on March 1, 2022, to 3.08% as of September 30, 2022 ā hasnāt managed to tire inflation out yet, and, if history is any guide, the Fed will have to continue to raise rates if it hopes to bring inflation under control.
The table below illustrates the highest inflation rate for each recession (represented by Core CPI, which excludes food and energy prices), the highest interest rate (represented by the Fed Funds Rate), and what happened one year and two years afterward.
This table tells us two things:
In each of the last 8 recessions, the Fed had to raise rates (āFed Funds Rateā) above the current inflation level (āCore CPIā) before inflation began to go down.
It often takes at least two years for a meaningful reduction in inflation to take effect.
Take 1981ās recession as an example: interest rates had to go to nearly 17% (!) before inflation fell, and it took two years for inflation to fall from 11.8% down to a more manageable 3.28%.
Notably, 2020 was the only time the Fed didnāt raise interest rates to exceed inflation, on the basis that inflation was believed to be transitory, and, wellā¦ here we are.
What does this mean?
Likely, it means interest rates are going to keep going up. On the plus side, that means interest rates on savings accounts and other cash-like products should also increase (so far, the benefits have mostly accrued to the wealthiest accounts, per WSJ). On the downside, borrowing money for things like cars and homes will keep getting more expensive.
Iām sure you saw versions of this headline this week:
Mortgage rates top 7% for the first time since 2002
And, if you own any bonds in your investment accounts, this yearās painful performance will likely persist.
Hereās the year-to-date performance of intermediate government bonds (dark blue), the aggregate bond index (light blue), and investment-grade corporate bonds (purple).
Bonds will recover long-term, but it sure looks bleak out there in the here and now.
Rising interest rates plus rising inflation in a stable-ish economic environment makes things more interesting for stocks.
Higher interest rates means it costs more to borrow money. Thatās true for regular people and for companies of all sizes and industries.
So, if youāre a company financing operations by borrowing a bunch of money because, up until recently, that money was basically free, that bill is coming due. Time tough.
While companies like Facebook, Apple, Amazon, Google, and Netflix arenāt scrappy start-ups anymore, even these big guys arenāt immune from the sea change rising interest rates appears to have initiated.
Perhaps unsurprisingly, the companies that benefited most from rising interest rates and rising inflation in the past were concentrated in āessentialā industries: utilities, healthcare, energy, and staples (grocery stores, household goods, and beverage companies). In other words, companies that you have to pay to keep the lights on, run your car, and feed your family.
Whatās the Upside?
So, what to do?
In your 401(k), likely nothing. The investment options for most 401(k) plans tend to be slim and focused on broadly diversified stock and bond funds. If you followed through on our suggestion to just buy the target date fund based on your expected retirement date, then thereās not much to do other than donāt look at your account statement and just keep contributing. Remember: You wonāt touch the money in your 401(k) for another 20+ years, most likely, which is plenty of time for stocks to rebound and resume compounding.
There are more options if you have an IRA (Roth, Traditional, or other). Here are some suggestions to get you started:
The Best Strategies for Inflationary Times (Duke University, the Man Group)
Inflation is back and so is momentum investing (Allianz Global Investors)
Reducing Inflation Will Come at a Great Cost: Stagflation (Ray Dalio)
The Market Owes You Nothing (Meb Faber Podcast)
Please note: these suggestions are not a recommendation or endorsement of any product, service, or company, nor are these suggestions a solicitation to purchase any product, service, or security. Investing involves risk, including the potential loss of principal. Consult your tax, legal, and financial professionals before committing any capital to any strategy. Investors should carefully read an investment strategyās prospectus before investing capital.
For Your Weekend
Read
The First Minute of Every Phone Call Is Torture Now by Ian Bogost (the Atlantic)
During the worst days of the pandemic, we all used Zoom, for better and worse. It had its quirksāYouāre muted, Cathy, and so forthābut it offered a necessary human connection. The rise of videochat also amplified the decline in telephony. Already spoiled by robocalls, phone calls receded, save for spammers and moms.
Watch
Reboot (Hulu)
āRebootā is a witty meta series from Steven Levitan (the co-creator of āModern Familyā). In its best moments, this fast-paced circus of hilarious one-liners and dysfunctional creative relationships depicts the formation of its own family, created through the changing conventions of TV comedy. Treating meta storytelling with its mix of new and older senses of humorāthe bounds for broad comedy have changedāāRebootā proves to be plenty smart and funny while celebrating how much work goes into the eternal form of the sitcom. (Full review here)
Chuckle
A 300 basis point move in a year counts as āblisteringā for normally sleepy central banks