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Maximum Uncertainty

Maximum Uncertainty

June 21, 2022
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Several weeks ago, we wrote a piece called “Money Heaven.” In it, we considered how money is created and destroyed. To recap, money is destroyed via two primary mechanisms: 1) Asset Devaluation, and 2) Inflation. We also discussed the root cause of inflation being a monetary phenomenon made worse in the present day by supply shocks. Irrespective of the presence of supply shocks, creating too much money is almost certainly the root cause of the inflation problem we are experiencing today. So, we need to destroy some money to fix the problem. Natural market phenomenon are at work on this task every day. We are getting somewhere, as unpleasant as it may be.  Below is the S&P 500 Index through Friday.

Ten days ago, the primary measure of inflation, the Consumer Price Index (CPI), came in at a higher rate than expected, registering 8.3%—the highest in forty years. In response, the Fed raised the Fed Funds Rate by 0.75%. This was the largest rate increase since the last time the Fed raised rates by the same amount in 1994. The difference between 1994 and today is that the 75-basis point increase last week represented a 100% increase in the Fed Funds rate. THAT’S A MASSIVE INCREASE from the base today as compared to the 15% increase 75 basis points represented in 1994. And really, no one has a clue what the impact of this massive raise will be, not even the Fed. Time and data are required to know the impact of these moves.

Not only did the Fed raise rates 75 basis points, but they are also on record to do more of the same to bring inflation under control. It seems safe to conclude this of the Fed policy position: between two lousy choices (high inflation versus recession) the Fed appears to be willing to cause a recession to kill inflation. Inflation is THAT big of a problem and threat to the well-being of the economy.

Here is why 8.3% inflation is a problem:

One can see from the chart above that 8% inflation has a profound impact on buying power IF it persists over time. This is what the Fed is fighting and why they are willing to risk a recession to fight it. To make matters even worse, asset values are not presently providing any protection against inflation because asset values almost across the board are dropping too. Many observers have described this as “no place to hide.” While perhaps over-used, this seems apropos. There’s really no place to hide.

So, we find ourselves collectively in a position of maximum uncertainty with respect to: 1) Inflation, 2) Economic Growth, 3) Corporate Earnings, and 4) Asset Values. To make matters worse, we will be in this period of uncertainty for some unknown duration. So, all we can do is step through this day-by-day, collecting new information as it is released to see which uncertain elements are becoming more certain. All of us are in the exact same position and there really isn’t any meaningful edge.

During this period of maximum uncertainty, it seems wise to make no drastic moves. Slow and steady almost always wins the race. Within the assets we manage on behalf of our clients, we continue to make incremental moves that are consistent with the environment we find ourselves in; whether that be adding inflation sensitive investment strategies or floating rate strategies. We have been particularly pleased with the relative performance of our Dividend Aristocrats stock portfolio, and our defensive equity portfolios during these challenging times. Our advice continues to be the same: revisit your plan with your advisor. A discussion of your plan in the context of your risk assessment will provide you with comfort knowing that, despite the uncertainty and volatility, your plan is durable. You can also make mid-course corrections as necessary to help ensure that you are on track to meet your objectives. We welcome that opportunity to talk things over. Thank you for your confidence in us as we navigate these challenging and uncertain times on your behalf.