Inflation: The punch we saw coming
Written by: Allie Schmidt, Financial Advisor, CFP ®, CPA
As you can imagine, the majority of our conversations right now are focused on the current market environment and even more specifically, inflation. We’ve heard about many clients’ first mortgages that they closed on in the late 70s or early 80s ranging from 12%-15%. They felt “lucky” to have locked in at 12% and have memories of how “normal” those rates felt at the time and how “crazy” they seem now. (On a side note, I can’t help but wonder what those Colorado starter homes are worth today). Typically, the conversation then turns to how much the last SUV fill-up was (mine was yesterday and it was $85.60), and then we almost always end up at the serious part of the conversation, which is the current environment. What to do with the market volatility and what feels like relentless inflation that’s eating into budgets, retirement spending, etc.
We have the highest inflation in over 40 years (I:USIR 8.58% May-2022). I wasn’t even alive then, let alone advising clients and managing money, in this type of environment. I think that’s why the mortgages of the 70s and 80s are so interesting…the rates are 4 times more than what we’ve gotten used to over the past couple years, and frankly, it was just a really long time ago. Steve and I have been preparing and talking about inflation since 2017. We’ve done blog posts, events, slides in strategy updates…so it’s not a “surprise” that we have inflation, but it’s like the punch you saw coming—it’s not that it doesn’t hurt (I mean you got punched), it’s just that it didn’t knock you out…you staggered but stayed on your feet.
So, the thing happened—inflation is here. A lot of discussions recently have revolved around 3 main things: how has this played out historically (over 40 years ago), what we have done/are doing within portfolios to deal with inflation, and what about retirees taking income. This is the first of a 3-part blog series to give some context around each of those topics.
A look at history: Like I mentioned earlier, I was in a very different place when inflation ran hot in the 70s/early 80s. So, I went back and looked at the US Inflation Rate (I: USIR)* from the late 1960s through the late 1980s. The most significant inflationary period ran from May of 1978 through March of 1980. During that time the average inflation rate was 10.55% and the max was 14.76% (72% higher than today at 8.58%). During this time period, the market (as measured by the S&P500) was very volatile with a maximum drawdown of about 18% (our maximum drawdown year to date is 23.55%), and the total S&P500 return was 4.62% or a real return of -5.93%. A tough time period for stocks. But, what’s interesting is what comes next. Inflation fell from the peak of 14.76% in March of 1980 for the next 3 years by almost 76% to a read of 3.59% in March of 1983. How did stocks react after the inflation peak? See the chart below for S&P500 returns over various time periods after the inflation peak.
The point of this is not to downplay the current market volatility. It’s just to look to history as a guide for how stocks have reacted in the past. History doesn’t necessarily repeat itself, but it does tend to rhyme. Historically stocks, over time, keep up with inflation, you just have to zoom out enough.
To put it simply, we want to own things that inflate in these environments, think stocks and real estate. We want to avoid overweighting things that are fixed, think bonds and cash. Stock investing in these environments is emotionally difficult and cash would have felt better year to date. Yes, but the challenging part is that markets tend to sell-off and recover incredibly quickly. The best stock buying opportunities are often when it feels the worst. Timing the market on the upside and downside is almost impossible, which is why having a dialed in investment process is crucial to navigating each market cycle. Couple this with financial planning—keeping an eye on what you need the money to do over the long-term (and if you need it in the short-term), we can successfully navigate through each volatile market cycle, and even benefit from the opportunities that are presented.
Stay tuned for part 2 where we’ll address your portfolio and how we have taken inflation into account to date and the investment plan moving forward.
*ycharts.com
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Higgins & Schmidt Wealth Strategies, a registered investment advisor and separate entity from LPL Financial. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification and asset allocation does not ensure a profit or protect against a loss. Stock investing involves risk including loss of principal. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.
