By Brendan Roath, EA, CFP® and Rod Roath, CPA, CFP®
Money Matters, Inc.
The three-headed monster remains after Halloween. For investors, the monster’s three heads represent political uncertainty, interest rate increases, and inflation fears. Let’s talk above each one.
Biden Legislation and Debt Ceiling: Last week Biden’s two legislative agendas - infrastructure and Build Back Better looked inevitable, today the odds of passage are nearly 50-50. Congress passed temporary legislation to defer the political showdown to December 3rd. A government shutdown would punch a hole in the economy. Last-minute political compromises have averted the debt ceiling crisis in the past. Let’s hope it works in 2021.
Interest Rates: The stock market has generally discounted the Federal Reserve’s widely expected start to gradually withdrawing its massive monetary stimulus this week. Also, they are signaling a rise in the inter-bank lending rate in late 2022. Yet Treasury Bond yields of 2 years or less have spiked recently. When bond yields rise, bond market prices fall. We believe the sudden jump in yields is overdone. Nevertheless, our advice to clients is to shorten fixed income maturities to lessen their market price drop. Market prices on short-term bond maturities drop less than intermediate and long-term prices. Also, clients with a bias towards investments in interest-sensitive stocks, such as REITS, preferred stock, utilities, and insurers should trim these holdings.
Inflation Fears: Opinion is split on whether the inflation spike’s duration is long-term or transitory. One side believe we are heading towards “stagflation” (slowing economic growth accompanied by rising inflation). The other side believes the spike is caused by two transitory factors, both of which are post-pandemic economic adjustments. They are (1) shift in consumer spending for services to goods, and (2) supply chain bottlenecks excess demand for goods. When these two factors resume to normal, inflation pressures will lessen.
Here are economic reports supporting either opinion. You make the call. Is inflation a long-term problem or a short-term transition?
- Economy slowing – Atlanta Federal Reserve projects only 1.2% increase in Q3 Gross Domestic Product from Q2. Also, the International Monetary Fund (IMF) downgraded their estimate of 2021 global growth from 6.0% to 5.9%.
- Economy not slowing - Consensus of Q3 GDP forecasts from Blue Chip Indicators survey is 3.7% increase over Q2. And the IMF raised their 2022 global growth estimate from 4.9% to 5.2%.
- Sustained Labor Cost Increases – NFIB survey of small businesses indicates half of their members face serious labor shortages. Resulting wage increases cause them to increase selling prices.
- Temporary Labor Cost Increases – Largest payroll increases are in lowest paying jobs, such as retail, leisure, and hospitality. Workers in these industries were hit hard by layoffs during the pandemic.
- Sustained Supply Shortages – Latest Personal Consumption Expenditures (PCE) report for durable goods shows a 7.0% increase over the previous year.
- Temporary Supply Shortages – Core PCE (excluding volatile food and energy prices) is only 1.6% increase over previous year.