Sure, there are a lot of things in life way more important than wealth. All that said…some people do get confused. I play golf with a man.
He says: “What good is health? You can’t buy money with it.”
~ Charlie Munger, vice chairman of Berkshire Hathaway (1924)
I've always been a cockeyed optimist.
I got it from my mom. I'm gonna stick with it.
~ Betty White, actress, entertainer, golden girl (1922-2021)
On the economy
Last year the world’s Gross Domestic Product grew by nearly 6%, even after the IMF revised estimates downward mid-year in light of supply chain issues hampering growth for richer nations and worsening pandemic dynamics for poorer, under-vaccinated countries. By these numbers, emerging economies are still outperforming their wealthier neighbors in both 2020 and 2021 due to an insatiable appetite for their natural resources, such as metals and oil. This overshadows the fact that many poorer countries have become even more vulnerable amid the pandemic and continue to lack access to critical healthcare. (As if to make the point for us all, the current Omicron variant likely developed in a South African host that was susceptible to a lingering case of Covid because they also suffered from untreated HIV; in South Africa HIV is still a pandemic where roughly 20% live with the disease.)
Admittedly the U.S. growth in large part is due to to shovels full of cash from the Federal Reserve and government payments to businesses and families. Twenty months into the pandemic, the U.S. consumer is still flush with savings, enjoys record net worth, and is backed by strong employment conditions. Corporations also have fat balance sheets. Interest rates remain very low and wages are going up. If one squints at the horizon, inflation looks like a passing annoyance and the end of easy money does not seem so daunting. Through fully opened eyes, our economy is looking a bit “peakish”.
In terms of a classical business cycle that repeatedly runs through expansion, peak, contraction and trough, the U.S. seems to be at the peak. It was a remarkably fast transition from the trough of March and April 2020 and subsequent expansion but here we are. The supporting data shows that inventories are growing on warehouse shelves. Manufacturing demand is still strong, but not accelerating month-over-month as it once was; new orders have also slowed. As has been widely reported, unemployment is no longer a problem, so cross that off the list. The jobs problem should be redefined as understaffing; big and small businesses alike are chronically understaffed.
Our economy can hang out in this peak stage for a while. Growth, although at more modest levels, can continue amidst a good backdrop. Inflation may already be moderating in many areas but it persists in food and housing. Some of the most extreme supply-chain issues are easing and even ocean transport rates are falling. Continued vaccination against Covid-19 is helping and the World Health Organization has called for 70% of the globe’s population to be inoculated by summer.
Next the Federal Reserve will start “normalizing” monetary policy. The Fed, which started buying bonds to inject liquidity and stability into financial markets in spring 2020, is ceasing this program. Within a few months it will no longer purchase new bonds. Interest rates will also be lifted. The consensus, as of this writing, is that rates will increase in May or June and possibly go up three times in 2022 by 0.25% each time. For context, the current federal funds rate is pegged at 0.0 - 0.25% and the current prime rate, upon which most consumers’ borrowing rates are based, is 3.25%.
There is little dispute that the U.S. economy can and should be operating at higher interest rates. Consider that inflation is the highest in nearly 40 years and unemployment is hovering around 4.3%. Yet Congress is considering a new round of stimulus to businesses that are suffering. It begs the question about whether we should be stimulating if we are on the verge of tightening.
On the markets
It was a banner year for stock index returns but also a tricky time, as prices wavered and investors bounced between the “reopening” and “stay-at-home” stocks. Leadership changed hands many times. The sectors of energy, finance and technology each dominated at one point. By the end of the year, every asset class outperformed inflation save for cash, bonds and gold, which notched its lowest yearly return since 2015, down 3.6%. A familiar theme repeated itself - five mega-tech companies, Apple, Microsoft, Nvidia, Tesla and Alphabet’s Google combined contributed nearly 1/3rd of the S&P 500’s annual returns. Europe’s stock markets, which tend to be much less technology and innovation-company driven, were also strong. However, Asia did not fare well and China’s data reflects that it is in a “growth recession”, defined as a decline in economic activity relative to a country’s long-term high potential. For many publicly traded companies, earnings growth outpaced the price appreciation investors afforded them. That may be because valuations are already above long-term averages. Thus, more modest returns over the near-term are expected. Economists at Fidelity Investments call the current economic conditions in the U.S. “mid-peak phase” of expansion and warn that the stock market questions itself most during this stage. Questions come in the form of stock market corrections, defined as a 10% or more drawdown from recent high price points. It seems some of those corrections have already been underway, particularly for technology stocks, including a couple of the named companies above.
In such times, any company with a weak balance sheet, weak or no profits but a high valuation, is going to struggle. Sometimes called long-duration stocks, these require an investor to hold on, perhaps for many years, before the business can mature into a profitable venture. A profitable company that also pays a dividend is called short-duration; in other words, an investor only has to wait a short period of time before a company delivers positive results. Short-duration companies are the preferred holdings during mid- and late-phase expansions that also see rising interest rates.
The Nasdaq Index is comprised of 2,500 companies, many of them long-duration companies. Bloomberg just noted that the index is nearing a metric last touched during the technology bust of 1999-2000. That is nearly 40%, or roughly 1,000 companies are down 50% from their 52-week stock high. Yet, the index ended the year just 3% off its all-time high valuation. Even if the headline number does not show it, the selling has clearly already begun.
On personal finance
It has been many years since an investor could get a decent yield on low-risk investments. Cash deposits at neighborhood banks barely yield 0.1%. A Certificate of Deposit (CD) has never been exciting but even less these days when a 5-year term yields less than 0.5% annually. Money markets have not risen above 1% since the Great Financial Recession. Investors in 10-year bonds have not seen yields over 3% in many years and neither has anyone in the market for a 30-year bond. So it is tough to get a decent return on money meant to be both safe and liquid. But there is one government-issued option that is getting a dust-off given our current high inflation – the Series I Savings bond.
The Series I bond is the type of instrument that grandparents historically bought for their newborn grandchildren. With the expansion of investments like college savings 529s and UTMAs, savings bonds have fallen out of favor as the go-to gift, but today they deserve another look. The current 6-month rate is a sky-high 7.12% annualized, thanks to inflation! That is because the Series I bond interest is made up of a fixed rate, currently at 0%, and a variable rate based on Consumer Price Index (CPI-U).
The variable rate resets every six months. The government does only allow $10,000 to be invested each year per person and investments must be made with after-tax, non-retirement, dollars. But investing is easy, done online via TreasuryDirect. Interest is state tax-free and can be deferred until the owner redeems the bond, which can be anytime after 12 months has passed, or after five years if one wants to avoid any interest penalties.
Of course, there are some caveats. Inflation can and will go down at some point and future rates will reflect that. The low investment amount may not be worth the effort for some. Investing can only be done via TreasuryDirect, not in other accounts, brokerages or banks. It should be considered a five-year investment. But with inflation here for now, it is worth dusting off old ideas for today's world.
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