- In a bacon and egg sandwich, the difference between the chicken and the pig is that the chicken was involved, but the pig was committed.
- Successful long-term investing requires commitment, not involvement.
- Market corrections, both minor and serious, occur with regularity.
- Following time-tested investment principles allows reason to rule over emotion.
During difficult weeks like this, the ability to plow through the noise and the chaotic trading is tied to your commitment to time tested investment principles. If you are merely involved with no rhyme or reason, markets can be treacherous. Students of financial history will understand that these lessons have been taught to us over and over again for hundreds of years, but over and over again, we tend to forget.
Coming out of the housing crisis in 2009, the Fed began to utilize extraordinary measures to bring us back from the brink of financial collapse. What many do not understand is that since then, those extraordinary measures essentially remained in place, which has been the primary driver for the mostly one-way markets since 2008. That means that we must work doubly hard to remember the lessons of past markets and stick with those time-tested investment principles, even though it often seems easier to put those principles aside and push all the chips onto the table.
The minor market chaos this week is a reminder that even with the extraordinary support of central banks, corrections of 5%, 10%, even 20%, continue to occur with great frequency, and those nasty declines of 30%, 40% or more, while less frequent, have not disappeared from the investment world. Being committed to time tested investment principles allows one the luxury of shrugging your shoulders in the face of a tough week, rather than become alarmed. These events are expected, rather than feared, and that allows reason to maintain control and emotion to be pushed to the background. These events arrive with some regularity and we are prepared for them.
We constantly advocate having a financial plan and this is just one of the reasons why. Having the plan; knowing how and why it was constructed as it was, is what allows us to remain calm during the intermittent market chaos and go on with our lives.
- Supply chain issues continue to plague the world and, in many cases, they are getting worse not better.
- A ‘shortage mentality’ pulls demand forward, making the situation a self-fulfilling prophesy, meaning that inflation expectations matter!
- The cure for high prices is…. high prices.
The great inflation debate (persistent or transitory) continues with no apparent end in sight. But one thing that is clear is that the shortage mentality that we quickly developed a year ago as the economy shut down is carrying over into the recovery. We are creatures of habit. Maybe that mentality of hoarding in the midst of the shutdown shortage remains ingrained so much that even in recovery, we are concerned about being left out. After all, this is the FOMO generation, is it not? If that is the case, then the incredible demand we are seeing today could merely be a pulling forward of demand based on an irrational fear of never being able to obtain the items what we desire.
Economist talk about inflation as if it were a scientific experiment, something that can be carefully measured and analyzed. In our view, inflation is an emotional thing as much as it is scientific. In many respects, inflation is a lot like Tinker Bell. We can create inflation even in a world where there is none, just by believing. In a world where supplies may be a bit tight by conventional standards, we have the power to make it much worse by reacting to it with an irrational demand for more ‘just in case’, which only exacerbates the shortage and makes it a self-fulfilling prophesy. Consumer expectations matter and for a wide range of goods there is clearly FOMO in the air and shortages are getting worse not better. This can be a significant additional driver for inflation.
We noted last week that one of the key sources of inflation was used cars, where prices are up over 20% from last year. We had a client this week talk to us about an offer from a dealer to take their leased car back a year early because there is so much demand for used cars and to apply the ‘equity’ in the lease toward a new car. Think about that… You lease a car for three years, you give it back after two years, not only with no penalty, but with a payment to you for the ‘equity’ in the car! That might be true now, but it is clearly NOT sustainable. Shortages drive up prices as they are doing now, and eventually high prices drive down demand, meaning that the cure for high prices is high prices. The real wild card in the inflation debate may be how ingrained inflation becomes in our collective psyches, and how long it will take to root it out.
The Fed Minutes Upset Markets
- The April meeting minutes of the Federal Reserve Open Market Committee (FOMC) were released and caused a bit of a stir.
- Some on the FOMC, stated that it might be time to start thinking about the timing for the tapering the Federal Reserve’s market accommodation (i.e., bond buying).
- What happens to markets when the taper begins is up for debate, but during the ‘taper tantrum’ of 2013, the first time the Fed spoke about tapering bond purchases, markets were ugly and expectations lean in that direction.
Back in 2013, then Fed Chair Bernanke stated in a Congressional hearing that the Fed intended to taper their bond purchases during the year and end those purchases around year end, but they fairly quickly relented to the violent market reaction to the statement. The turmoil mid-week was derived largely from a statement made in the April FOMC minutes which said:
“Their discussion of the Federal Reserve’s asset purchases, various participants noted that it would likely be some time until the economy had made substantial further progress toward the Committee’s maximum-employment and price-stability goals…”
“A number of participants suggested if the economy continued to make rapid progress toward the Committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.”
It was that last comment that got the markets riled up. Simply stating that it might be appropriate to begin to discuss a plan to reduce asset purchases was enough to send market briefly into a tizzy.
We note the following:
- The statement is modified by ‘if the economy continues to make rapid progress’
- This comment was made at the April meeting, before the much weaker than expected unemployment number was announced.
Weaker unemployment will clearly push the Fed timeline back, but at some point, in the not-too-distant future, we can expect the Fed to begin to taper bond purchases. If and when that begins, we also begin to regain some real price discovery in markets, something that is need, but is also a bit frightful for markets to consider.
What We’re Reading
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If you’re like most people, you want to know whether the weight you’re losing is coming from fat rather than muscle or water.
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The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.Ben Bernanke, Fed Dual Mandate, Fed Minutes, Federal Reserve, Financial Planning, FOMC, Inflation, Jerome Powell, Long-Term Investing, Market Correction, Market Timing, Persistent Inflation, Shortages, Supply Chain, Taper Tantrum, Tapering, Transitory Inflation