The Verdict

Last week we mentioned the Wall Street adage ‘buy the rumor, sell the news’ and wondered how markets would react to the first rate cut. The answer still isn’t clear. On Wednesday, the market swung wildly right after the 50 bps rate cut was announced. That is typical right after a Fed announcement, but as the market closed on Wednesday, stocks took a modest dive. Surprisingly, financials and REITs, which would normally be expected to rally on lower interest rates, didn’t.

Then came Thursday, and stock market took a large one way trip higher. What happened overnight to cause the surge? That’s not clear, but there was no doubt that the stock market liked the rate cut on Thursday.

Then came more weakness on Friday. The market has already had a good run this year in anticipation of the rate cuts, maybe it is just a bit tired. As far the market direction post the rate cut, it looks like the jury is still out.

Inflation

Inflation, shrinkflation. It seems that everywhere you look there is a reminder of how prices have changed over the last few years. It is important to understand that inflation (rising prices) is just an alternative way of viewing the declining value of the dollar – prices are going up or your dollar just buys less. It’s the stealth tax that eats away at your savings.

On the chart below, the green line is the core (ex-food and energy) CPI index over the last 10 years. The orange dotted line is the 2% inflation trend targeted by the Fed. From 2014, into 2021, core CPI was very closely tracking the Fed’s target, until the pandemic inflation hit.

That burst of inflation has largely been squeezed from the economy, but that doesn’t mean prices have returned to where they were. Prices are still rising, they just aren’t rising as quickly anymore. While that is a welcome fact, it’s easy to lose sight of the long term effect of that inflationary episode. The blue dashed line on the chart below is the trend line for 3% inflation. The point is that over the last 10 years, we have actually experienced 3% inflation, not 2%.

We may get inflation back to 2%, but we will never reverse the pandemic inflation and that holds important lessons for investors that are either retired or saving for retirement. While day-to-day, or even month-to-month, stock market volatility gets all the headlines, the biggest risk to your retirement is inflation. The Fed may target 2% inflation, but there is no assurance they can actually accomplish that goal. We can be sure that there will be other inflationary episodes, which simply means the inflation we actually experience has a high probability of being greater than the 2% target. The longer our time horizon, the more likely that is true.

If you’re young and a long-term investor, you should do your best to ignore short term market volatility. If you own strong companies with solid cash flow and high returns on invested capital, you don’t have to worry about short term market swings.

If you retired, or approaching retirement, you probably still have a long period of retirement to fund. If you are married and both 65 years old, statistically, there is a 50/50 chance that one of you will live into your early 90’s. The lesson is that even if you are retired, you may need to have a fairly large equity allocation in your portfolio. For this group, the risk is short term volatility combined with systematic withdrawals to fund your retirement. That can be troublesome, but there are strategies that can largely protect you from making forced withdrawals while prices are down, allowing you to manage successfully through short term volatility events.

Have a great week!

What We’re Reading

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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.

 The views expressed in this commentary are subject to change based on the 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.

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General News

By: Adam