As we embark on a new year, I want to start with some important data points:
- America’s GDP is at a record high of $ 23 trillion.
- The S&P 500 is at near record levels of close to 4,700, a record high.
- Housing prices are at a record high, along with retail sales.
- The net worth of American households is at a new high of $ 150 trillion.
- New business formations are at near-record levels with 440,000.
- There are 10.4 million job openings, and 4.4 million people are sure to quit and find a new job (US non-farm quits).
- Hourly wages have risen by 4.8%, especially for the lowest income groups.
- Lending rates are almost record low (10-year government bonds) at 1.58%.
- In the last 30 years, a 30-year mortgage has gone from 9.90% to 3.10%.
And yet, consumer sentiment has fallen from 100 in 2019 to 66.8. People are not happy with the current situation in the economy. Why has confidence fallen by almost 30% in two years?
- COVID fears remain a problem for businesses and consumers.
- Inflation is running at 6.22%, the highest level in more than 30 years ($ 100.00 cash will only buy $ 93.78 in goods and services next year).
- Supply chain disruptions cause longer delay times (so you pay more and wait longer). Companies are worried about labor shortages.
Even with a rising paycheck, people are feeling inflation. Whether it’s the price of a can of soup or the price of petrol, everything feels (and is) more expensive. At the beginning of 2020, gasoline was below $ 2.00 per liter. gallon, and today it is more than $ 3.00. The 15-gallon filling went from $ 30.00 to $ 45.00 in a hurry and without notice. Inflation puts a dent in household budgets and a psychological dent in attitudes. While the U.S. economy may boom, the smaller economy in household budgets and spending gets a hit.
Rising inflation should come as no surprise. History and basic economics tell us that low interest rates tend to give way to higher inflation. With more than a decade in which the Federal Reserve manipulated interest rates to historic lows, the real surprise is that it has taken so long for inflation to emerge. Remember that the Fed actively sought higher inflation for several years until COVID hit. Thereafter, they pumped 39% more cash into the economy in the form of “stimulus” without offsetting increase in production. The result is more money chasing the same goods and services, causing higher prices: inflation.
A simple example illustrates this monetary phenomenon. If you have an economy of 10 apples and $ 10, the price of each apple is $ 1. When you have $ 14 in the economy chasing 10 apples, the price per apple goes up to $ 1.40. Increase the money supply by 39% and inflation is the obvious result.
Inflation can also occur when supply is restricted, whether intentionally (cancellation of the Keystone Pipeline) or unintentionally (backlog in the Suez Canal), the same amount of money chasing fewer goods and services, which in turn results in higher prices. To continue our illustration, we have $ 10 chasing eight apples. How do we get out of this jam?
The typical answer is to rebalance the equation: to raise interest rates in an attempt to manipulate inflation. Mathematically, it makes sense, but it does not always work in the real world. The worst result is an environment of high inflation unaffected by rising interest rates. This is how we end up with sky-high mortgage rates similar to those in the 80s. Consumers feel the burden when everything becomes more expensive, including the cost of borrowing money.
There is currently a silver line for rising interest rates; Borrowing costs are below inflation. Borrowing money at a lower rate than inflation means that every dollar you borrow today will be repaid with lower “costs” in the future. Based on “real cost, real return”, your mortgage currently has a negative interest rate. It is great for borrowers for whom mortgage debt accounts for about 70% of total household debt. In fact, their equity is rising while their borrowing costs are negative. The problem is liquidity: you can not easily use your newfound equity. Equity does not help when the price of goods and services rises faster than your income. The balance may look good, but your wallet will feel empty.
How long is this likely to continue? We do not have the ability to predict with any accuracy (nor does anyone else). But given some of the inflationary trends, I think:
- The supply and demand imbalances are resolved as they always are. When demand exceeds supply, companies adapt to meet the market.
- Innovation will continue to be a massive deflationary force, as it has been for decades.
- Monetary policy will eventually turn the course. Sometimes too late or too little. Eventually, the Fed gets their policy right, and sometimes after the damage has happened. Paul Volcker taught us this lesson by lowering the money supply and raising interest rates. It was painful, but it worked.
Inflation is a headwind we all face, especially at the levels we see today. It does not take many years before inflation of 6% drastically affects a fixed income, whether you retire or from an employer. A rising income is the only way to ensure that your lifestyle remains unaffected. An increasing dividend portfolio is a potential method of achieving this goal, and it is one we prefer. A rising income sounds like a “nice to have”, but in reality it is more a “must-have” with inflation cutting back on your purchasing power. The real inflation is here, and it’s someone’s guess how long it will last. Make sure your plan meets your needs, and if not, consider making the necessary adjustments to ensure that your consumables last.
Steve Booren is the founder of Prosperion Financial Advisors in Greenwood Village. He is the author of “Intelligent Investment: Your Guide to Growing a Retirement Income.” He has been named by Forbes as a 2021 Best-in-State Wealth Advisor and a Barron’s 2021 Top Advisor by state. This column is not intended to provide specific investment advice or recommendations.