Evan Simonoff THE BIG PICTURE
photo of tom connelly via versantcm . com
In 2010 , federal debt of $ 13.6 trillion translated into about 90 % of the $ 15 trillion ( GDP ) U . S . economy . Today , the debt figure is approaching $ 30 trillion , or more than 130 % of a $ 22 trillion economy . “ Inflation shouldn ’ t be a surprise ,” Connelly says .
The notion that markets are in the clear after June could be fanciful . Some believe quantitative tightening , delayed for several months , is already priced into financial markets . Others estimate that removing $ 5 trillion in liquidity in the next year could take the S & P 500 back to the 3500 area .
If the current path of inflation is any indication , the U . S . could find itself earlier in the Fed tightening cycle than many market participants would like to believe . “ When QT kicks in [ in September 2022 ], speculative investments are going to have a big problem ,” Connelly says .
Those old enough to have lived through the hyperinflation of the 1970s in early adulthood or even as children recognize that their lifestyles may be impaired .
Younger clients , however , are far less likely to see any real threat . Conditioned by the last 15 years , many in this group believe that renewed Federal Reserve magic will ride to the rescue and salvage their portfolios while defenestrating inflation .
Connelly isn ’ t convinced . He isn ’ t the only one to perceive a deterioration in living standards unfolding as the world emerges from the pandemic . Allianz senior economic advisor Mohamed El-Erian and former U . S . Treasury Secretary Larry Summers have called it a global challenge .
Rising food and fuel costs will hit other nations much harder , but Americans have enough problems of their own . In Arizona , Connelly has watched housing prices surge at a faster pace than most other markets , increasing home equity for older residents while hurting affordability for younger people .
While the rate of inflation may moderate in the coming months , some price increases are likely to be permanent . Connelly believes that pressures on prices in sectors like housing , labor and food aren ’ t going away .
There is also a worrisome directional shift in national priorities . In contrast to the period following the Great Recession in 2008 and 2009 , when both fiscal and monetary policy in the form of bank bailouts and quantitative easing received sharp criticism , “ nobody [ in either political party ] is championing any kind of budget restraint ,” Connelly notes .
This despite pandemic government spending that dwarfed the financial crisis relief more than a decade ago . “ We ’ ll probably have to print money in the next recession . People and politicians aren ’ t willing to pay the price ,” he says .
In 2010 , federal debt of $ 13.6 trillion translated into about 90 % of the $ 15 trillion ( GDP ) U . S . economy . Today , the debt figure is approaching $ 30 trillion , or more than 130 % of a $ 22 trillion economy . “ Inflation shouldn ’ t be a surprise ,” Connelly says .
And the powerful inflationary undertow is likely worse . In June , Summers , along with IMF economist Marijn Bolhuis and Harvard lecturer Judd Cramer , wrote a paper for the National Bureau of Economic Research arguing “ current inflation [ rates ] are much closer to past inflation peaks than the official [ statistical ] series would suggest .”
Put another way , if one applies the measurement techniques and weightings from the 1980s to inflation calculations over the last year , we get a number much closer to the 14 % rate of the hyperinflation era than the 8.5 % recent annual CPI rate . That takes a lot more out of spending power and helps explain the foul national mood .
Portfolio Concerns
During the first two years of the pandemic , Connelly was hearing a lot of second-guessing from clients whose friends boasted about whopping gains in crypto and hyper-growth stocks owned by the likes of Cathie Wood at Ark ETFs . The fear of missing out was particularly acute among younger clients listening to virtual cocktail party tales of people buying $ 5 million homes with their crypto profits .
Versant clients typically have portfolios constructed with a value tilt , so many are pleased to be enjoying minimal single-digit losses this year . Connelly favors quality dividend-paying stocks , short-duration bonds ( notably municipals ), commodities and ( to a lesser degree ) real estate . Small allocations to reinsurance and private credit have also paid off .
Even in these asset classes , behavior has turned somewhat zany . Gold hasn ’ t been a great inflation hedge — though gold miners have been minting profits . But it ’ s far more stable than crypto , which hasn ’ t been a great hedge either .
Real estate has performed well , most notably the residential sector . Here Connelly isn ’ t thrilled . He worries about lofty “ cap rates ,” which are “ so high ” people are going to need “ big increases in wages ” to keep paying their rents and mortgages .
When it comes to crypto , Connelly
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18 | financial advisor magazine | september 2022 www . fa-mag . com