How to Respond to the Impact of Inflation on Today’s Stock Market
Look for the Silver Lining
The bears have current control of the market. Inflation will be with us for some time, and preservation of capital is critical.
The HCM-BuyLine®, Howard Capital’s proprietary math-based indicator, recently turned negative for the first time since the start of the pandemic in February 2020, which recommended our portfolios move a portion to cash and/or short-term bonds.
The inflation bear, too, is most definitely real, and it’s not transitory. During 2021, this higher bout of inflation has been felt at the grocery stores and gas pumps. Now it’s being felt by the markets. It was only a matter of time before the markets buckled under the weight of rising inflation and the prospects of higher interest rates.
Are we in a longer-term bear market or is this just a nasty correction? Only time will tell, of course, but for now the trend is down and fighting the trend can be expensive and painful. We will let the market find its base, and when the HCM-BuyLine® turns positive, we will re-enter.
How Did The Markets Get Here?
The Federal Reserve has put quantitative easing on steroids since the beginning of the pandemic, ballooning the federal balance sheet to nearly $9 trillion. This was done to increase the money supply and stimulate economic growth during the COVID pandemic. As the growth of production of goods and services slowed, the money supply growth eventually overtook it, causing the price of goods and services to be bid up. When too many dollars are facing too few goods, the result is inflation.
Then add in supply chain issues and increasing wages. Payroll has gone up as employers have had to pay more to get people to come to work. That has contributed heavily to inflationary pressures on the market. There are still four to five million people not working right now.
Often ignored in the inflation equation is the velocity of money—the rate at which money is exchanged in the economy. Following the financial crisis in 2008 and the COVID pandemic in 2020, consumers were more inclined to save their additional dollars out of caution. During COVID, savings increased because many services were no longer available for purchase, such as travel and restaurants.
Now, as many COVID restrictions have been lifted, consumer activity has reached pre-pandemic levels, increasing the velocity of money, but setting the stage for a more prolonged inflation, which we think could be with us for the next 12 to 18 months.
How Should Advisors and Their Clients Respond?
Whether we’re in for a repeat of the 1970s will depend on how the Federal Reserve responds to inflationary pressures. The Fed was a little late to the game and missed a rate hike opportunity in January. The Fed now has to walk a tightrope with future rate hikes later this year. Rising rates too quickly could potentially hurt markets, but not acting at all is only fueling the inflation problem, which is now at a 40-year high. The Fed is in a no-win situation of having to make some difficult decisions that may sting a bit. The latest indications are that it will hit the brakes on printing money in March.
The basic arrow left in the Fed’s quiver is to raise interest rates, which we expect them to do three or four times in 2022.
Some equities could hold up better than others. High-dividend-paying and big-value stocks have been performing relatively well so far. Look for value stocks and cyclicals to potentially outpace growth stocks, while an increase in interest rates later this year could mean a strong headwind for tech stocks. Energy stocks may also do well. But in a deep and sustained selloff, most stocks will likely get caught up in the contagion.
Advisors and their clients need to avoid making decisions based on emotions as it invariably leads to bad outcomes. Some specifics:
- Know that the market fluctuations are normal. Declines of 5% have happened on average three times a year; declines of 10% on average have historically occurred every 16 months; and declines of 15% have happened every three years. Stay the course.
- Aim to maintain enough investment power to get back in the market at lower prices when the market turns positive.
- Seek to avoid going to long-duration bonds, especially those relying on their investment capital in retirement. Once interest rates start rising, bond prices may become an instant loser.
- Consider short-duration bonds or even cash. Cash isn’t ideal because, at a 7% inflation rate, people would be losing 7% of their money. But it may be the best of the options.
- Avoid interest rate-sensitive stocks like utilities.
The world is not going to end. It’s just going to be a bit more volatile than usual. It’s like being in an airplane. It doesn’t mean we don’t land safely, but advisors and their clients might want to tighten their seat belt along the way.
Reasons To Be Positive
There are several reasons to be optimistic right now. COVID may finally be waning, the economy has remained strong, and virtually anyone who wants a job can get one. Investors have had three excellent years in a row, so a downturn is to be expected. These market cycles run about three years, and they never last long, maybe six to twelve months at worst. This is completely normal market action.
Indeed, market selloffs may be healthy because they may allow for valuations to normalize. Note that volatility and risk are not the same. Risk refers to the permanent loss of capital. Volatility is simply the price fluctuation of a security. Firms with non-volatile stock prices may not generate a profit. Embracing volatility may lead to great buying opportunities for high conviction picks and how positive returns are generated. Advisors and their clients may want to welcome volatility—because it’s how positive returns are generated. For those reasons, embrace volatility and avoid letting emotions drive their investing decisions.
The HCM-BuyLine®
The HCM-BuyLine® has been identifying and confirming trends for three decades, enabling Howard Capital Management to sidestep catastrophic market declines in 2000, 2008, and 2020. To learn more about the HCM-BuyLine® and how it is used to tactically manage mutual funds and ETFs, please click here.
