The Impact of Inflation
As consumers, we note the impact of inflation in rising prices of everything from filling up a tank of gas to buying groceries. It started with rising housing prices, making homeowners feel richer. As mortgage rates move higher, buyers are frozen out of the market and sellers will be stuck in place. That’s the recipe for a housing slowdown. This also means less spending on furnishing new houses will add to an economic slowdown.

Plus, there's more to come. Ukraine is Europe's breadbasket and harvests this year are predicted to be from 20-40% lower this year, while their export ports are blocked. Shortages can only lead to higher food prices and even hunger.  

Is there any place to hide and protect your assets during a period of high inflation?

For retirees living on fixed income and Social Security, this coming period of inflation – however long it lasts—will be devastating.  For 2022,  Social Security checks jumped an astounding 5.9% (though impacted by higher Medicare premiums).  The latest predictions suggest an 8.9% increase in Social Security checks for 2023.  Unfortunately, that still won’t keep up with increased costs in everything from rents to food.

Stocks have always been a good hedge against inflation over the long run.  In fact, according to market historians, there has never been a 2 year period in the last 100 years where stocks didn’t outperform inflation.  Those periods included deep market declines.  Those close to retirement might panic if they need to withdraw money from their retirement accounts in a temporary market decline, perhaps caused by higher interest rates.

Keeping some cash on the sidelines creates an obvious risk.  Buying power of cash is destroyed by inflation – unless interest rates keep up.  The system is so flooded with liquidity that banks have no incentive to raise rates and attract deposits.  With the inflation uncertainty, banks are reluctant to lend.
 
If you need cash for living expenses, it might be worth taking the inflation hit to have some immediate liquidity, so you’re not forced to sell stocks at a  loss for required withdrawals.  Free market savings rates will rise eventually.

According to the Rule of 72, divide any number into 72 and the result will be the number of years it will take for the value to be cut in half. Thus, 3% inflation cuts your spending power in half in 24 years.  But 8% inflation cuts your spending power in half in less than 10 years! 

So much for choosing an immediate annuity with a lifetime payout that looks good today.  Thank goodness, Social Security adds an inflation adjustment.  (Wait to take benefits and start with a higher base check to get more money in those annual adjustments!)

Bonds can be devastated by inflation.  Who wants your old 3%, 20 year bond if inflation rages much higher?  Try to sell and you’ll lose money since no one will give you that $1000 face value for an old low-rate bond, even from a great company.  If you don’t sell and take the loss, you’re stuck earning less.

If you need to own bonds, at least own TIPS – Treasury Inflation Adjusted bonds – easily found in mutual funds from major companies.  Warning:  Only buy TIPS inside a retirement account.  Otherwise you will be taxed on the unrealized appreciation every year.

Gold might be old-fashioned, but it has awakened from its long sleep as an inflation protector, now approaching the $2,000 mark.  For those who thought crypto was the new gold, perhaps think again.  It didn’t help Russia avoid sanctions.  It hasn’t been hidden from governments, per the recent seizures of crypto assets taken in frauds.  Digital might be the wave of the future, but at present it has not been an escape from governments that would degrade their currencies.

Series I Savings Bonds have become the go-to inflation beating investment.  Currently they carry a 7.12% rate, which will be adjusted every 6 months in May and November to match inflation.  Expect the May 1st adjustment to be higher.  Sadly, there is a limitation of $10,000 per year on individual purchases of these digital savings bonds purchased through TreasuryDirect.gov. A reminder, you must hold them at least one year.  And if you sell before holding for 5 years, there is a penalty of 3 months loss of interest.

Commodities, everything from energy to soybeans, are rising in the face of inflation expectations.  You can hedge by using ETFs that track commodity prices, but be warned that these are volatile investments.

The Outlook for Inflation
There’s a wide range of estimates on Wall Street for how high inflation will go, and how sharply the Fed will act, and whether those actions will trigger a recession.  There are no perfect answers.  In a worst-case scenario we could have the worst of BOTH worlds:  high inflation and an economic slowdown. Expect to hear more about the word STAGFLATION. 

And if the economy does slow, we will likely see the return of the “Misery Index” – calculated by adding the unemployment rate and the inflation rate.  Surely the Fed does not want to see that!

The U.S. dollar is the world’s reserve currency, reflecting the underlying strength of our economy.  This is not the end of the dollar or Armageddon for our nation.  Times will be turbulent and few have any memory of the impact of inflation on the public psyche and on the markets.
 
You’re smart.  This inflation is not transitory.  It will not end without pain.  Be diversified.  Stay on top of your entire financial situation.  Adjust your lifestyle to prepare.  No inflation in the past has been contained without pain. 


Source: Savage, Terry. www.TerrySavage.com. 13 April 2022.

It's the most important financial headline of this century:  Inflation!

A new generation of Americans is about to face the impact of inflation – on their daily lives, their financial decisions, their investment choices, and their retirement lifestyle.  While many pundits proclaim that this period of inflation will come to a quick end, history shows that inflation has always ended not with a whimper, but with a bang.

Once started, the fires of inflation are not easily tamped down.  Whether in Germany in the 1930s or in Zimbabwe a decade ago (their trillion-dollar note became worthless!) or in the United States in the late 1970s, it has taken a ruthless hand to stamp out the persistent belief that prices would go higher.

It’s important to understand what inflation is—and isn’t, what causes it, what “cures” it –- and the potential impact on your life.

What IS Inflation?
The late, great Nobel laureate Milton Friedman clearly established that inflation is always a monetary phenomenon.  It may show up as higher prices, but the root cause is excessive money creation.  The fear of declining value of the currency leads sensible people to exchange their money for goods and services before prices rise again.  The cycle is exacerbated by workers demanding higher wages to “keep up” with inflation, thereby driving the cost of everything still higher.

We may point to shortages because of supply chain disruptions or the war in Ukraine and its impact on energy prices as contributing factors.  But if governments—ours and in Europe – had not created so much new “liquidity” (a euphemism for money printing in this digital age) to fight the impact of the pandemic, there wouldn’t be excess money in the system to push prices higher.  People would suffer and stop buying.   And with lack of demand, prices would eventually come down.  But not without pain.  That’s Econ 101.

Lessons of History
History tells us the only way to stop inflation is to slow the economic demand by slowing the economy.  That slowdown comes from raising interest rates.  Paul Volcker had the determination and discipline to do that in the early 1980s.  And it cost then-President Jimmy Carter the election (along with other factors).   As Fed chairman, Volcker pushed the prime lending rate to 21%.  Mortgage rates jumped to over 15%.  And the economy moved into a steep recession.  It worked – but not without pain.

So that’s what policymakers face now.  Jerome Powell tried to wish inflation away by pronouncing it transitory. But as of this writing, the Fed has still not started to withdraw liquidity from the economy by selling its bond portfolio.  Interest rates remain historically low.  And inflation is roaring.

The longer the Fed waits, the more likely we will see double-digit inflation in the coming months. In an election year.

And even if the Fed moves soon and more strongly than expected, policy always works with a lag. That means a slowdown (recession?) would come at exactly the wrong time – at election time!

Continue reading in next month's newsletter to find out the impacts and future outlooks of inflation.

Source: Savage, Terry. www.TerrySavage.com. 13 April 2022.

Corrections are common, and so are rebounds
​While they can be unsettling, stock market declines greater than 5% are a normal part of the market’s cycle. Thirty-six of the 42 calendar years since 1980 have had sell-offs of more than 5%, including 19 greater than 10%. Corrections have been especially likely when the Federal Reserve (Fed) starts raising interest rates: Each first rate hike in a tightening cycle has prompted a more than 5% stock market decline. But investors should remember that rebounds are just as common as corrections. Since 1980, every time the Fed has started raising rates, stocks have followed their initial drop with a gain greater than 10% (Exhibit 1).

Value beat quality in the correction, and may keep leading
High-quality stocks—shares of companies with especially strong fundamentals—have outperformed value stocks during two-thirds of corrections, historically. This time, though, value led quality. Should investors tilt toward higher-quality stocks to take advantage of lower prices? Maybe not: After past corrections with value leadership, quality trailed value by a wide margin over the next 12 months, on average (Exhibit 2).

Value stocks remain cheap, implying further leadership
​Valuation metrics also make value’s leadership look sustainable for 2022. Value stocks have been consistently cheap this cycle, relative to history. Even after the recent correction, the S&P 500’s least-expensive quartile trades at a historically extreme discount to its median stock, based on forward earnings yield (Exhibit 3). Value stocks have outperformed the market more than two-thirds of the time from comparable relative valuations in the past, with average outperformance of 12%.

Value tends to outperform after interest rate hikes too
​Investors who worry about the impact rate increases will have on stocks may want to look to value for protection. Value factors across the board have tended to outperform the market following Fed rate hikes (Exhibit 4). The likely reason: Rate increases usually reflect strong economic growth, which can improve the prospects of beaten-down companies with improving earnings.

Based on these dynamics, value stocks continue to appear well positioned. I believe that the current disconnect in valuation—with cheap stocks continuing to trade at extreme discounts relative to the broader market—is likely to be a more persistent driver of value stocks than many of the other macroeconomic dynamics investors are considering.


Source: Chisholm, Denise. Fidelity Investments. 2022 March 15. https://institutional.fidelity.com/app/literature/item/9905173.html

Traditions Wealth Advisors
Noah Skrudland/Brien L. Smith, CFP®
Financial Analyst Intern/TWA Owner

Ukraine/Russia Update:
It seems as if the war in Ukraine is not broadening. Negotiations with Russia are continuing, and some insiders believe a solution should come by the end of March or early April. This is an optimistic viewpoint, but there are no signs of Putin getting more aggressive and threatening allied countries, yet. Still, the biggest economic impact of this crisis is the commodity price shock. With energy and commodity prices already rising, uncertainty and supply disruptions are hindering growth and driving inflation. Ukraine and Russia are also major exporters of wheat, fertilizers, and sources of industrial metals. So, we could see increasing prices from several sectors.

Central Banks and Interest Rates:
Typically, Central Banks raise interest rates when the economy is hot. Increasing rates will increase borrowing costs and will slow economic growth. However, when the economy is slowing down then Central banks will lower interest rates to induce economic activity and growth. Last Wednesday, March 16th, the Federal Reserve began its rate hike in the hope to combat the spiraling inflation. They raised rates by 0.25% last week and signaled a forecast for six more 0.25% or 0.50% hikes by the end of the year. Fed Chair, Jerome Powell, stated that he supports a faster pace increase in interest rates for upcoming meetings. This would include rate hikes greater than a quarter percent increase.

Recession Risk:
As of right now, many macro-economic teams do not call for a U.S. recession. However, there are several risks that need to be closely examined. First, an inverted US Treasury yield is a sign that has been used throughout economic history as a recession indicator. An inverted Treasury yield is defined as when short-term bond yields exceed long-term bond yields. Many economists like to compare the 2-year and 10-year treasury yields to determine if it is inverted. As of today (3/21/2022), the 2-year yield sits at 2.14 and the 10-year at 2.32.

Figure 1 to the left shows the Treasury Yield Curve as of March 21, 2022. Since the late-1970s, every inverted yield curve has led to a recession. It should be noted that inversions do not cause recessions but are merely a symptom. Second, higher oil prices tend to slow economic growth. Nine of the last 11 recessions have been preceded by sharp rise in oil prices (Ned Davis Research). Unlike inverted yield curves, oil shocks do have the ability to be a leading cause of a recession.


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Figure 2 below shows past surges in energy prices and US recessions. We currently believe these are the most prominent indicators of a recession. Again, there are few economists that believe the US is in danger of a recession due to our strong labor market, solid consumer spending and savings cushions, and better-than-expected corporate profits. But we believe it is important to closely watch these two indicators for the following months as the Federal Reserve continues to tighten its monetary policy.

Economic Perspectives: ​https://mailchi.mp/b0393d780534/ukraine-impact-special-edition-3

What Russia Invasion of Ukraine could mean for U.S. Markets? Find out more here: ​https://mailchi.mp/fe54d3a88a9f/ukraine-impact

Special Edition newsletter sent to clients on Saturday, February 19, 2022:
​Remain Calm about Investments during this Ukraine Crisis

Current Event:
Russia has gathered over 100,000 troops near Ukraine’s borders. The U.S. has responded by deploying an additional 3,000 troops to Eastern Europe. One-third of deployed US troops will be going from Germany to Romania. The other two-thirds will be moving to Germany and Poland.
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When it comes to energy production, Russia is one of the largest producers in the world. They export over 5 million barrels of oil per day (eia.gov). Analysts are concerned that if Russia invades Ukraine, then this will shift oil prices above $100 a barrel. Meanwhile, Europe obtains about one-third of its natural gas from Russia. Therefore, causing European countries to lean harder on Americans for fuel shortages caused by the Russia-Ukraine invasion. This would have a significant impact on inflation considering energy is an important driver of inflation.
​This chart shows the market’s reaction to the 2014 Russia invasion of Ukraine. Slightly after the initial invasion, the markets slid about 25% throughout the next month. 

Inflation:
It seems everyone was talking about inflation in 2021. The Federal Reserve started its inflation stance as being “transitory”, while quickly adapting to a “non-transitory” stance in the latter half of 2021. Supply chain issues coupled with rising wages make us believe that inflation will not be going away anytime soon. The latest 12-month reading of the Core-CPI, which is a measure of consumer prices without accounting for food and energy prices, was 6%. The latest 12-month reading of CPI-All Items increased 7.5%. We are going to be watching closely the CPI reading for February 2022, which is scheduled for March 10th, 2022.

Interest Rates:
The Federal Reserve plans to start the interest rate hike sometime this year. Increased interest rates will influence all asset prices. As interest rates rise, this could hinder equities as borrowing becomes more expensive and economic growth slows. Some money managers are drawing comparisons to 2018, in which the U.S. economy slowed due to Fed tightening of fiscal and monetary policy. Some ways to combat this are to rotate into more defensive sectors, which include banks, staples, and utilities.
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As for bonds, rising rates will cause their value to decrease. It is known that bond yields and prices move in the opposite direction. Therefore, the expected rate hikes this year could cause longer-term bonds to lose value. One way bond investors fight against rising rates is by considering bonds with shorter durations. The shorter a bond’s duration, the less sensitive it is to interest rate hikes.

Foreign Investments:
Global equities found strong returns in the 4th quarter and double-digit returns for the calendar year. The best returns typically arose from European holdings; financials, pharmaceuticals, consumer staples, and machinery. With the end of 2021, JP Morgan Chase continues to favor US, Europe, and Japan equities but remains skeptical on emerging markets. In 2022, they expect to see above-trend global growth, with upside to earnings and a positive outlook for markets.

Over the year, foreign currencies declined against the US dollar. Which have helped American consumers with cheaper imports and less expensive foreign travel.

Reducing the amount of money you owe in taxes is always an admiral opportunity. Tax credits and tax deductions are two of the ways to reduce this number, although they are not identical opportunities. There are key differences between them in how they work to reduce your total tax liability.

Tax Deductions

Tax deductions reduce your taxable income. That is, the amount of your income that gets taxed by the federal government. Reducing this taxable income therefore reduces the amount of taxes that you have to pay for a certain year. The most common form of tax deductions is the standard deduction. The amount of your standard deduction is dependent on your filing status and is adjusted every year.

Other available deductions are listed on the IRS Schedule A and Schedule 1 on Form 1040. Many tax deductions do come with certain eligibility rules and restrictions. So, you can’t automatically claim all deductions on your tax return. Be sure to confirm qualification rules with the IRS or a professional tax preparer. Deduction amounts also vary depending on the limit or size of particular deductions. For instance, deduction limits for Traditional IRA and HSA contributions is $6,000.

Tax Credits

Tax Credits directly lower your tax liability, on a dollar-for-dollar basis. For example, if you end up owing $6,000 in taxes this year and are eligible for a tax credit of $2,000, then your tax credit would lower your tax bill to $4,000. Contrary to tax deductions, the value of tax credits is not tied to your income tax bracket, so a $2,000 credit is worth exactly $2,000 when it comes to how much you save on your taxes. As is the case with tax deductions, you will not qualify for all tax credits you come across, so you must get details from the IRS or a professional tax preparer for any credits that you would like to claim.

There are two types of tax credits: refundable and nonrefundable. Refundable tax credits simply mean that any unused amount of the credit will be refunded to you. However, with a nonrefundable tax credit, the amount of taxes you owe can only be reduced up to the amount of your tax credit. Any portion of the tax credit that remains unused won’t be refunded to you. For instance, if you owe $500 in taxes and have a $2,000 nonrefundable tax credit you qualified for, you could use $500 of that credit to bring your tax bill to zero. But the unused $1,500 would be forfeited.
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It is important to remember that in order to claim tax deductions and tax credits, many eligibility requirements are present. These requirements mean that the IRS expects certain documentation to be provided with your tax return to show that you are indeed qualified to claim them. So, it is important to partake in good tax recordkeeping as well as maintaining contact with the IRS, or a tax professional should you be unsure about a deduction or credit.

Our newest financial analyst intern is Sam Cox class of 2021. Sam was born in San Antonio, Texas and raised in multiple cities including Nashville, TN and Corpus Christi, TX. Sam is a graduate student at Texas A&M University. He is pursuing his Masters in Economics with a Financial Economics concentration. Upon graduation, Sam aspires to work for a capital management firm. Aside from work and school, Sam enjoys playing golf and basketball at TAMU's recreation center. Let's get to know Sam further below:
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1. Why did you pick TAMU? I picked TAMU due to its unique economics graduate program and for aggie football. I grew up an A&M fan and since I didn’t attend during my undergraduate years, I wanted to finally become an aggie.
2. How many siblings do you have? I have an older sister who lives in Washington D.C.
3. What are you plans after you graduate from TAMU? My plan after graduation is to work for a capital management firm. If that doesn’t go according to plan, I would further pursue more schooling for financial engineering.
4. What has been your favorite moment or memory of TAMU? My favorite memories are all about football. If I had to choose a single memory, beating Alabama during the 2021 football season was incredible.
5. Tell us one fun fact about you, that not too many people know? In the fourth grade, I was homeschooled, and my family and I traveled around the country in an RV.