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Making Up For Lost Time: Prepping for Return to Normal Spending in 2022

Making Up For Lost Time: Prepping for Return to Normal Spending in 2022

I originally wrote this blog post in July 2021. I am updating the post as a great deal has changed in our lives since last summer. We are still dealing with the impact of COVID on a daily basis; albeit, it is in many different ways. Our consumer habits are much closer to pre-pandemic patterns. We are dining in restaurants and shopping in stores. Travel is returning to more normal levels as well. All of that said, we are still a country very much dealing with this virus. Our hospitals are better equipped to handle life-threatening cases and, fortunately, those case numbers are falling. We are still seeing friends and family members test positive at a high rate, and we are frequently utilizing home testing kits to determine the cause of symptoms. I believe that most people are coming to the realization that COVID will be us, in some form, for many years to come.    

Through the first year and a half of the pandemic, we heard the phrase “new normal” ad nauseam. Pundits and media types love to tell us that this is a different time, situation, or environment than we have ever seen before. I tend to look skeptically at these prognostications because history has a way of repeating itself. However, this won’t be a new normal as much as a move toward “back to normal,” not only in our personal and social lives but also in our financial lives. 

In the chart above, 2020 became one of only two years since 2000 that Americans’ personal savings rate eclipsed 10%. Click here for the interactive chart. Source: Statista.com

Savings Rates Are Off Of Their Early Pandemic Highs

We all were forced to adjust our lives and adapt to a COVID world. We all stayed at home more and limited our exposure to crowded situations. A silver lining emerged from this very difficult period in our lives by way of our personal savings rates. Personal savings rates in the United States skyrocketed in 2020. The savings rate in 2020 was almost double that of 2019 and more than doubled the respective rates of 2016 and 2017

That’s changed over the last year. Savings rates have fallen off of their pandemic highs, dropping in all but two of the last 13 months since March 2021 and trending below the 10-year average. The recently released rate for the month of April shows that the savings rate for Americans hit its lowest level since 2008 (4.4%). This is likely a result of people’s spending habits returning to pre-pandemic levels as well as an increase in the cost of goods. Inflation is having a very real impact on household budgets. For this reason, we should review our cash/emergency savings levels and determine if we need to allocate more of our income to short-term savings accounts. The economy is facing headwinds that we haven’t seen in some time, and we should all be prepared for a possible slowing of economic growth. 

The Challenging Beginning to 2022

The domestic stock markets are dealing with myriad economic issues as we near the mid-year point. Supply chain issues caused by COVID shutdowns are still generating disruptions with companies trying to deliver finished products and keep shelves stocked. As a result, companies are having to forecast lower revenue projections, and the equity markets are reacting negatively. This, in conjunction with a bond market facing strong indications from the Federal Reserve of significantly higher interest rates, is stressing the fixed income markets and yielding an uncertain second half of 2022. The country is also seeing a shift away from work-from-home employment to workers going back to offices, stores, and production facilities. This puts pressure, particularly on technology companies such as Zoom, DocuSign, and others, which soared in the WFH environment and are now struggling to adjust to employees traveling back to work.

Assess Your Financial Situation 

Your financial life is in a different place than it was at the beginning of 2020. 

We are all attempting to find the correct footing for ourselves and our families in this post-pandemic, but still lingering COVID world. From a financial perspective, it is important to keep in mind that correctly positioned emergency funds are imperative. It is difficult to predict how 2022 will finish and where the economy will sit at this time next year. For that reason, reviewing your financial plan and understanding the impact of recent market downturns have had on your plan is critical. Prioritizing your financial situation during these times will most likely produce better results as the country hopefully gets beyond this current phase of COVID. 

Nate Condon, Financial Advisor

The Year of Impossible Choices: 2022 Market Outlook and 2021 Review

The Year of Impossible Choices: 2022 Market Outlook and 2021 Review

In last year’s market outlook, I described the current state of global monetary policy as a giant exercise in price control, specifically, control of the cost of capital. An environment in which perpetually falling rates and equity premiums favor longer duration growth stocks, but hardly resulted in what might be described as widespread prosperity. 

The (short-lived) revenge of the bottom half

During the grand re-opening of 2021, for a brief moment, dare I say it, things seemed to be going well. Bolstered by massive government stimulus and a strong job market, something remarkable happened to the average American household: they got richer.

While household wealth rising is not surprising given equity, real estate, and cryptocurrency gains, what was truly remarkable was the relative gain attributable to the bottom 50% of American households, whose share of total wealth rose above 2.5% in Q3. While the percentage remains low in absolute terms, we had not seen this metric rise above 2% since the 2008 crisis, and 2.5% was last witnessed in the early 2000s.

A tight labor market, marked by the “great resignation” (an unusual number of people quitting their jobs), has certainly contributed to the slight, but noticeable, narrowing of inequalities. For the first time in years, the labor market appears to have shifted in favor of workers, who may be in a much stronger position to secure higher wages, strengthening their ability to accumulate wealth. Direct COVID relief payments and expended child credits also contributed to this continued improvement in household wealth.

Unfortunately, before anyone could celebrate a resurgence of the American middle class, a much bigger story would steal the headline: the return of inflation. In the short term, moderate levels of inflation can have a beneficial effect on the job market, support asset prices, ease debt burden, and even reduce income inequality. In the long term, however, the upside risk to inflation makes me less than enthusiastic about the potential for a continued trend in narrowing wealth inequalities. 

While higher inflation means that everyone, in aggregate, gets poorer, some might get hurt more than others. Over time, cost pressures are likely to favor owners of productive assets at the expense of small savers and wage earners. A recent analysis by the Penn Wharton Budget Model already highlights the increasing burden on middle-income family budgets, who spent about 7% more in 2021 for the same products they bought in 2020 or in 2019.

The era of low inflation never started, now it may be ending

The return of higher inflation, in the form of her CPI numbers, was heralded as a momentous shift in the economic environment in 2021. After all, inflation has not been a major concern in most of the developed world in the last decade, some have even suggested that we lived in the era of low inflation, and central bank action certainly focused on fighting the perceived threat of deflation first and foremost.

I was never a huge believer in the idea of a “low-inflation era.” To be sure, we may have had moderate levels of inflation on average, but more importantly, we’ve had an era of uneven, patchy inflation, where falling prices in some areas were offset but rapid increases in others. 

What charts like the one above highlight, is that the supposed low-inflation era has, in fact, been an era of selective inflation. An era in which, broadly speaking, the price of things we don’t really need, like toys and electronics, has collapsed, but the price of things we need (say, food, housing, and healthcare…) has continued to rise. 

In this environment, it is perhaps no surprise that middle-class households hardly seemed to reap the benefits of low prices. All else being equal, and despite the prevailing inflationist narrative: no inflation is good, deflation is even better (how often have you complained about prices at the store being too low?). For two decades deflation has been limited to a relatively small segment of largely discretionary expenses, while higher costs in other products may have actually reinforced inequalities.  

Regardless of how the Consumer Price Index is composed, it is also important to recognize the limitation of the CPI (our policy makers’ main tool in measuring inflation). CPI is a complex set of data maintained by the Bureau of Labor Statistics. Over the years, its methodology has been revised multiple times, and most recent adjustments have tended, in my opinion, to make monetary policy look better. Some of the most convenient CPI adjustments include: substitutions (the idea that if something is too expensive, we’ll just buy something else, say lemons instead of bananas…) or, even better: hedonics (an adjustment made when a price increase isn’t actually deemed to be a price increase, but just a reflection of improved product features). Not to mention the fact that shelter, one of the largest components of CPI, is for the most part not collected using a market-based mechanism. Instead, most of the CPI’s shelter data comes from something called Owner Equivalent Rent (OER). OER is basically a survey of homeowners, who get asked a simple question about how much they think their property could be rented for (imagine calling your parents who’ve lived in their house since 1976, and asking them what they think the rent is). 

Regardless of how much I doubt inflation numbers, what became obvious in 2021 is that no amount of adjustments could make inflation look benign. Since March 2021, CPI inflation started exceeding the Federal Reserve’s 2% target and has continued to rise ever since.

In August 2020, the Federal Reserve implemented a new flexible approach to inflation, effectively warning the market that it may allow inflation to “run hot” for a while if it deemed necessary. We are now in our ninth month of excess inflation, and just how much more of these inflation numbers will be tolerated is unclear. 

Over the last few years, central bank officials have often felt the subtle (or not so subtle) pressure to keep their policy stance accommodative (remember Donald Trump praising Janet Yellen for being a “low-interest person?). But politicians and the general public can be fickle, and the pressure to remain accommodative can just as easily morph into a pressure to tighten. If inflation continues to take hold, being a low-interest rate kind of person may not look so flattering anymore.

The trillion-dollar checking account

I have long been telling clients that the pandemic could, somewhat counterintuitively, be the catalyst for higher inflation. By pushing governments and central banks to implement a combination of both extremely loose monetary and fiscal policy, they may just have poured fuel on a fire that had been simmering for years underneath the low CPI numbers. While 2020 saw unprecedented levels of new debt issuance and stimulus, a lot of promises only reached full implementation in 2021, which may explain the sudden, but somewhat delayed, change in inflation dynamics. 

The U.S. Department of Treasury’s general account with the Federal Reserve (effectively, the government’s checking account) spent most of 2020 swelling up to unprecedented levels: normally fairly steady at a balance of around $300 billion, it reached a balance of $1.8 trillion in mid-2020 at the height of the pandemic.

In contrast, 2021 was truly the year of the great spending spree, when checks were finally cashed, even as treasury bill issuance slowed. $1.6 trillion was promptly spent in a matter of months between February and July 2021. As Citi’s market strategist Matt King highlighted back in February 2021: the flood of cash created by the drawdown in the treasury’s general account (TGA) risked tripling the amount of bank reserves, and pushing rates even further towards zero or negative territory: “surfeit of liquidity and a lack of places to put it – hence the rally in short-rates to almost zero, with the risk of their going negative.” As King further notes, “if relative ‘real’, inflation-adjusted Treasury yields fall, it could weaken the dollar sharply (…) at the global level the TGA effect will indeed prove highly significant.

As shown above, real yield would indeed fall throughout 2021, to levels unprecedented in modern history, and one of the side effects of negative real yield may have been to propel the now-familiar “risk on” investment theme to new heights. We all thought money was cheap at -1% real rates in February, how about -6.5% In November? 

The treasury department wasn’t the only one spending. As it turns out, American households too were fast and loose with their checkbooks. Individual savings rates had risen during the pandemic and remained relatively elevated well into the beginning of 2021. Since March 2021 however, saving rates have fallen back to their pre-COVID levels.

Against this backdrop, it is perhaps no surprise that the “buy everything” ethos, long limited only to financial assets, now seems to have spread into housing, commodities, energy, various consumption goods, and even used cars.

With gains of nearly 50% since December 2020, the Manheim Used Vehicle index outperformed both the S&P 500 and the Dow Jones in 2021.

Impossible choices

Over the last decade, central bankers have been almost entirely focused on supporting the economy. With the threat of inflation only a distant concern, there has been basically no downside to perpetually flooding markets with free money. To be sure, central bankers have been fairly successful in averting deflationary fears and consistently driving down real (inflation-adjusted) rates. With short-term rates at zero and longer-dated bonds at historic lows, many observers felt that yields had nowhere else to go. Real, inflation-adjusted rates have no such lower bound. And as much of what the recent spike in inflation will be heralded as a change of regime, in many ways, it can also be seen as the culmination of a broader trend in lower real rates that started many years ago – and arguably as far back as the mid-80s.

With real yield deeply negative, and central bank balance sheets at all-time highs, 2021 brought the scale of global monetary policy to yet another record-breaking year. However, for the first time in over a decade, inflation may truly force central banking officials to tighten policy this time. So far, policy response in the U.S. has been mainly limited to tougher talk and a planned reduction of the pace of asset purchases (the now-famous “tapering”). While FOMC guidance does indicate an expectation of multiple rate hikes in 2022, the Federal Reserve will be walking a very fine line as it looks to change course.

One of the paradoxes of the current environment is the continued flattening of the yield curve. A flood of bank liquidity may have contributed to the collapse in real short-term rates but has not resulted in any real upward shift in long-dated bond yields. This could be interpreted in numerous ways. Perhaps the bond market is simply not buying the idea of long-term inflation or may think it raises the probability of a policy mistake (excessive tightening leading to a deflationary crisis), or perhaps the Federal Reserve’s bond-buying program has simply distorted bond prices to such a degree that rates no longer reflect any realistic growth and inflation expectations. Whatever the case may be, hiking rates in this environment would mean running the risk of yield curve inversion: a situation where short-term rates would exceed long-term rates. While not always predictive of a crisis, an inverted yield curve generally sends a very negative signal and isn’t consistent with a healthy economy, in which opportunity cost should correlate positively with time.

Central banking officials are very aware of the risk, and the issue of curve flatness was explicitly brought up by members of the FOMC in their December meeting. There is a certain common-sense logic to the idea that, before resorting to traditional monetary tightening policies (raising short-term rates) the Federal Reserve should first get rid of the more exotic, experimental, crisis-time measures, such as quantitative easing. Doing so may allow long-term interest rates to rise, resulting in a more constructive environment in which to hike short-term rates. After all, if the economy is strong, to the point of raising rates, why have QE at all? That does not seem to be what committee members are thinking. In fact, according to their latest minutes, they seem intent on doing the exact opposite: begin to raise rates as early as March 2022, and then tackle balance sheet reduction. Even so, balance sheet reduction would not resemble a complete termination of their bond-buying program, but would probably involve a monthly cap on the amounts of “runoffs” (treasury bonds allowed to mature without being reinvested). Assuming that the monthly cap on runoffs does not exceed monthly maturities, the net effect of this policy may be that the Federal Reserve will be continuing to buy billions of dollars worth of bonds every month for the foreseeable future. Presumably with the hope that slowing the pace of balance sheet reduction will act as a buffer against the possible negative effects of rate hikes. 

In this balancing act between tapering and rate hikes, one might perhaps perceive a subtle acknowledgment that central bank officials have made themselves into de-facto custodians of stock prices. After all, their previous attempts at an interest rate hike cycle in 2018 ended in a 20% market sell-off and had to be promptly reversed. At today’s valuations, a similar sell-off would wipe out nearly 10 trillion dollars of value from the S&P 500 alone. Ultimately, the message buried in the complex mix of central banking rhetoric may simply be that the Federal Reserve intends to stay behind the curve in its attempts to tackle inflation. That it intends to tighten policy slowly, while remaining accommodative and relying on the magic of negative real rates to support asset prices and the economy, tightening without tightening. Exactly how long they can get away with this in the face of higher inflation is anyone’s guess. Given the huge political stakes around issues of wealth inequalities, and with midterm elections around the corner, I expect pressure on the Federal Reserve to ramp up over the coming months. Backed into a corner, central banking officials may just have to pick between continuing to support market valuations and curbing cost pressures. However things turn out, 2022 may very well be the year when investors and US households alike realize that free money does have a cost after all.

Syl Michelin, CFA

2022 Investment & Market Outlook Guide

Syl Michelin’s piece is part of Walkner Condon’s 2022 Investment & Market Outlook Guide, a comprehensive reflection of 2021 and glimpse at the factors impacting the year ahead in 2022.

The Slow Pace of Fast Change in a Post-COVID World

The Slow Pace of Fast Change in a Post-COVID World

One of my favorite (perhaps apochryphal) quotes comes from the French novelist Gustav Flaubert who, while surveying Paris during the Franco-Prussian War of 1871 declared, “After all of this, we will still be stupid.” And while Flaubert’s view of human nature is perhaps slightly more negative than mine, I do think that one of the things at which we excel as a species is overstating the long term effects of recent or current events.  

That quote came to mind when I saw this morning’s headline from the Wall Street Journal: “Europe Lease Deals Suggest Traditional Office Will Endure in Post-Covid World.” The assumption at work in this headline is that a universally accepted truth in a post-COVID world has been that real estate rentals were going to take a hit, as businesses would all shift to work from home via Zoom and the various other productivity apps that link us. However, as this article suggests, the shift away from traditional offices to full-time remote working will likely not happen overnight.  

We have seen a sharp decline in travel in this pandemic, since even in the best circumstances, airplanes tend to be petri dishes of disease. However, this is not the first time that the industry has faced an existential crisis. Recall the predictions about the industry’s demise during the climate of fear immediately after 9/11. Students of history will remember that not two months later, a plane crashed outside of New York City, and, in December of 2001, the infamous shoe bomber was also arrested, compounding the fear of flying that was already in the atmosphere. Similarly, in an article in the Financial Times, airline experts believe that the industry will change– more point-to-point flights, perhaps fewer giant planes– but that ultimately, according to former head of British Airways Sir Rod Eddington, “if we get a vaccine, people will be back to normal in a year.”

None of this is to say change won’t happen– perhaps men will start washing their hands after going to the bathroom more— but the changes will be more subtle and less dramatic than we think. And, like taking our shoes off when we board airplanes, they will likely soon become the new normal.  

Perhaps the greatest confirmation of the fact that the ways of the world will be slow to change is that I, who passionately embraced working from home (almost as much as my dog), am writing this to you from our office on the corner of Glenway and Monroe.    

 

Keith Poniewaz

 

Post-Lockdown Changes & Predictions

Post-Lockdown Changes & Predictions

It is a rare event that impacts the entire world. COVID-19 has changed our way of life in the short term, with long-lasting ramifications yet to be determined. In the context of our business at Walkner Condon, we have some items that we believe will be permanently affected and some guesses on others.

More Virtual Meetings

We have offered video appointments for a number of years now, and with the exception of Keith (who works with expats across the globe), very few of our meetings have been conducted virtually. We expect this to change, as our clients and prospective clients have increasingly become much more comfortable with Zoom meetings. With the added comfort of our clients, and frankly, the comfort of our advisors as well, we’ve found that we are able to offer a very similar experience to an in-office meeting. We plan on continuing to offer these meetings, and are likely to schedule “home office days” where we conduct our meetings virtually in the future.

Screen sharing allows us to work collaboratively with our clients in many different ways – including administrative tasks where paperwork is involved, as well as sharing financial plans and allocation information. If you haven’t seen us in a while, now might be a great time to schedule that Zoom meeting! Additionally, for those clients that may have been hesitant to recommend us to their friends and family members outside of Dane County, we want to let you know that we are well-equipped to help them as well, and would welcome the introduction.

Increase in Customized Asset Management Offerings

When you are able to take time to work on your business instead of in your business, that’s when we have found unique solutions for client needs. In analyzing feedback from clients and meeting as an investment team, we will be building out customized portfolios using individual equities. Currently, we are looking at developing a few core models, focusing for now on U.S. large cap stocks with strong balance sheets, as well as U.S. small and mid cap stocks. In the future, we anticipate rounding these out with additional models, including a focus on ESG (environmental, social, governance) factors and international stocks.

The barrier to entry on many of these in the past has been “ticket” charges charged by the custodian per trade, as well as fees by outside investment providers for these strategies. Our team, spearheaded by Keith Poniewaz and Mitch DeWitt, have been working on developing these in-house to eliminate those manager fees. Additionally, by  lowering trading commissions down to very low in some cases and zero in others, this strategy becomes significantly more feasible. 

There is much to write about the benefits of these strategies, including the ability to manage taxation, lower or eliminate expense ratios, and offer greater customization. Keith and I discussed “direct indexing” about a year ago on Gimme Some Truth, and will expand on this topic in a future blog post.

Probable: The Death of the Suit

As we’ve all become accustomed to working from home, the dress code has become increasingly relaxed. It’s certainly not uncommon to see people in sweatshirts and hats conducting meetings, and it’s become an anomaly to see someone show up to a Zoom meeting in something as formal as a dress shirt. While a return to the office will likely send us back to business casual, it’s difficult to imagine anyone reaching for a suit anytime soon.

Possible: The Elimination of Handshakes

Certainly a more minor – but still important – interpersonal moment may be coming to a close. With a greater focus on the communication of viruses, could this be the end of the handshake? As we enter a post-lockdown world, it seems like a certainty in the short term that handshakes will be out of fashion, and polite waves or nods will become the preferred greeting. (Though, if elbow-bumps get too popular, we reserve the right to revert back to good ol’ fashioned handshakes!) 

Probs Not: Zoom Happy Hours the New Normal

I’ve been on a few Zoom happy hours, which have been kind of nice to do with people I haven’t been able to see for a while. It’s also brought together family members and friends that live far away. But to think that it will replace your favorite dive bar and those greasy burgers? Doubtful, at least in Wisconsin.

COVID-19 and the Real Estate Market

COVID-19 and the Real Estate Market

The Coronavirus is affecting our lives in many different ways. Eating in with carryout and delivery instead of reservations at restaurants and bars, Zoom meetings and teleconferences instead of office meetings, waves instead of handshakes and hugs; the world is a different place than it was two months ago.

More of the Same….and Then It Wasn’t

The beginning of 2020 looked quite similar to the start of the last few years in the housing market. Then, as we know, everything changed in March with COVID-19. We are now left with many more questions than answers. Mortgage rates have fallen to even lower levels as the Fed is desperately trying to help the economy. This, in turn, created a glut of refinancing applications for mortgage lenders. However, the negative economic impact of COVID-19 is far reaching, creating tremendous liquidity problems within the banking system. It is difficult to close on a mortgage refinance when the money to pay off the existing mortgage is in limbo, or lock a rate on a mortgage application when the lender has no idea how long it will take to get to a closing table. Delinquencies on existing mortgages will certainly increase as homeowners deal with an uncertain job market, leading one of the country’s largest mortgage lenders, JPMorgan Chase, to change their lending guidelines in recent weeks.

Uncertainty Abounds 

The economy is in a very different place as well. Strong earnings reports and record low employment numbers have been replaced with the utmost of uncertainty. Almost every aspect of the economy is dealing with some level of ambiguity, with the housing market taking center stage. The housing market over the past decade has been, for the most part, quite strong. This has been fostered by low interest rates, ample cash liquidity, and friendly lending guidelines. This, however, has led to the issue of low inventory and excess demand for the last few years. While this has been positive for house prices and mortgage applications, it has created an imbalance. Builders are trying to take up the slack by fast-tracking new home construction, and anyone remotely interested in selling a home has been enticed with the idea of completing offers to purchase within days, instead weeks or months.

Housing Recession Imminent?

With all of this said, it would be easy to assume that the housing market is headed for a recession of its own, but I wouldn’t be so quick to come to that conclusion. This is one of the more resilient components of the overall economy. People need to buy and sell houses every day, regardless of what is happening in the rest of the economy. We will likely have a low interest rate environment for the foreseeable future, which should keep the market somewhat stimulated. 

What To Do?

What should you do if you are in the process of a refinance or house sale/purchase? First things first…don’t panic! Nothing good will come with trying to force the process to go faster or demanding that things happen. The task at hand will require more patience and understanding than in previous years. The refinancing timeline has shifted to a couple of months versus a couple of weeks. Locking rates will almost certainly become more difficult than it was before, and underwriting guidelines are changing. My recommendation would be to work with a mortgage lender who is in touch with the current protocol and can guide you through the process. You need to be working with a lender who provides specific advice and has a strategy for operating in this environment. This, in my opinion, isn’t the time for the internet lender who is offering a teaser rate of slightly below the market rate. This is a time for trusted advisors. If you need a recommendation, please let us know and we would be happy to provide you with the contact information of different lenders.

Nate Condon