Transcript:
Tom Vaughan:
I’d like to start off the week with a commentary about kind of a summary of what I saw happen in the market this week. Really straightforwardly, this week was all about inflation. The market was doing fine Monday, Tuesday. They reported inflation numbers that were quite high at 6.2%. On Wednesday, the market dropped pretty strongly. It did come back Thursday and Friday. It’s up at the moment, as we speak, a little over half percent, which is great. It still looks like we might have our first down week in a while this week, at least for the S&P 500. And so let’s talk about inflation, and kind of how that impacts stocks, and then really, what I think might happen coming forward here.
Just flat out from the very beginning, I’ll say that I think that in this particular environment, even though we have higher inflation, I still think you can make money in the stock market, especially in the right types of stocks. Normally, the big fear about inflation is that earnings will drop, because a company would have increase in costs, and then they can’t pass that increase along to their customers, because of competitive pressures or what have you. And you end up with a situation where earnings start to drop, and ultimately, earnings drive the stock market, and if earnings are dropping the stock market’s probably going to come down also.
The other expectation is that the more inflation moves upward, the more that we’ll see the Federal Reserve get more aggressive in raising rates. And when you raise rates, that raises borrowing costs, which create less liquidity for the stock market as far as that go, and less liquidity for consumers and etc. So let’s address some of those. First of all, if you look really closely, the number that they’re talking about, the 6.2% was from last October to this October. And if you look at what was working in that same time frame in terms of investing, you’ll find a lot of companies that can really do a very good job of managing their business, and sometimes be able to push along the increased cost to their to their customers. I’ll give you a great example, just to solidify this point, look at Microsoft. So Microsoft was actually up 65%, from last October to this October.
So inflation is up 6.2%. One of the keys to making sure that your retirement can keep up with inflation is to have some stock market pieces. There’s two pieces historically they’ve done well: stocks and real estate. So let’s talk about Microsoft. And so one of the reasons they can do well in an inflationary environment is just because of the fact that they have great name recognition, people know who they are. They have a great market share, right? And they have an installed base that’s very, very strong. So for example, here at our practice, we have Microsoft, everything. The operating system, Microsoft Office 365, we use the Microsoft Teams, etc. So, even if the cost goes up, it will be painful for the practice to pay that, but we’re not going to stop it, just because there’s really no place else to go.
So that’s another key thing, is low competition, and/or offering some unique products that you have or what have you. So there’s kind of a category of stocks that are able to continue to increase their prices, as their costs rise. And they’ll do quite well. So that’s, why you want to look at companies like that, that have that name recognition and market penetration. And if you actually look at the S&P 500, it is full of companies just like Microsoft, which is now the number one stock in the S&P 500. But all kinds of companies with great name recognition, low competition, and what have you. And you’ve got a scenario where you can hopefully keep up with inflation. That index was up 42.7%, from last October to this October. Again, when inflation is 6.2%, that that helps a lot in that direction.
So, my overall outlook right now is that the demand is surging upward, people are continuing to buy, continuing to want more. And I think that’s just going to get more and more so especially as we head into next year. I’m hearing more and more from my clients, for example, how much they want to get out and do things or how many trips they have planned for next year and those types of things. So as that demand moves up, and really, really increases, even if things cost more, they’ll continue to buy. And so that means that the earnings can at least maintain. And the growth on earnings in that last 12 month period has been fantastic. So even though we had high inflation, earnings still grow very well, because the demand was so high, they’re willing to pay the higher price. And so the consumer, both the business and the personal consumer is in very good place right now.
Lots of cash on hand as a whole and lots of pent up demand. So, I think it will probably continue to see an inflationary environment for a while here, but I don’t know that it’s going to dramatically impact the earnings of some of these great companies. And so that’s one piece.
And then the other piece is just what the Federal Reserve’s gonna do. Ultimately long term, the Federal Reserve has the big, at least in my opinion, impact on the big downturn. So, 2008, we had 21 upturns in the Federal Reserve’s Fed funds rate, before the market really came down, we had like 19 increases before the 2000 downturn. So it’s very important what the Federal Reserve does. And as inflation gets stronger, there’s some expectations that they might be doing this a little bit sooner. But, keep in mind that rates are basically at zero right now. And if you look at even 2019, rates are about two and a half to two and a quarter, someplace in that range.
For example, Microsoft made 55% in 2019. It was a good year, but it just shows you that companies can still make money, even if if the borrowing costs go up. It’s just ultimately when you really, really ratchet that borrowing cost up, that’s the issue. But that’s probably a pretty long ways away from here. And there’s a lot of potential gains in between here and when we get to high on the interest rates with the Federal Reserve Fed funds rate.
So, very fascinating. Obviously, as a consumer inflation is a bad thing. It’s tough going to the grocery store and those types of things. But right now, there are an awful lot of companies that are doing very well in this environment. I don’t see that changing. I think when the market sells off on Wednesday, I think they’re thinking about the old version of inflation, like we saw in the 70s. This is a reopening of the economy, with a surging demand, that’s going to continue to pay these higher prices. And as a whole, both businesses and consumers are seem to be quite capable of paying this at this point in time. So really interesting to see what’s going to happen here and go forward. But I would basically keep that positive mindset. That’s what’s been winning here all together, because they don’t see the basics changing at this point in time. I think these companies are still going to retain some pretty good earnings. So look forward to seeing what’s going to happen next week.