Transcript:
Easan Arulanantham:
Tom, how do I invest in a high inflationary period? So the consumer price index came out at 8.5, which is the highest since the 80s. You know, everyone’s because of the gas pump and sees those high prices, and we know inflation, we see it every day.
Tom Vaughan:
Yeah, it’s a great point altogether. Lots of questions from the clients about this, too, you know, because like you say, the number was so big for March. It’s kind of scary, you know, as far as that goes, and I get it. And so how do you invest? What do you put your money in? I’ll give a warning. First, I have seen so many articles and had so many questions. And essentially, people are making pretty radical moves right? into areas that will do well in inflation. And they’re over weighting their portfolios into that particular area. Well, what if we don’t have inflation, right, the market is not that predictable. You can’t say for certain that something’s going to happen, you got to keep a really good balance, for starters. And if you’re going to move in one way or another, it should be smaller portions of a portfolio. So you’ve got to keep that, you know, overall thought process in mind. Because you know, all of the news is about how much inflation is here and how it’s going to keep going. And it’s just incredible. And again, fear sells. So that’s what they’re going to focus on, there is another path to understand that inflation could pull back to be lot less by the end of the year, beginning of next year. And everything that you might be buying right now to try to find inflation could fall or do worse in the market. If that does happen, the market is looking forward six to 18 months, right? So think about that. If the, if the inflationary environment gets significantly better than next six to 18 months, all of those things that you’re trying to buy now we’d be at a peak,
right?
Easan Arulananantham:
Yeah. And there’s a kind of this turbo, this bias that we have, that you talk about and behavior or finances, or regain anchored to a specific idea. And then when we look at the news, are we only looking for news that kind of confirms that bias. And so we don’t want to get stuck to any kind of idea, because we don’t know if this idea will hold in the future. So we need to be flexible.
Tom Vaughan:
Yeah, exactly. So that that’s the, that’s the thing to talk about. So let’s just look at the other side, why there might not be inflation as much in the next six to 18 months. And a lot of that has to do with the situation that we’re in. So I just read this great article that after World War Two, all the soldiers come back home, and there’s just this huge pent up demand. And we’ve got this scenario where people want to buy houses don’t buy cars. So if I nylons, and all the production is geared towards wartime production, making airplanes and different things on those lines. And so it’s similar what happened here, right, got the situation where everything got locked down and shut down, and then the production was stopped. And all everybody’s coming back now and want to buy things, and the production takes time. And so we had this high inflationary scenario, after World War Two, that eventually worked its way back down to a normal inflationary scenario, once the supply could be redirected and restarted for the things that people really wanted at that time. And then we ended up with a pretty nice period, right? The end of the 40s. And the all the way through the 50s was a really good time period. Economically, the stock market did well in that timeframe also. So I think this, this particular correlation, that’s the strongest we can get for modern correlation, you have to go back to 1918. For the last pandemic, we did end up with the roaring 20s, right, starting about 1925 to 1929. That was the second biggest run in the stock market, and a five year period in history. And so, you know, we’ll see how this plays out. But this is not normal.
This is not like the 70s and 80s, as much as it’s like the end of World War Two. And, and the and the situation that happened in 1980 with the pandemic. So, and I think a lot of people are kind of missing that. So let me share some things with you here. We’ll take a look at that. So first of all, this particular chart just shows consumer spending. And you can see here, that it was very smooth. Yeah, prior to the pandemic, just marching up very nicely, actually. And when that happens, you know, production can keep up things are okay, as far as that goes. And then that gray line there shows kind of that recession that happened because of the shutdown of everything. Look at what happened to consumer spending, it just plummeted. You know, people were afraid. Yeah. And then some places we couldn’t spend the money. There was no restaurants to go to, there was no planes to get on, you know, airline miles dropped 96%. And then we started to reopen. And you can see that blue line comes back up. And what I did there is I drew in a little red dotted line, if we just had kept on the same, you know, path, exactly along that same path of growth. And not only did we catch back up to our normal expenditure growth path, we passed it. Right. And so we passed it for two reasons, in my opinion, number one, trillions of dollars were pushed out by the government, in in an end stimulus to try to make sure that we didn’t end up in the next great depression, because of the shutdown. And so that money should burning out there it’s coming in. And then secondly, there’s this pent up demand, some of us are, you know, hey, we’re sitting in our house, want to go do things, want to be able to spend on things, and maybe there’s a retail therapy that helps there? I know, for me, Amazon, you know, probably got a lot of my money. So, you know, just things to do. When you’re stuck at your house. You know, I did a lot of things around the house, for example. So we have that, right, we have this big spending, demand comes back, it comes back very quickly, because it’s super easy to pull out your credit card.
Easan Arulanantham:
Yeah, like I can go to Amazon swipe my credit card, but to make that production, when you shut down production, you’re you’re either laying off people, putting them on furlough, and ramping that back up and gain all the chain, every part. Everything moving back in order, again, is pretty hard. And when businesses during that pandemic, they didn’t know what’s going to happen. So they tried to cut as much expenses as they could just to stay afloat. And they didn’t realize that demand would have spotted spiral upwards again, and so they’re not ready for that. You saw that with lumber when everyone was no one thought lumber was going to be needed. Because we’re in a recession. No one’s building houses. But then everyone’s at home doing their remodels. And the lumber prices have skyrocketed.
Tom Vaughan:
Yeah, exactly right. So all of these things have been affected by the pandemic itself. And you got to realize how unique the situation is. And this to make your point, here’s a chart on employment, right, which is well behind the trend. So if you look, you know, prior to the pandemic, really smooth, again, a nice trend, I put in that red dotted line to show the trend continuing, you know, if it would have stayed on with no pandemic, massive number of job losses, 15 million jobs lost overnight, essentially. And, and now we’re climbing back up and we’re actually closing at a pretty fast rate, you can see that line coming up is pretty steep. But we’re not caught back up. And so it’s so much easier to order something than it is to get it set up. So restaurants reopened, great, everybody wants to go to a restaurant that’s easy to decide, I can do that. It’s very difficult for that restaurant who just let go of all their employees to then rehire, they got to interview and rehire and train and get back in. And then we had problems actually getting people that wanted to come back out to work. So a big chunk of people retired earlier than they might have, and other people had kids at home. And then some, in some situations, there was just people afraid of the virus, because a lot of the jobs that Re-opening And that were lost and tried to rehire, we’re facing public facing jobs. And so just as one example, and so you can’t produce as much services or products without humans. And so if you don’t have as much humans, you’re not going to have as much products or services. And if there’s still money chasing those, their price goes up, people still might pay that. And they have, right. I mean, we’ve seen this go on and on so far.
So even though prices have gone up, people are still buying, right. And so that’s what causes that price. But there is a potential here that things start to work their way out, right, that humans start to come back to work at the right rate to meet that there’s still there’s 11 point 3 million jobs open right now. So we still got a long ways to go. We got to get people back out to the to the workforce, but the job numbers have been really good recently, you know, 400,000 500,000 jobs a month being created, you know, we’ll catch back up to that line here, you know, possibly sometime this year, depending on what happens. And so that we need to get, you know, supply kind of matching this demand. There is another component, though, and the fact that demand probably starts to slow down, at least that growth curve. Yeah, if we go back to where we were here, so if we see that personal consumption, I wouldn’t be surprised to see that come back down to that red line at some point in the future for a couple of reasons. Number one, we’re no longer putting out big stimulus. There’s no childcare credits. There’s no you know, big infrastructure bills, build back better programs doesn’t seem like it’s happening. So there’s not a lot of new money coming from The government, you have a scenario where savings are starting to be burned off. Yeah. And we’ve got another scenario where the Federal Reserve is trying to slow things down. So far, they’ve only raised rates one quarter of a point. But they could. They, they’ve used their words to get rates to come up a lot. The 10 year Treasury went from a half percent to 2.8%. Mortgages went from maybe two and a half to 3%. And now 5%, that’s going to slow down demand. Yeah, no, because there’s going to be a situation that happens, where people just don’t have as much money to spend on all these things. The combination of demand coming down a little bit of supply coming up, some could get us back to a situation where at say, three and three to 4%, year over year inflation by the end of the year, all of those things that people are buying right now to high inflationary things would probably underperform the market in that timeframe, if that does happen. So I’m not positive what’s going to happen. But I don’t think a lot of people really have the full story about inflation, in terms of you know, how it could resolve itself, versus just running away for the rest of, you know, the next two years or something.
Easan Arulanantham:
Yeah, the Feds not gonna let inflation run away. If they let it run away, it just becomes a death spiral for them. And so you also also remember that the feds go and try and react, but there’s gonna be a lag period, inflation is a lagging indicator, it’s not going to be you’re not gonna see it instantaneously, they raise rates, and then, you know, everything comes back into par. Yeah, it’s gonna take some time, it does take some time.
Tom Vaughan:
Exactly right, so. So now, in terms of the portfolio, go the right direction here. This is our current 6040 60% bonds, 40% Sorry, 60% stock 40% bond portfolio. And I’ll go through this kind of piece at time because I think it’s important. If you look at two of the big blue pieces there. The first one is the Vanguard Total Stock Market Index, exchange, Traded Fund, ticker symbols VTI. That is the most diversified us exchange traded fund that I can find has 4,124 stocks in it, basically, almost all of the tradable stocks here in the US. And so the reason we have that is because we don’t know, we don’t know if inflation is going to run or stop. So we own all of it. We have the Large Cap, the micro cap, the Small Cap, the Mid Cap, we have everything. We have growth, we have value, we have financials, we have energy, right, we have all the pieces, it is driven more by the bigger stocks, but nonetheless, still we own everything. And then the second big blue piece, there’s the S&P 500 And that’s the vanguards VOO is the symbol for their exchange traded fund. Now we already own that in the previous piece, right? Because we own everything there. And what we’re doing is we’re concentrating some money into those companies, they have a great chance of handling this environment. If inflation goes up or doesn’t go up. These companies have loyalty, they have cashflow, they have earnings. And they are very, very popular in terms of a stock around the world, people try to buy the S&P 500 when they think about buying American stock. So those two pieces are very, very broad, very diversified. And I think they’re important to have in the portfolio in large quantities. And if you skip over to the two first green pieces here, the first one is the total bond market index from Vanguard.
Again, this is a very, very broad bond market index from Vanguards exchange traded fund that ticker symbols B and D. This has over 10,000 bonds in it. And again, inflation goes up, you can have trouble with treasuries and maybe better in some of the higher yielding corporate bonds that might be in there. If inflation goes down treasuries, you know, could stabilize and start doing quite well. So we’re not trying to guess with that we’ve got a majority of the bonds. And the one next to it is the iShares total US bond market, which is IUSB that has 13,000 bonds, so even more diversified. So if you look at those four big pieces at 66% of the portfolio. So this is what I’m afraid of when I read these articles, and somebody produces an article saying, here’s what you should buy for that your portfolio should look like this. It’s all the way over on the spectrum. It’s all inflation. I think that’s a mistake, only going to work if you happen to be right. And inflation continues to grow and grow and grow are going to be dead wrong if it doesn’t. And so keeping that monstrous diversification first for a majority of portfolio, that’s my first piece of advice. I think that’s super critical. Then we have in the blue there we have four little four 4% pieces. These are our target It index pieces. And these are things that I think could do well in this environment, and maybe even survive in multiple of different environments. So there’s a short term real estate piece, Microsoft and Apple and semiconductor. Those do well in inflationary environments, potentially they do well in non inflationary environments, you know, Apple, Microsoft have great loyalty, they can raise prices, and generally still keep their margins. And at least so far, they have huge cash positions, you know, those type of things. So I’m very interested in companies, I think, can survive or have huge demand, or have higher dividend or whatever it is, right. So that’s the targeted area that I change, depending on kind of what I think might happen. But even there, right now, I’m trying to stay pretty broad in concept. And then the last two pieces of sorry, last three pieces of the green are inflation related bond issues. So treasury inflation protected securities, which are treasuries that are issued, and their, their, their yield, their interest rates go up, as inflation goes up, keeps the price more stable, right, I’ve got two of those. And we have an interest rate, hedged high yield, which has actually been doing quite well versus the bond market. And so that’s our, you know, push towards inflation protection on the bonds portion of the portfolio. You know, again, we’ll have to make some adjustments to those if inflation doesn’t turn out to be an issue as things go. So that’s the mixture, what I would call surviving inflation, and how you want invest, please have a balanced approach to the thought process of whether inflation is going to be ramping up here for the next six to 18 months, because that’s what you’re investing for. Not now, it’s for the future. And then have some balance in the portfolio and make your you know, your your, your guesses your targets, you know, smaller and manageable, and even then try to keep them pretty broad. As far as that goes.
Easan Arulanantham:
Yeah, you never want to miss something. You know, too much of a good thing is can always turn out badly.
Tom Vaughan:
Yeah, exactly. I think 2020 was an interesting year, where things got really narrow, because so many things closed. And it’s probably the first year in my career where we got a bit more narrow, because kind of had to the broad market had so many pieces in it energy was down, airlines were down, you know, all the service industries for down hotels were down, you know, because they’re all closed for all intensive purposes. So, you know, this, though, is just a more like a normal year. Yes, we’re having some inflation. But this is the cause of, of this as a Re-opening. And normally in a recession, like we had for a couple months there after the great after the pandemic, you get the slow comeback and demand because people don’t have jobs. They don’t have money. This is totally different than government put out money and we got lots of openings. And people have savings. They didn’t spend as much for a while. And so a Re-opening is a totally different animal than a recovery. Right? And so I think you got to keep that in mind when you’re looking at inflation. Eventually the Re-opening kind of works its way out. Hopefully, this is more like what happened in World War Two at the end of World War Two right then it is what happened in the 70s and 80s.