ONE FOR THE TEXTBOOKS (OF THE FUTURE)

Although our retirement fund is managed professionally, I still fret over how it is positioned on an overall aggressive/defensive basis even though it appears to be well-hedged and conservative. My major concern is that IF/WHEN interest rates start to rise again, as they certainly will at some point in the future (a 100 percent safe bet), the market value of those holdings will decline. It’s an arithmetic thing, not a guess. At the same time, as interest rates begin to rise and become more attractive to investors, money may well shift into interest-bearing debt securities and out of the stock market, thereby leading to lower stock values. I’ve oversimplified, but there is some truth in what I say, that if/when rates start to rise the interest-bearing debt in our portfolio will decline in value and so will the stocks. Not happy thoughts. Pulling everything out of the market and putting it under our pillows is not the solution, but the purpose of this essay is not to discuss portfolio management practices, even though portfolio management strategies are especially important at this point in the business/economic cycle. No, today’s topic arises from the fact I cannot remember another period in my lifetime when there were so many major countervailing forces at work within our economy. It is not at all clear to me how interest rates, stock prices, employment rates, housing prices and other variables will behave over the next two years in response to this tug-of-war among so many countervailing forces working their way through the American and global economies. Yet at breakfast this morning with a friend/former student of mine, I was struck by a statement he made, which I would paraphrase this way: Everyone seems to be waiting around for something to happen, not sure what it will be, but quite sure something “big” is going to happen. It’s an almost surreal or eerie feeling. My objective in this essay, therefore, is to lay out ten major trends I see going on, many of which have implications that conflict with one or more of the other trends, and to ask you to share your thoughts about them with me. If something “big” is going to happen, I expect it will be related to if not directly or indirectly caused by one or more of these ten trends. If I receive enough feedback, I will publish readers’ (anonymous) responses on this topic in another essay this month. Please understand that any discussion of generalized trends in the U.S./global economies necessarily involves over-simplifications. Here are the ten trends I see as having significance for my future economic health and most likely for yours as well. My numbering sequence is not meant to suggest the rank ordering of the importance of these trends. They all are potentially important. 1. COVID-19 remains a negative force clouding the economic outlook 2. Omicron, Delta and other present and future variants of COVID-19 are potential major threats to economic activity in the U.S. and globally 3. With interest rates remaining near historic lows, the Federal Reserve seems to be in an analytical quandary regarding whether, and if so, when, to initiate decidedly more restrictive monetary policies in order to begin raising interest rates more than minimally and slowing the acceleration of consumer and producer prices. At this point they seem past talking the talk. They are now walking the walk, but with tentative strides suggesting to me they are not in a hurry to launch a full-throttle restrictive monetary policy strategy. 4. Several trillion dollars of new Federal Government spending approved by the U.S. Congress in recent years promise to continue pumping large sums into the U.S. economy, stimulating additional spending on a multiplier basis and pushing up prices, especially while the next trend (#5) persists 5. Supply chain problems are substantial, are not likely to be resolved in the near future, and continue to wreak havoc on the availability of a wide range of consumer and business products, contributing importantly to supply shortages and rising prices at the consumer and producer levels alike. I can only imagine one or more ships floating off Long Beach, CA, anxiously waiting to offload their precious cargo, to be shipped directly to Costco’s across the nation, so that we can again buy more than one package of toilet paper at a time.! 6. For reasons* not entirely clear, the U.S. economy is facing serious labor shortages in many areas, resulting in sizable increases in wage and salary levels. Interest rates and/or price levels increase as well as decrease because they are subject to the ups and downs of economic cycles. Wages and salaries are sticky, however. Once increased, they tend to stay higher. Even if a cycle turns down and incomes/revenues decline, labor costs most likely will not decline. The net result will be a reduction in jobs and/or employers’ profitability. 7. Substantial restraints on travel and entertainment in recent years, coupled with reduced spending on items like commuting, dry cleaning, meals away from homes, etc., due to the pandemic leading people to work from home, have boosted consumer net incomes, liquidity and confidence 8. Bitcoin and a host of other cryptocurrencies continue to expand their reach and acceptability in financial markets and cannot be ignored. Though I fail to see their legitimate benefits, their common sense-defying growth rates suggest they are heading toward either world dominance or global collapse, both being unacceptable results. If there were a way to isolate these markets so that their end games could not harm mainstream financial markets, I would be much less concerned. Unfortunately, I am not aware of any campaigns to isolate cryptocurrencies 9. Facing sustained low interest rates on debt securities, which are not attractive options, many investors favor the stock market and have pushed stock indices to record high levels. Money pouring into stock investments reaffirms the apparent wisdom of investing in equities versus debt. But the bloom may be falling off this stock market rose. 10. Low interest rates (borrowing costs), high stock market prices and profits, strengthening wages and salaries and highly expansive Federal Government fiscal policies (spending programs) contributed to a frothy housing market with consumers bidding above asking prices and rental rates rising relatively rapidly. Trying to draw credible conclusions from these countervailing forces with any degree of confidence is a monumental challenge. But I am not Chairman of the Federal Reserve Board of Governors. That’s Jay Powell’s responsibility. He and his colleagues have access to the most comprehensive and up-to-date information available anywhere in the world. My best guess is Chairman Powell and his colleagues at the Fed are not at all convinced of the “right” monetary policy strategy to pursue, one appropriate to the economic and financial uncertainties foreseeable in 2022 and 2023. Consequently, they are going to err on the side of caution and have begun to raise interest rates and withdraw liquidity from the financial system on a gradual basis. My back-up expectation (guess) is that the Fed will continue to bump along being relatively accommodative, allowing interest rates to stay in a relatively narrow range at or only slightly above where they are today, until some of these clouds lift and allow for a clearer view of the economic landscape ahead. My least likely scenario would be the Fed resuming expansive monetary policy, pushing interest rates back down to new historic lows and boosting consumer and business liquidity. Those days are over. If you want to assign probabilities to these three possible Federal Reserve strategy forecasts: my best guess (moderately restrictive, 70 percent), back-up guess (accommodative, 29 percent) or least likely, (expansive, 1 percent) monetary policy strategies. In all the years I’ve studied economics and finance on a formal basis, at Loras College, Washington University and the University of Michigan, I don’t recall analyzing the effects of pandemics with virulent variants of a killer nature. Nor do I believe we studied the effects of logjams of ships outside California harbors, unable to be offloaded with imports into the U.S. and reloaded with exports for the rest of the world. Artificial restraints on petroleum supplies by producer nations from time to time? Sure, political risks are part of any formal risk analysis. But supply chain problems of the sorts going on today? Not so much. Academic studies of supply chain issues are relatively recent, like in the last 20 -25 years, which is still “new” in the context of long-term trends in the U.S. economy. Yet until the pandemic and its variants, and supply chain bottlenecks, get resolved, the economic and financial outlook is likely to remain extremely cloudy, which translated, means full of uncertainty. Which is the basis for my expectation the Fed will err on the side of caution, snugging up interest rates, and reducing some of the excess liquidity in the economy while trying to wait out resolution of the negative effects of the pandemic and supply chain bottlenecks. Today’s situation is historically unique and, therefore, genuinely intriguing. It truly is one for the textbooks (of the future). If you have read this far, you’ve earned my most sincere respect. In return, I’d like to have earned your response to my thoughts. Please consider sending me your overall views of what’s going on today and whether or not you think my trends analysis holds water or is nothing much other than a leaky bucket! END OF ESSAY *A friend familiar with minimum wage and similar jobs offered this explanation for labor shortages in those markets. People to aspire to two major purchases in life, an automobile and a home. Automobile (and fuel) and home prices in CA have had price increases so large that even by working two full time jobs many cannot afford a new, or recently new, car or home. In recent years, new cars have come with increasing arrays of expensive add-ons, making them unaffordable for growing numbers of families. So too with homes built in recent years, most of which include what formerly were upgrades as basic elements of the house’s today, at higher costs. For housing and cars, it actually is worse, cost-wise, because Federal, state and local legislation and regulations are adding substantial sums to the cost of developing even entry-level housing and more basic models of automobiles. If I were working two full-time jobs only to see my ability to buy either a nice car or nice house diminish because their costs were rising faster than my income, I too might want to walk away from the job market.