Dr. David Kelly returned to the quarterly education meeting of the Financial Planning Association in Orange County. For those who don’t know him, he’s an Irish born (how could you know that with the name Kelly) economist who’s worked with JP Morgan for over a decade.
He is an old friend who does a great job describing the world in simple terms, and today I earned an hour of CFP® continuing education credits to listen to him illustrate current realities. He uses some charts from the industry-leading “Guide to the Markets”, but I’m just going to talk a bit about what he said, in my own words.
But from notes I took during his talk.
First up, the virus and vaccines. The recent dramatic declines in new cases, from over 200,000 per day to about 65,000 daily is substantial indication that we’re much closer to the end of the pandemic than the beginning. We can see the light at the end of the tunnel, so to speak.
When we emerge from that tunnel, and the world opens up again, massive pent-up demand is likely to drive the economy at near historic levels. There’s likely to be some reluctance of individuals to “get back to normal,” but the industries whose employees that got run over by the pandemic will be able to get back on the train and unemployment is likely to fall at record pace.
He’s hopeful we see the percent unemployed drop below the historic averages by the end of this year and rivaling pre-pandemic numbers as soon as the end of next year.
That’s great news because that means all those people can get back into productive roles.
But don’t expect that influx of labor and pent-up demand to overheat the economy. Instead, expect a slow-growing economy, much like we had during the recovery following the financial crisis. It was easily the most lackluster expansion in our history, and demographics combined with immigration policies aren’t likely to improve the growth rate.
That’s because our population isn’t growing, and with stagnant population growth, economic expansion must rely exclusively on productivity gains of the existing workforce. We’ve just seen the impact of pandemic productivity propulsion, my version of the PPP. Even retired baby-boomers previously reluctant to do zoom meetings are now seeing their doctors online. That wouldn’t happen without my PPP.
Next up, the vast stimulus. The government put five times more into the economy for the pandemic than it did for the financial crisis. That’s huge!
And it isn’t going to be inflationary, because there are no productivity-crunching bottlenecks. Floods of money don’t create inflation, just the conditions to allow for inflation. There needs to be a bottleneck in an important supply chain item, like the gas shocks in the 1970s, which impact a wide swath of the population.
Our limited labor force could become the inflationary trigger, but for every American unwilling to work an entry-level position there are at least two alternatives: technology or immigration. And that only assumes the work cannot be pushed off-shore. Through the internet, businesses of all sizes can employ skilled workers online at a fraction of the cost and headaches of hiring locally.
So don’t expect high inflation to strike anytime soon.
But also don’t think that mild, normal inflation rates aren’t important to your financial plans. Even at long-run average inflation of 3%, costs double in 24 years. That’s roughly the length of a typical retirement.
Dr. Kelly turned to one of his fabled stories to describe FED policy.
Imagine we’re in a drag racer, and the stimulus is the race itself. We’ve covered the ¼ mile in about 14 seconds. Now we have to slow the stimulus without destroying the economy. We need a parachute. That’s the trick.
The FED is continuing to buy bonds, keeping interest rates as low for as long as possible. If rates climb rapidly, the Federal budget hits a wall of exponentially growing interest costs. Metaphorically, the car hurtles into the wall at the end of the racetrack.
The parachute is defined by how well the FED signals and implements its eventual scaling back of bond purchases, allowing the markets to determine interest rates.
In the meantime, bond investors are hard-pressed to find yield in traditional places. And, as all bond investors should know, when interest rates rise, the value of bonds they already own falls.
So, that’s probably the biggest known risk to investors, today. That the FED parachute doesn’t safely slow the stimulus.
But there’s always another risk which could appear at the next crossroad. No one ever sees it. Like the drunk driver running a red light, T-boning the unfortunate, innocent, law-abiding driver pulling into the intersection after waiting patiently for the signal to go.
We call those events “black swans” after the 2007 book The Black Swan by Nassim Nicholas Taleb. Black swans are extremely rare and thought mythical until discovered in Western Australia in the 17th century. Recent such events include the pandemic, the sub-prime mortgage crisis, and the attacks of 9/11.
In Kelly’s words, it’s possible to hedge against known risks, but for black swans, diversification is an important defense while staying invested.
He mixes in another metaphor for opportunity seekers: lots of babies will get thrown out with the bathwater, and I agree with his opinion that active managers stand a better chance than passive investors to find those gems.
Now I’ve got to figure out why the CFP Board hasn’t yet given me that one hour of continuing ed credit. I’ve seen the mandatory two hours for ethics post already, but this class preceded the ethics session.
You getting a taste for all we go through to provide wise council?
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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
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