Perception vs. Reality. Why Bonds are Not a Safe Haven

Advocates of formulaic investing along the lines of 60 percent stocks, 40 percent bonds are not doing so well these days. Year to date, bond indexes are down about 13 percent. This is the second consecutive year of negative returns from fixed income. While this may be better than the twenty percent decline in stock indexes, it is still shocking to those who advocate asset allocation as the be and end all of investment management. Over extended periods of time bonds have lower variability of returns. This has been translated by some as being less risky. Yet buying almost any debt of medium to long term in the face of rising interest rates seems a curious way to diversify. Higher interest rates mean loss of value for an instrument that pays periodically and returns principle at maturity. The longer the time to maturity, the greater the potential loss of value. While such losses in principle can be recouped if the bond is held to maturity, the purchasing power of the funds returned can be less than when they were invested. If one is invested in a bond, ETF or mutual fund, the participant has no control of a decision to sell the bonds in the portfolio, locking in the loss in the process. Should there be material redemptions from the bond fund, liquidating losses cannot be avoided. Ah, but you say that stocks, while posting higher returns over time, have higher variability of returns and thus must be riskier than bonds, correct? Not really. Stocks can raise dividends, which acts as an inflation hedge. They can buy back stock, which can improve the value of the remaining shares. The company they represent often can raise prices, which funds the rising dividends. Bonds, which are contractual obligations to repay money, typically have none of the features of stocks. Bonds have had a very well forty-year run since the days of Paul Volcker (1979). Then interest rates soared to over thirteen percent, to the post-2008 period, when interest rates came close to zero. Since companies benefitted from falling interest expenses favorably influencing corporate profits, stocks did well in tandem with bonds during this time frame. Bond investors also did well, as falling interest rates made older bonds worth more because they paid more than subsequent issues. The future will not look like the past. With soaring inflation world-wide, interest rates will rise until there is again a real (after inflation) cost to borrowing. While this may cause economic dislocation in the short run, the expectation of interest rates returning to their lows is wishful thinking. As other countries are swept along in the increasing cost of money, look for lower economic growth world- wide going forward. Add to this the loss of trust between countries caused in part by the pandemic, and a lot of the benefits of free trade become history. More recent investors see this as the end of an era. Those of more advanced age see a return to an earlier time. Six percent mortgages were common as recently as the 1990s. Even in the Great Depression of the 1930s, government bonds seldom went below four percent at issuance. As for international trade: the economic philosophy of comparative advantage, where each country would make what they were best at depended on a rational world. The image of such a world was destroyed by Russia’s invasion of Ukraine and China’s willingness to end relationships over Taiwan. Russia’s willingness to disrupt its principal exports of oil, gas and gold for territory shows how countries can subsume economic attainment for political influence. Both countries also found the creation of external threats a convenient distraction from the shortcomings of those in power. Neither of these events are economically rational, yet they do exist The next shoe to drop will probably be currency. As of now, the value of the US dollar relative to the currency of most other countries is strong, fueled by foreign investors buying dollars to acquire US dollar bonds with their high risk-adjusted interest rates. As other countries raise interest rates the US dollar should decline in value. A decline in the dollar would cheer on other nations who feel that it is US interest rates that are disrupting their own economies. If the US dollar does fall, it would have an immediate domestic inflationary impact which could prolong the elevated interest rates currently witnessed. Imports would cost more as they would require more US dollars to buy. The Economy Economic activity is slowing but not yet negative. Ironically, most of the layoffs in the economy to date are in the technology and management ranks. Economists are wondering if this will be the first white-collar recession. Blue collar jobs still have two openings for each applicant. Many companies are coping with sharply higher inventories as sales stalled out in May and June and have not resumed. Clothing vendors seem to be especially hard hit, as deep discounts are being required to move merchandise before it goes out of fashion. Supply chain issues seem to be getting a bit better. Ports are being streamlined to operate more productively. Inflation Inflation is slowly coming down. We are close to lapping the upsurge in prices of a year ago. Housing is a continued hot spot, as is transportation. The Federal Reserve has stated that they will keep raising interest rates until the cost of borrowing exceeds the inflation rate. Their goal is to reduce inflation to two percent per year. The consensus currently is for the Fed to raise interest rates to 4.4 percent and keep them there until sometime between late 2023 to 2025. Interest Rates To acknowledge that interest rates are going up is to state the obvious. The key issue is how high they will go and for how long. Assuming the goal is 4.4 percent, this could be attained by year end. How long it will be required to stay at this level is anyone’s guess. There is some speculation that a major event like a large bank failure or a currency crash would compel the Fed to relax interest rates earlier. It does not appear that many are banking on such a scenario. The Stock Market Stocks are undergoing a rotation. Shares of companies that have good prospects of raising dividends seem to be the best positioned. Companies in industries where competition is rising may have sub-par returns. This would seem to include most of technology. Going forward, the cash return component in the form of dividends will be critical to returns on stock investments. Stocks that do not pay a dividend will have a high bar to clear compared to the recent past. This also includes stocks that do not earn their dividend as it will be assumed that such dividends will be reduced or eliminated at some point.   Warren M. Barnett, CFA September 27, 2022   Statements made within the Perspective are those of the author and should not be considered as individual investment advice. For personal investment advice, please contact the firm at 423-756-0125 or This email address is being protected from spambots. You need JavaScript enabled to view it. to set up a meeting with one of our investment advisors.  Thank you!        
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What happens to stocks when interest rates rise? A historical pattern gives us a clue

End of an Era: Powell Channels Paul Volcker Like today, in 1979 the perception was that inflation was out of control.  The hapless administration of G. William Miller at the Federal Reserve had left its reputation for control of the purchasing power of the US Dollar in tatters.  Every time Miller would have the Fed increase interest rates (gradually, so as not to trigger a recession), the inflation rate would go higher.  Tourists going to Europe that summer were shocked to find that their American money was not wanted, such was the degree of fear in the inflation rate of the US being out of control.  The domestic currency was treated as in the category of a banana republic. In order to shore up the credibility of the Fed, then President Jimmy Carter appointed Paul Volcker as chairman of the Federal Reserve.  Volcker immediately abandoned his predecessor’s policy of “gradualism” in raising interest rates to have them go up by leaps to get ahead of inflation.  At one point the prime rate charged by banks to their best clients briefly reached 22 percent.  Such high interest rates effectively halted the inflation mindset that was gripping the country by making speculation in assets so expensive people did not buy beyond what they did not need.  While everyone was in agreement that interest rates would decline, no one knew when or by how much.   Today the country is in the grip of a similar sense of inflationary fever.  The events of the past thirteen years, when the Federal Reserve willingly and deliberately set interest rates below the inflation rate, brought a decade of prosperity at the expense of savers, who have received a pittance for their savings.  These meager returns on cash and equivalents drove millions of investors into the stock market who otherwise would not have.  It also provided the kindling for the current inflation fire the Fed is trying to put out. Jerome Powell, in his eight-minute speech at Jackson Hole, Wyoming last Friday, put the world on notice that business as usual would change.  Exactly how much would depend on the inflation rate going into 2023, but it appears the Fed will again use the inflation rate to benchmark the interest rate.   This has not been done for quite some time.   The instruments for raising interest rates will be both the interest rate set by the Federal Reserve to charge banks for funds as well as the liquidation of the Federal Reserves’ bond portfolio which now totals almost $9 trillion.  The vast majority of the portfolio’s holdings are government bonds and mortgage pass-through certificates.  By letting the interest and principal payments not be reinvested, it is estimated that the portfolio can be reduced by $200 billion per quarter.  The effect of not reinvesting the cash flows will be a contraction in the nation’s money supply. A branch of economics once headed by Milton Friedman believes that inflation is the result of too much money in circulation.  This branch of economics, called monetarism, believes that inflation follows the direction of the amount money in circulation with a thirteen-month lag.  If this is true, then inflation should begin to decline materially by next year.   The effect on investments from higher interest rates will likely be profound.  If money market fund rates were to return to the range of four to five percent, a significant source of public demand for stocks will be diverted to a safer and less volatile venue.  Such a rate would put pressure on banks to increase their loan rates to compensate for the rising interest rates on deposits.  All risk assets would be impacted, especially those which need low interest rates to generate returns.  Less liquid investments like private equity and venture capital will be under renewed scrutiny given a higher risk-free benchmark. Cash returns will likely become more prominent in investor’s thinking. This would adversely impact firms that need capital to expand and have no track record for repayment.   An inability to generate cash returns will be less tolerated.   Finally, this higher interest rate environment will impact the largest creditor of all, the US Government.  It is estimated that every one percent increase in interest eventually costs the Federal Budget $300 billion a year in higher outflows.  Lots of changes to go around. How does inflation effect businesses? So far, the economic data has largely not felt the impact of higher interest rates.  Increases thus far have been less that the inflation rate, being of little account. That is likely about to change.  Cyclical industries like housing and transportation are experiencing sharp contractions in demand.  Buyers are cancelling housing contracts, even if this means walking away from deposits, for fear of overpaying after the recent runup in prices.  Computer semiconductor chips have gone from shortage to surplus for many applications. Retailers are grappling with ballooning inventory that needs to be moved before becoming stale.   Causes and effects of inflation Inflation for the past several months has been the product of supply chain disruptions caused chiefly by the lockdowns in China. Energy inflation from the war in Ukraine. Domestic stimulus from the administration’s efforts to prevent the country from stalling out during our own Covid lockdown. Of these three factors, only domestic stimulus has been eliminated going forward.  Energy demand, especially for natural gas, is focused to be higher going forward.  China has yet to formally change its Covid policy of disrupting entire cities and regions to prevent its spread. Finally, it has to be acknowledged that inflation is a world-wide phenomenon.  While people tend to treat inflation locally, it is actually in this instance an international problem.  It may thus require an international solution. Interest rates. What’s next? Interest rates are due to go up.  How much depends on the trajectory of inflation which in turn depends on international events and the response of other countries.  Should US interest rates rise too much they will attract funds from other countries, complicating their own economies. Relationship between interest rates and stock prices A higher inflation environment will put growth stocks under even more pressure, which is to say their declines since last summer are set to accelerate. The sharp correction of last Friday will probably have further to go.  Out of it shall come a new upturn based on cash returns and the ability to increase dividends going forward. Energy, especially natural gas, has been a bright spot.  Pharmaceuticals have also been strong, with firms with specific strategies being the eventual winners. The chief question for investors is whether current holdings should be held to the next market upturn, added to, or eliminated.  Bear in mind that fewer than one in five leaders of a given market survive to lead the next strong market.  Those invested in packaged products like index funds in effect have the market making their investment decisions for them.   Warren M. Barnett, CFA August 29, 2022     Statements made within the Perspective are those of the author and should not be considered as individual investment advice. For personal investment advice, please contact the firm at 423-756-0125 or This email address is being protected from spambots. You need JavaScript enabled to view it. to set up a meeting with one of our investment advisors.  Thank you!
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Oil Refinery Economics: How a Shortage of Refineries Cause an Increase In Gas Prices

Economics 101 - Law of Supply and Demand: legislating oil refineries decreases supply With the exception of a small refinery launched in North Dakota in 2014, no new oil refineries have been built in the United States since 1976. In 1972, Richard Nixon formed the Environmental Protection Agency (EPA), charged with restoring the environment to its "original pristine state." As oil refineries are material polluters, the EPA did not take kindly to their existence. As a result, oil refining joined a list of any number of industries that exported their pollution by building plants abroad and taking factory jobs with them.  While the usual reason for outsourcing was cheaper labor, often such rationale was an excuse to escape American environmental laws. For the average company, direct labor costs come to less than five percent of the cost of production. Factors such as cost of transportation, inputs, taxes, and environmental regulation are usually far more significant factors in the price of producing an item. These elements of refinery economics have a huge impact on what we pay for gas. Marry this with the NIMBY (Not in my backyard) movement, and you have an impetus not to build oil refineries in America.  Oil companies have spent the past half-century increasing the efficiency of existing plants because of local opposition to new facilities. This increase can only go so far on the limited amount of land. In 2019, the oil industry shut down about five percent of domestic refining capacity as demand fell off a cliff in the early days of COVID. Most of the closings were among smaller refineries lacking economies of scale to be as efficient as the larger facilities. That capacity is probably gone forever.  Economics 201 – Finding equilibrium: A decrease in refineries’ supply leads to an increase in price The truth is that restarting a refinery is not easy and takes a good bit of time and money. Any crude oil left in the pipelines turns into sludge after a while. Restarting a refinery requires that most pipes be dismantled, cleaned out, and reassembled. In addition, there is the matter of finding workers to staff the facility, most of whom have retired with the shutdown. Petroleum engineers are highly skilled and not easy to come by.  The position of the Federal Government on this issue is, at best, inconsistent. It can best be described as someone trying to drive with a foot on the accelerator and the brake simultaneously. On the one hand, the President accuses "big oil" of profiteering by letting prices get too high and threatens the industry with an excess profits tax in the manner of Jimmy Carter in an earlier era. On the other hand, the government wants the industry to spend more to expand production (including refining production), including building the refineries that the EPA likes to cite.  The fact of the matter is that, with a few exceptions, all net new refining capacity in the world has been concentrated in four countries: China, India, Russia, and Saudi Arabia. Russia is off limits due to Ukraine, and India's capacity is almost entirely spoken for by its own economic growth. Saudi Arabia's new refining projects are only now coming on stream. Output has primarily been earmarked for Europe to replace Russian jet fuel and diesel. China has excess capacity due to its COVID lockdowns. It would perhaps be asking too much to expect them to help an American administration that cites them for human rights violations every chance it gets.   Then there is the government's love affair with electric vehicles (EV). There is not only a lack of electrical capacity but also a grid system to deliver the electricity where it needs to go; the government promotes the EV as the car of the future. The total vehicle market is mature. EV will need to take market share from gasoline and diesel vehicles to succeed. A new refinery requires forecasting profits 15-20 years out. How can an oil executive do so when the government actively promotes the industry's demise with tax credits for EV purchases?  A final note: LyondellBasell Industries operates one of the country's largest refineries in Houston, Texas. They have announced they would like to exit the refining business, buying feedstocks from others rather than making the raw materials themselves. The problem is that no buyers have come forward. The company has announced that they will shut the refinery down if they have no buyer by the end of 2023. LyondellBasell makes about two percent of the gasoline refined in the United States.   The Economy: Two key factors for recession Economic activity has remained strong as a shrinking workforce continues to meet strong demand in most areas. Unemployment has stayed stable, and wage growth has proceeded apace. Thus, two recession factors, increasing unemployment, and falling wages are not present.  Both residential and non-residential construction is due to expand. Housing has not seen the present demand gap since the end of World War II. Infrastructure is expected to get a boost from Federal Programs. Auto productions need to accommodate almost two years of pent-up demand due to the semiconductor chip shortage. Any demand decline won’t be until 2023, if that.  Inflation: What is affected by inflation  Inflation continues to be skewed to food and medical care, which fall most on the lower economic classes. The good news is that we are close to lapping the increases of the past year. Once this is done and inflation no longer continues at its original trajectory, we should see a decline in the inflation rate. My best guess at this point is three to four percent year over year by the fourth quarter.  For all the complaints about inflation, much of the effect of prices of imports has been blunted by the strength of the dollar relative to foreign currencies. As it takes more Euro, Pound, etc., to acquire a given number of US dollars, domestic buyers are rewarded with better prices than previously. Just ask any tourist traveling to Europe. This also means countries with weaker currencies must pay more for dollars than previously. This is one of the causes of domestic unrest in many parts of the world.  Interest Rates: All inflation isn’t bad Interest rates are destined to go higher. This is due to establishing an interest rate higher than the forecast inflation rate of 4-5 percent.   High-interest rates are also needed to continue to attract foreign funds into the US to maintain a strong dollar. If the dollar were to fall, the US would effectively be importing other countries' inflation.    The Stock Market: It’s a waiting game As usual, the market is being pulled in several directions. On the one hand, the strength of the domestic economy would argue for its appreciation. Offsetting this is the fact that not all stocks that were bid up in the last upswing have come back to earth. The cryptocurrency mania is also a mitigating factor and will continue to be so until it flames out. Companies in need of borrowing funds to expand are especially vulnerable.  Price corrections have, in some cases, been pronounced. So long as you do not need to sell, you can wait and pick up bargains while waiting for more rational minds to assert themselves.   Warren M. Barnett, CFA July 26, 2022     Statements made within the Perspective are those of the author and should not be considered as individual investment advice. For personal investment advice, please contact the firm at 423-756-0125 or This email address is being protected from spambots. You need JavaScript enabled to view it. to set up a meeting with one of our investment advisors.  Thank you!
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Market Decline Accelerates: How to Find the Bottom

Market Decline Accelerates: How to Find the Bottom At this writing, the Standard & Poor’s 500 Index is down 16.8 percent year-to-date.  Within this fact, several stocks have gone down less and some have gone down a great deal more. For those who would rather invest in the future than the present, an analysis of the sectors that look to be leaders in the next upswing is in order. First, some insights into what has done worse than the overall index.  As usual in most stock market retrenchments, stocks with the highest price/earnings (P/E) ratios have as a group gone down the most.  The so-called FANG stocks (Facebook [now Meta], Apple, Netflix, and Google [Alphabet]) have all gone down more than the overall market.  This is somewhat logical, as they all went up more than the market in the last upswing. In a market characterized by high appreciation, it is easy to insist that valuations do not matter and point to the returns of the favored few as evidence.  Alas, there is a difference between momentum and what is being obtained for the price paid.  The stock market is one of the few places where people want more of something that is going up in price and less of what is falling in price.  From this breakdown in logic, all sorts of investors’ losses flow. The second source of investor losses is not knowing one’s investment time frame.  Even those who “time the market” by getting out at higher prices have to decide when to get back in.  If this is done in a personal account, capital gains taxes accrue.  While there is no disgrace in paying taxes, there is a problem in switching in and out of the same stock in an effort to scalp a few points of gains.  Even if this is done in a tax-deferred account, the transaction costs can eat the portfolio up. So, if an investor’s portfolio is constructed of stocks and bonds that the investor understands and is comfortable with for some longer term, the remaining issue is where to invest new funds or proceeds from sales.  In a falling market, the additional issue is when. Market bottoms are only known in retrospect.  A strong day can be followed by a weak one.  Still, there are things to consider, such as the number of stocks making 52-week highs compared to similar lows. A market is considered “recovering” when the number of advancing issues is greater than declining issues for several consecutive days. For recent investors, the only material decline experienced was in 2020.  At that time, the market plunged over 30 percent in four months, only to reverse and be up for the year. This time, the odds of a quick snap back are lower, with rising interest rates, higher energy prices, and inflation present.  This would suggest the recovery in stock prices will be more protracted. This is an environment that favors value stocks.  Companies that have strong balance sheets, dividends, and high cash flow would seem to do best in this market.  Higher interest rates alone will prove stiff competition to growth concepts; the ability to find firms that can deliver in a slow growth/high labor cost situation (which will probably be the norm for some time) will be key. The cost and availability of labor is of special note.  Aging demographics, immigration contraction, and greater use of part-time workers will all impact workers’ pay and productivity for most companies.  This will be less of a trend and more of a regression to the mean.  Labor costs have been abnormally low for a number of years.  A return to average labor factors relative to revenue will likely suppress the bulge in profit margins for many companies but this will be a return to historical averages. Many investors see the Federal Reserve as the bad guy here.  However, with inflation rampant, something had to be done to reduce demand; normally, this is what raising interest rates does.  One can debate whether the Fed should have acted earlier, but it was evident it had to act sometime.  For the past decade, low interest rates, generous credit terms, and low inflation was the norm.  The non-existent returns on cash forced many into the stock market who would rather not be there.  As this trend reverses, expect some to go back to money market funds, reducing demand for stocks in the process. The current economy is notable for the increase in the demand for services like vacations, flying, meals, etc., but also for the decline in demand for goods purchased through retailers.  After three years of Covid-19, individuals want to do things.  Most of what goods they need they have already purchased.  There are some exceptions, as some goods have not been available due to shipping constraints, but this is slowly loosening up.  When markets stop going straight up, one realizes it is a market of stocks and not a stock market.  One should invest accordingly. The Economy Many people are judging economic activity by corporate profits.   A better criterion would be corporate sales.  While inflation reduces consumers’ purchasing power, wage increases restore it.  Consumers as a group have strong balance sheets and good cash flow, especially the lower wage earners to whom most of the wage increases have been awarded.  Looking ahead, it would appear that there is a business slowdown but no recession at this time.  Much will depend on external events like the war in Ukraine with its international repercussions.  Inflation Inflation is expected to level off going forward.  Much will depend on the cost of energy and better shipping from the Far East.  As we lap last year, the inflation rate is expected to fall to four percent or less.   Prices are not expected to retreat, but will not keep rising at the rate of the past year. Interest Rates One of the few ways the government can regulate demand is in the pricing and availability of credit.  For this reason, expect interest rates to continue to rise and the terms of credit to tighten. Some previous credit candidates will be rejected. The Stock Market The stock market is entering a period of re-valuation, as higher interest rates and tightened credit can be expected to both limit growth of companies as well as compress the P/E ratios of the same.  Prior to the last ten years, about 40 percent of a stock’s return was in the form of dividends.  After a period in which dividends were an afterthought, it seems they are receiving more consideration again.  Warren M. Barnett, CFA May 26, 2022  Barnett & Company is a fee-only registered investment advisory firm registered with the U.S. Securities & Exchange Commission working with the investment and financial planning needs of individuals and organizations.  For a brochure on the company and its available services, please contact Elizabeth at 423-756-0125 or This email address is being protected from spambots. You need JavaScript enabled to view it.. 
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What Happens When Markets Fluctuate: Maintaining Balance While Others Are Not

After the cascading decline of year-to-date, the market indexes are down 10 percent in terms of the Dow Jones Industrial Averages, 13 percent for the Standard & Poor’s 500, and 23 percent for the NASDAQ Over-the-Counter Market.  Relatively recent market participants ask the question: what is going on? What is going on is the ebb and flow of a liquid market whose overall value is based on the most recent transaction. This is hard for some to grasp.  If there were, say, 100 million shares of a firm’s stock outstanding, and the most recent trade is down a dollar from the previous day, the firm’s market value declines by a hundred million dollars.  If we further assume that one million shares were traded that day, then the million shares traded imposes its value on the 99 million that did not.  If this sounds crazy, add a second point: some people take market values seriously.  In fact, some people even assume that the value imposed by the market is always “right”.   If a stock that sold last summer for $100 is now $50 per share, there must be rational reasons for it being so; same for the stock that was $50 last summer and is now $100.  If this were not so, the prices would not have moved.   Out of this line of thinking we have the concept of markets as “efficient” in the sense that they reflect all data about a security at that point in time.  Last week’s performance of Netflix was especially insightful.  The stock fell 20 percent in a day due to reporting its first negative subscriber growth in a decade.  The stock, which had been selling for $700 a share as recently as last fall, can now be had for $204.  When Netflix was $700 a share, its Price/Earnings ratio (P/E for short) was about 70.  It is now about 20.  The ratio for the overall market is 17.  A stock with a P/E ratio over four times the overall market should grow four times faster than the overall market, not just this year but every year thereafter.  Netflix’s revenues are projected to be $35 billion this year, up around 10 percent. Four times overall growth was not to be.  Earnings growth estimates for this year for the overall market are about 15 percent.  Netflix’s earnings would have to gain 60+ percent to justify its December price – hard to do when revenues are growing 10 percent per year. Netflix was one of the FAANG stocks, which were “disruptors” who would justify their price by relegating old line companies to the dust bin of history.  Of the others– Metaverse (nee Facebook), Amazon, Apple, and Alphabet (nee Google)—only Apple has not collapsed, and it almost always had the lowest P/E ratio of the group.  Like all hot concepts, the FAANG stocks fed on cheap and easy money.  Covid-19 further helped them, as they catered to those who were trying to minimize social interaction.  As Covid-19 subsided, people returned to their more social ways.  In the case of Netflix, the number of streaming services increased faster than the population demanding them.  As inflation caused cutbacks among customers needing funds for more basic items, some streaming services were cut back.  Netflix evidently was among them.  The impact of FAANG stocks on some index funds this past decade has been material.  An S&P Index fund could hold as much as 20 percent of its assets in these five companies.  This was not a judgment call.  The stocks comprised 20 percent of the relevant universe, so the computers that were programmed to mimic the indexes bought.  Now that the stocks make up a smaller share of the market, index funds are buying less.  This only accelerates their decline.  What was once a virtuous circle of outperformance leading to greater purchases by indexes becomes a vicious circle as fewer investment dollars go to the stocks that had gone down more than the index. All this suggests that what we are witnessing is not so much a large-scale decline in stocks as a temporary changing of leadership.  A sector like energy, which disappointed investors as recently as 2019, is up 57 percent in the last year.  Consumer staples are up almost 11 percent.  Utilities are up 7.6 percent.  History teaches us that the leadership in one market stands a less than one-in-five chance of leading the next upwards move.  As interest rates rise there will be more pressure for companies to both pay and increase dividends.  Technology companies, due to their internal demands for capital, are not well suited for this environment. As for markets being “efficient”: tell that to the Netflix investor who purchased stock at $700/share last year.  What markets measure is the popularity of an investment, usually in the context of some investment concept.  Like fashion, popularity in stocks change.  The trick is to research and know what is being bought so that your stock does not wind up on the remainder table.  The Economy There is a school of thought that posits that every recession begins with a stock market decline.  While that may be true, not every stock market decline results in a recession.  This fact causes all kinds of confusion among investors.  Many head for the exits when they should be taking a look at other sectors. There is still over $1 trillion in savings from Covid-19 that has not been spent.  As the environment becomes more normal, expect large scale demand for vacation spending and all the things done pre-Covid-19 that have not been done thereafter.  International travel is still a bit problematic, but domestic holidays will be in strong demand.  In a similar vein, the slow but sure increases in the supplying of semiconductor chips to manufacturing will help the sales of everything from cars to gadgets.  Average prices should come down, as makers will have enough chips to build lower cost versions of what is being sold now. Interest Rates Interest rates are continuing to climb.  As rates get over the inflation rate, expect them to moderate and level off. Interest rates above the inflation rate will reward savers for the first time in over a decade. This is important, as the economic recovery has been carried on the backs of savers who received little or nothing for their savings.  There are rumors afoot of a 75-basis point increase in Federal Reserve rate in June and July.  This is hard to contemplate, especially with the bond buying program also set to reverse.  It could be the rumor was started to make a 50-basis point increase seem moderate by comparison. Inflation Inflation is set to moderate.  Currently running over 7 percent, it is expected to moderate to 3 to 4 percent by year’s end.  While still high by recent standards, it is less of a factor than previously.  Factors driving inflation are the cost of housing, weather-related food inflation, and challenges in getting imported goods delivered.  Some of these factors will get better, others will have to wait until 2023 to be addressed.  At some point inflation will reduce demand in the categories it affects.  The Stock Market Stocks in general are having a rough go of it.  This is the result of changing internal dynamics, as previously stated.  Once new leadership is established the market should again find its footing. The question is: how fast will the market recover and what will its projected trajectory be like?  Given its rich valuation, we could see several years of low overall returns while different sectors jockey for leadership.  This will emphasize stocks and sectors over a broad index.  An index fund will let you buy the market.  The question is, do you want to? Warren M. Barnett, CFA April 27, 2022 Barnett & Company is a fee-only registered investment advisory firm registered with the U.S. Securities & Exchange Commission working with the investment and financial planning needs of individuals and organizations.  For a brochure on the company and its available services, please contact Elizabeth at 423-756-0125 or This email address is being protected from spambots. You need JavaScript enabled to view it.. 
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1938 Redux: Who Will Gain And Lose From Ukraine

Someone once wrote, “History does not repeat itself, but it does rhyme.”  The current Russian invasion of Ukraine has been compared to the 1938 German invasion of Czechoslovakia.  Like Nazi Germany, Russia made a series of escalating demands on Ukraine and used their lack of compliance as a pretext for invading the country.  The key difference is that the Ukrainians have risen up to fight the Russians, whereas the Czech government was intimidated into acquiescing by a combination of Nazi bellicosity and intimidation of its allies.  It was here that Neville Chamberlain, the Prime Minister of Great Britain, went before the media waving a paper and boasting of securing “peace in our time.”  That peace would last for a year.  The Ukrainian conflict is entering its sixth week.  Russian progress has been blunted at great cost.  Both sides are committing to sending in both material and soldiers, sometimes in the form of mercenaries.  How long this will go on is anyone’s guess. Given its pariah status, Russia cannot win even if it prevails militarily.  Most of the rest of the world has severed ties with the country. The architect of the conflict, Vladimir Putin, risks being arrested as a war criminal if he leaves his borders.  His dream of a Russian Empire is out of step with the 21st Century.  Nowadays countries control one another through trade and access to technology. Which brings us to the chief winner of this conflict: China.  China has proclaimed that it will not stop trading with Russia.  This means that oil and material exports will move from Russia to China.  On one hand, this should be a zero-sum game.  Oil bought by the Chinese from Russia replaces oil imported from other countries.  On the other hand, China will now reduce oil purchases from the middle east, who will now presumably sell to Europe.  Grain purchased from Brazil and the US will now come from Russia, and so on.  Natural gas, which Russia exported to western Europe, will now be replaced by Liquified Natural Gas (LNG) from the US and other countries. European dependence on Russian energy was advocated by Angela Merkel, the former Chancellor of Germany.  The idea was that by buying oil and gas from Russia, the country would prosper and become closer to its market.  This thinking is classic economics; the problem is that it disregards political intentions. By the time the rose-colored glasses came off, the dependency was established.  China, being Russia’s only trading partner of any size, will be able to ask for steep discounts from world prices for the commodities it purchases.  Over time, this will reduce Russia to a vassal state of China, or as diplomats put it, a “junior partner”.  China will provide Russia with its only source of technology.  Over time, such technology will make Russia even more dependent on China economically. While China is smart enough to let Russia continue to exist as its own country, Chinese influence over them will only grow over time.  Having been cut off from export markets for oil, gas, steel and aluminum, Russia is at the mercy of whomever will trade with it. In addition to China, only India has expressed any interest in supporting the country with trade.  Smaller states like Venezuela and Cuba show support but given their size such support is more symbolic than real.  The next commodity issue is going to be the materials necessary for car battery production for Electric Vehicles (EVs).  Cobalt is a critical material found mostly in China and Russia, along with the Congo in Africa. China has been busy buying up cobalt mines as a way to corner the market in the material, forcing buyers to pay whatever it wants.  It is a similar story with lithium and other earth resources.  China, through an international public works program called the belt and road initiative, has been constructing a land route from China to Europe.  It has financed this through the foreign exchange acquired by the US’s trade deficit.  It is billed as a modern- day version of the silk road that existed to send tea and spices to western Europe in the Middle Ages.  China’s goal is to make the countries that take its loans to build infrastructure literally in its debt.  As with Russia, China understands the influence of money to a country lacking the same. China is a clear winner here.  NATO and the western alliances are at best hoping for a removal of Russia from Ukraine.  Given Russia’s capacity for nuclear weapons, such is the best that can be expected.  A change in leadership from Putin may or may not prove helpful.  In a dictatorship, there is no clear line of succession.  If time goes by, perhaps China will have some say. This may not prove to be to the West’s advantage.  The Economy Economic activity continues apace. Lower income people are being whipsawed by energy and housing prices, including rising rents, while more affluent consumers are flummoxed by the extent of demand and lack of supply. By one estimate, there is a deficit of five million housing units in this country.  Most of that is in the lower income bracket.  To build affordable housing here requires a smaller lot size. A neighborhood of craftsman or shotgun style houses can be built on quarter acre lots. The typical suburban development requires a minimum one acre lots by zoning.  Since zoning is set locally, it does not respond to federal programs; thus, the limited influence economic policy has on housing. Economic forecasting calls for a decline in growth to three percent this year and two percent next year.  None of the forecasts have been adjusted for the disruptions caused by the cessation of trade with Russia.  Items like steel, wheat, corn, barley, and aluminum are all up due to the lack of supply out of Russia.  Inflation The sharp rise in gasoline prices has upended the middle class, as cuts elsewhere have to compensate for greater energy costs.  The rising cost of diesel and aviation fuel has made inflation a broader occurrence.  Couple this with the irregular ability of most vendors to deliver, and things are very chaotic in terms of pricing of goods. Since these shortages are the result of supply disruptions rather than demand growth, it would seem that normalizing supply would cause inflation to recede.  The problem is that supply has been disrupted by one thing or another since the pandemic first hit.  It does not seem that supply will normalize anytime soon.  The forecast is for four percent inflation this year and three percent next year.  This should be considered the minimum expectation.   January saw a new high in home prices.  Until supply catches up with demand, expect this to continue.  Interest Rates With inflation showing no signs of ebbing, interest rates are rising to match the environment.  Home mortgage rates are now over four percent for the first time in almost four years.  While some investments are still showing positive returns net of inflation, low-risk investments like government bonds are not showing positive returns at this time. The Stock Market The market overall looks to be neutral.  The median stock has a Price/Earnings ratio of 17, in line with historical averages. Two trends may disrupt this.  As interest rates rise, the overall market’s PE ratio tends to decline.  Second, there have been to date few if any revisions for the write-offs that will have to be taken by companies withdrawing from Russia.  McDonalds walked away from 850 stores in Russia, most of which were company owned.  Other companies made similar abandonment of assets.  The ensuing write-downs of earnings (asset impairments are charged against earnings) may materially reduce the earnings of companies with Russian exposure.  The aircraft leasing sector is very vulnerable to write-offs.  Because of the danger of seizure, Putin has decreed that all leased planes cannot be flown out of Russia.  This has resulted in what one industry publication calls “Putin’s Great Plane Robbery”.  Putin has said Russia will pay for the planes but has not specified the price.  Warren M. Barnett, CFA March 31, 2022 Barnett & Company is a fee-only registered investment advisory firm registered with the U.S. Securities & Exchange Commission working with the investment and financial planning needs of individuals and organizations.  For a brochure on the company and its available services, please contact Elizabeth at 423-756-0125 or This email address is being protected from spambots. You need JavaScript enabled to view it.. 
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Ukraine, Russian, And The End Of Free Trade

As this is written, the invasion of Ukraine continues to evolve.  While talks are scheduled, there is little hope of a diplomatic solution. A product of the Ukraine war waged by Russia is an international condemnation of the conduct of the Russian government in general and of its head, Vladimir Putin, in particular.  A number of sanctions have been levied by the Western European states and the US against Russia and its leaders and benefactors.  The sum total is to make the transfer of financial assets more difficult between Russia and abroad.  It also makes Russian exports more difficult to purchase.  Travel by certain Russians is also restricted. These barriers, while on only one country (albeit the largest country in the world by land mass), come as the ability to do business in Hong Kong is imperiled by decrees issued by China.  The EU is placing limits on the conduct of American social media companies to operate in Europe; further, airlines are having to reroute planes to avoid Russian airspace after Russian carriers lost the right to land in any number of foreign airports.  Taken as a whole, these incidents point to a trend where international trade is being made either more expensive or not available.  This has led to a scramble as companies try to find alternative sources of supply.  International trade is becoming more expensive and less reliable than even three years ago.  While Covid-19 did disrupt trade in 2019-21, the current changes in the terms of trade have nothing to do with the pandemic.  There is now a palpable level of corporate distrust in the ability of foreign sources to deliver goods or materials free of government interference.  Most businesses feel that they can plan around a change in public health, as there is an assumption that things will return to normal.  Changes in government decrees are a different matter.  The easiest way for a firm to address these issues is to move all production to their host country for assembly; however, this will result in higher prices.  The original premise of free foreign trade was the economic argument of “comparative advantage”.  This idea is that each country makes what it is best at making, passing the savings on to other countries so that all can benefit.  Tariffs, which raised the price of imports, were considered a tax on consumers as it made goods more expensive to assemble. Page Two Sanctions are considered even more disruptive than tariffs, as they make output from the sanctioned countries more expensive by being no longer accessible at any price. This requires alternative sourcing.  In the case of Russia, most of their exports consist of energy and other industrial and agricultural commodities.    These actions represent a reversal of the free trade movement that began at the end of World War II.  In 1945, a group of financial heads of state met in Bretton Woods, New Hampshire.  Out of the meeting came a framework for lowering tariffs to expand free trade throughout the world.  The idea was that if two countries had commercial relations then they would be less likely to jeopardize the same with an armed conflict. Putin’s conduct effectively ended this assumption.  In his effort to bring the former Warsaw Pact countries back into the orbit of Russia and re-create the USSR in the process, Putin has gambled that Russia could maintain trade ties even in the face of its belligerent conduct. Most of the rest of the world has called his hand on this, and this leads us to the current situation. China seems to be the only major country to maintain trade ties with Russia.  China and Russia share a common border, and Russia has agreed to supply China with oil and gas. This relationship is expected to deepen as both countries have totalitarian governments.  Should the relationship strengthen, western countries operating in China will be pressured to leave. A world of more expensive trade will be inflationary for all involved. Such higher prices will slow down economic growth.  It will also be a world more polarized internationally, as countries limit sports ties and cultural travel among nations.  This is expected to go on so long as the current leadership in Russia and China continue to exist.  Barring the unforeseen, this could be a long time. Of particular note are the deposits of materials in both countries necessary for the production of electric vehicles.   Cobalt, rare earths, lithium, etc., are all needed to create the batteries for EV use. Most of the known reserves are in China and Russia.  It will be interesting to see if such materials are available and at what price. Page Three The Economy The disruption of Ukraine production could be a supply chain shock as great as was Covid-19.  Many crucial components for autos are made in Ukraine.  About 20 percent of the world’s wheat is grown in Ukraine, as well as barley and other farm products.  Of great concern is Ukraine’s output of neon, which is used in the production of semiconductors.  Neon is a gas which is a byproduct of the production of steel.  The situation in Ukraine is still fluid.  However, should Ukraine fall to Russia, there would likely be significant disruptions to the world economy.  Interest Rates There is a group of investors that believe that interest rates will impact the economy and stock market more than Ukraine will.  Given the events of the past few days, that may be debatable. The official line is that interest rates will go up by either .25 or .50 in March.  If the events in Ukraine prevail, that schedule may be overtaken by events.  This is especially true if the US Federal Reserve is required to pump money into the international economy to offset Russian payments, which may not be made due to the conflict. Inflation Inflation will probably be revised up with the events in Ukraine.  Gasoline prices will probably stay elevated, and companies are becoming increasingly aggressive in raising prices. Page Four The biggest brake on inflation is the prospect that, at some point, demand will contract in the face of higher prices.  This will happen sooner if the Federal Reserve raises interest rates next month.  The Stock Market Stocks have proved the truism that it is the unknown rather than the foreseeable that often moves markets. While the US is not expected to be directly impacted by the events in Ukraine, the supply chain disruptions are not to be ignored.  With elections slated for November, it is expected that increasing stock market volatility will be a way of life.  Warren M. Barnett, CFA February 28, 2022 Barnett & Company is a fee-only registered investment advisory firm registered with the U.S. Securities & Exchange Commission working with the investment and financial planning needs of individuals and organizations.  For a brochure on the company and its available services, please contact Elizabeth at 423-756-0125 or This email address is being protected from spambots. You need JavaScript enabled to view it.. 
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So Long 60/40: How Circumstances Can Get In The Way Of Recipe Investing

So Long 60/40: How Circumstances Can Get in the Way Of Recipe Investing For at least 60 years, it has been an article of faith to invest one’s assets along the lines of 60 percent stocks, 40 percent bonds.  This formula was originally coined by the Ford Foundation; they advocated the allocation to endowments and large charities who previously had invested only in bonds.  The idea was that the stocks would provide rising dividends, which would preserve the purchasing power of the portfolio, while the bond portion would provide stability to the values of the total investments.  In effect, the two categories were to offset each other.  The performance of financial markets, both in this country and abroad, so far this year points to an unsettling uniformity of performance.  Bonds have gone down in value with the talk of increasing interest rates by the US Federal Reserve and their equivalent in other nations. Bonds with the longest duration (i.e., longest time to maturity) have declined the most in value. At the same time, stock indexes have declined with the indexes representing the longest duration stocks (i.e., highest price/earnings ratios) going down the most.  Since these two categories are supposed to offset each other in order to reduce the portfolio’s fluctuation (technically known as reducing volatility by holding non-correlated assets), their declining in unison is not a good thing. Ditto for the declines occurring world-wide, which blows a hole in the risk reduction that is supposed to come about from international investing.    The reason for the uniformity of the declines is that low interest rates helped support both asset classes.  Reversing low rates has caused both categories to take on water.  As interest rates are expected to increase for some time to a level far higher than now, stocks and bonds as asset classes are both expected to be under pressure.  There is not much bonds can do to escape the carnage that awaits them.  All bonds are essentially contracts to pay money, usually every six months, then the principal at maturity. It is hard to distinguish between debt.  One bond does not pay in greener dollars than another. Bonds are sometimes categorized by default risk, with riskier bonds paying relatively more in interest than less risky issues.  With years of low interest rates, the return between more- and less- risky bonds have compressed to the point where almost no bond issue pays more than inflation at any level of risk. Most bonds pay a lot less.  This is in contrast to 1980, when government agency bonds paid interest in the range of 16 percent, while inflation was trending down from 13 percent.  So if stocks and bonds as a group are slated for less than projected returns for the next decade, where are the assets that, as asset allocators like to say, do not correlate in terms of their returns? Enter the rabbit hole of alternative asset classes. To salvage asset allocation, enter alternative assets.  As the name would suggest, “alterative assets” covers a broad spectrum, including commodities, real estate, collectibles, hedge funds, and private equity (to name a few).  The common thread is that all these investments are not very liquid; this means that they are not bought and sold with the regularity of stocks or bonds, and thus the cost of buying and selling is far higher in terms of transaction costs, assuming a transaction can be arranged. If not traded often, how are such assets valued?  Usually by appraisal.  The accuracy of such appraisals varies, and they are usually no match for an actual transaction.  Then there is the matter of selling to raise funds should such be necessary.  It can take a long time to find a buyer for an illiquid asset at a price quoted by appraisal. What is the solution? For income, conservative value stocks with strong and rising dividends to offset inflation can address the need for cash flow.  Smaller companies that can grow and be taken over can assist in preserving the purchasing power of one’s holdings.  Both categories are volatile, but volatility is not necessarily risk.  Sufficient cash should be set aside for funds needed in the short term with this approach.  For smaller portfolios, there are ETFs that can represent these areas.  Investors with larger asset positions can purchase the same investments directly and avoid the expense of packaged financial products.  Investors with very large sums of money, like endowments and foundations, can best invest a portion in alternatives directly because they can, through their sheer size, acquire assets whole at lower cost as well as have the staff to oversee the investments.  Either way, it is important to acknowledge that the past is not prologue for the future.  As Dorothy once said, “…we’re not in Kansas anymore.”  An asset allocation formula that was adopted 60 years ago when inflation was trending down will not work when inflation and interest rates are trending up.  Choosing investment assets is a different matter than choosing asset categories.  Categories is the role of an asset allocator.  Investing is the matter for portfolio management.  Woe to the person who confuses the two.  The Economy The economy, while strong, continues to gear down from last year as the stimulus funds make their way through the financial system.  Economic growth in 2021 was 5.7 percent after inflation.  This year it is expected to be about three percent, and down to two percent in 2023. The greatest economic variable is Ukraine.   If Russia chooses to invade, the economic upheaval in Europe, Russia, and the US will be material.  The price of oil and other commodities will likely go through the roof given the supply disruption expected from such a conflict.  Much of Europe is dependent on Russia for natural gas.  For the last twenty years, Germany has been dismantling its nuclear program with no strategic alternative power source.  On the other hand, Russia will become insolvent quickly without the sale of oil and gas and the foreign exchange it provides.  The Russian people are not enamored of fighting in Ukraine, but Russia is not a democracy.  It will be interesting to see how this plays out.  Interest Rates Interest rates are rising.  The question is how much. The projected time rates officially rise seems to be in March, when the Federal Reserve meets.  As usual, there is a parlor game of how much interest rates will be increased.  Right now, the betting is between three and five quarter-point increases.  Much will depend on the economy and its ability to absorb such increases without sliding into a recession.  Of less focus but perhaps greater impact is the decision to begin reducing the government’s bond portfolio.  Such a reduction would serve to take money out of circulation, in theory reducing inflationary pressure in the process.  As the amount of bonds held is about $9 trillion, a reduction of $200 billion per quarter for about ten years would be enough to eliminate this prior source of stimulus.  As many of the bonds are made up of mortgages, the government may be able to reach this target by simply letting the bonds mature and not purchase new bonds with the proceeds. Inflation Everyone seems to have a story of higher prices.  Such pricing pressure, brought about by demand for goods, seems to be a world-wide phenomenon.  Like the economy, the course of inflation in the short-term hinges largely on Ukraine and the Russian decision whether or not to invade.  If a decision is made to invade, the disruption of supplies of energy and commodities will be felt all over the world.  On the other hand, a reduction in tensions between Russia and Ukraine would lead to some reduction in European energy prices and the price of other materials as well.  Labor shortages are also international in scope.  Demographics are changing in most parts of the world as populations get older and fewer children are raised.  This is expected to become a more embedded source of inflation going forward. The Stock Market While overall indexes have declined, there are companies and industries that excel in this environment.  Firms that pay dividends, cater to the general public, and are not overvalued are the drivers of the current market.  Stocks of those who are richly valued, pay no dividends, and need years of earnings growth as far as the eye can see to justify their current prices are at best going to tread water going forward. Warren M. Barnett, CFA February 1, 2022 Barnett & Company is a fee-only registered investment advisory firm registered with the U.S. Securities & Exchange Commission working with the investment and financial planning needs of individuals and organizations.  For a brochure on the company and its available services, please contact Elizabeth at 423-756-0125 or This email address is being protected from spambots. You need JavaScript enabled to view it.. 
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Forecasting 2022: The Road Steepens

The New Year will bring all sorts of changes.  A stock market floating on cheap money and excess funds will learn to float with less or capsize in the process.  Many speculative enterprises like cryptocurrencies, electric vehicles and the like will face a time of testing.  Not all will survive.  Inflation will become both more entrenched and more of a source of concern.  Interest rates are slated to rise but will need to rise more than forecast to rein in inflation. The Economy At this time, the American economy is slated to rise around 4 percent in 2022, net of inflation.  This will be down from an estimated 6 percent for 2021, but ahead of the 2-3 percent rate the economy is expected to fall back to in 2023.  2-3 percent is considered “normal” economic growth for an economy of the size and maturity of the United States. Most forecasts for 2022 are front-loaded, meaning the bulk of the growth will occur in the first two quarters.  This is due to the waning effects of the various stimulus programs launched by the Federal Government to shore up the economy during the Covid-19 pandemic.  If the pending round of stimulus is rejected by Congress, expect the economic deceleration to occur sooner than would otherwise be the case.  Even if passed, the economy will slow down in 2023 as the effects of no population growth impacts domestic demand.  The sectors most likely to expand in 2022 are those related to health care and infrastructure.  Health care is driven by demographics, while infrastructure benefits from the government programs already passed as well as potential future programs. The most vulnerable sectors are those who find themselves left out of the current economic environment.  Office-based firms are grappling with surplus space, given the number of workers who continue to ply their trade from home.  Passenger transportation is struggling as people become fickle and price-sensitive about travel and up to half of business trips are probably gone for good.  While movie theaters are falling behind, even their streaming replacements are having a problem as more outlets compete for the same audience. Ancillary leisure businesses like hotels and restaurants will also feel the pinch.  Restaurants on the surface have bounced back, but higher menu prices may translate into fewer customers.  Staffing is a major issue, with many who once worked in food service the most personally knowledgeable about the fatal nature of Covid-19. Inflation A tight labor market is the surest precursor of inflation.  While logistical bottlenecks will get better in 2022, supply chains are not the biggest inflation worry.  Finding qualified workers at a cost that still provides a profit is an ongoing battle.  Unless matters like childcare are addressed, there is little reason to believe things will get better. In this regard, larger companies who can spread the cost of labor, including benefits, over a larger volume of business have an edge over smaller firms.  Smaller firms can often offer a better work environment and sense of affiliation.  With inflation so much of an issue, these advantages may become less enhancing. The biggest driver of inflation currently is the cost of housing.  Those with houses have benefitted from the appreciation of real estate.  Those who do not own a house have not.  This accounts for why more turnover is evident in the lower end of the job market than the higher end.  In some cases, the cost of housing is close to 50 percent of a lower wage family’s income.  This is not sustainable. There is another aspect of inflation that most do not yet talk about: this is the expectation of more inflation in the future.  Inflation expectations are important.  They serve to make workers demand a certain rate of pay increase for inflation that does not yet exist.  By doing so, future inflation becomes more manifest. The Federal Reserve has done a dismal job of convincing the public that the current inflation is “transitory” as they once put it.  As inflation stays at the current level, the Fed’s credibility will be further reduced.  Their signaling of three interest rate hikes in 2022, along with tapering bond purchases, may be inadequate to the task.  The key question is whether the Fed has it in them to get ahead of inflation or if, by lagging, they will make it worse.  Already businesses are moving away from just-in-time inventory, where inputs are minimized, to keeping more inventory in stock.  While this was done originally to address the effects of supply chain disruptions, businesses are earning inventory profits on what they are holding.  This is being passed on the form of higher prices.  When holding assets earn more than holding cash, all bets are off for price increases.  Interest Rates Interest rates and the availability of funds are the two most obvious ways the Federal Reserve directs the economy.  Back in the days of Alan Greenspan, the Fed would cut interest rates to counter declines in stock market levels.  This strategy took on an additional impetus in 2008 when Ben Bernanke was Fed Chair.  He believed that prodigious quantities of cash pumped into the economy was the best way to avoid another Great Depression.  Jerome Powell has continued this approach with interest rates now below the rate of inflation and cash being pumped into the economy by way of bond purchases that now total some $8 trillion.  More recently, Powell has indicated he will begin to taper off the bond purchases which will have the effect of taking about $300 billion in cash out of the economy.  He has also signaled a desire to raise interest rates, although a timeframe is not yet known.  In this regard, Powell is trying to avoid the mistake of the last taper in 2018.  At that time, the stock market fell 20 percent in two months, until the Fed reversed itself in January of 2019.  More recently, the economic trauma of the Covid-19 epidemic again caused the Fed to provide abundant funds and close to zero interest rates.  The issue is how to raise rates to combat inflation without killing off the economy.  In a less complicated time, the chief job of the Federal Reserve was to control inflation.  More recently, the Fed has been tasked with the job of providing full employment.  In some ways, the additional mandate conflicts with the original one.  Full employment is usually inflationary.  Less than full employment is not.  Only during the Trump administration were the two goals met in tandem.  This is attributed to an abundance of imports, which kept domestic inflation down as other countries wanted US dollars.  Currently, inflation is world-wide, as those same exporting countries grapple with the effects of labor shortages of their own, and Covid-19 compromises the output of many areas lacking adequate vaccination supplies.  Add to the mix supply chain stresses and what was a steady source of non-inflationary goods disappears.  For 2022, look for the Fed to tighten in an effort to reduce inflation and regain its credibility.  If inflation is not contained, a Paul Volcker approach of rapid increases above the inflation rate to tame not just inflation but inflation expectations will be warranted.  Look for inflation to be around four percent officially, perhaps more for those who rent. The Stock Market Higher interest rates and more restricted lending are the enemies of inflated equity prices.  However, even the overall market can contain elements of appreciation if one knows where to look. The most vulnerable sectors of the stock market are those that are the most overvalued.  Large technology firms that may have good prospects but have gotten ahead of themselves in terms of price is an obvious example.  Some of these companies have aided the appreciation of index funds in years past.  As an index is carried by fewer names, it becomes less of an index and more of a potential trap, at least in terms of appreciation. Most people forget that index funds came into prominence around the time of the last market upturn in 2009.  They have not experienced a full market cycle in terms of a decline of any duration.  The investment issue is this: if index funds decline and stay down for a period of time, will investors sell them to go on to other things, or will they stay the course until the next upturn? Market strength should be found in health care, some home builders, infrastructure, and other special situations.  Markets that move sideways or decline are more the province of individual issues rather than packaged investment products.  For those who have sufficient funds to construct a portfolio, the results can be gratifying over time.  We at Barnett & Company wish a safe, happy, and prosperous New Year to you and yours! Warren M. Barnett, CFA December 30, 2021 Barnett & Company is a fee-only registered investment advisory firm registered with the Securities & Exchange Commission working with the investment and financial planning needs of individuals and organizations.  For a brochure on the company and its available services, please contact Elizabeth at 423-756-0125 or This email address is being protected from spambots. You need JavaScript enabled to view it.. 
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