Bob’s Journal

Some Notable Events That Grabbed My Attention This Week

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Stocks and Inflation

Inflation is back in the headlines and worrying investors. So, it is a good time to review how stocks do in an inflationary environment.

There are different types of inflationary environments, and stock returns vary according to the environment.

Inflation could be coupled with strong economic growth. In those cases, stocks do well. But they only do well in the early stages of the inflationary period.

After a while, the inflation causes investors to reduce the valuations they’re willing to pay for stocks and worry about future earnings. Returns lag as the inflation cycle goes on, and the returns might not be high enough to offset the inflation.

There’s no solid pattern in how long it takes for returns from stocks to weaken in that environment. It depends on how long it takes investors to accept that inflation will continue and that they should pay less for stocks.

Sometimes inflation occurs when economic growth is low or negative. Stocks don’t do well in those environments at any stage of the inflation cycle.

Those are the results for the major stock indexes. There are sectors of the stock market, such as those related to materials and commodities, that tend to do well when inflation is rising, even when the broad indexes are faltering.

Today, we have strong growth with rising inflation. I expect the growth will continue until the Fed tightens monetary policy. So, we’re in the first type of inflation cycle.

But inflation has been building the last couple of years. In the last few weeks, the stock indexes faltered. The stocks that performed best over the last year have started to underperform the indexes. So, we could be in the phase of the inflation cycle when stock returns start to decline.

Whatever the inflationary environment, however, a basket of traditional inflation hedges performs much better than stocks.

We continue to own stocks in our portfolios but we also own inflation hedges such as gold, Treasury Inflation-Protected Securities (TIPS) and real estate investment trusts. It is possible that in the coming months, we’ll reduce our stock holdings.

The Rush to Retire

All the evidence isn’t in, but it’s clear that Americans accelerated their retirement plans during the pandemic.

In September 2020, about 3.2 million more baby boomers were retired than a year earlier, according to a Pew Research Center report. In each of the previous four years, the number of retirees increased on average by fewer than two million people annually.

About 2.7 million Americans who are age 55 or older said they are contemplating applying for Social Security benefits before full retirement age, according to a Census Bureau survey. Only 1.4 million in the survey said they planned to continue working to full retirement age.

The percentage of people who expect to work past age 67 declined to a record low, according to a New York Federal Reserve survey.

There are a number of reasons for the surge in earlier retirement, which reverses decades of a slowly rising average retirement age.

The pandemic caused many people to rethink their priorities. It also forced others out of the labor market.

Rapid increases in stock and home prices improved the financial position of many people, causing them to conclude they could afford to retire earlier.

Whatever the cause, it’s bad news for the Social Security retirement trust fund. We’re still waiting for the latest annual report from the program’s trustees, but it’s likely to show the trust fund will run out of money years earlier than estimated in last year’s report.

That could create problems for the big spending plans in Washington. The politicians might be told that they’ll have to start adding hundreds of billions of dollars to Social Security fewer than 10 years from now.

The move toward earlier retirements also could be bad news for retirees. They’ll face increased demand for all the goods and services they buy.

Housing in traditional retirement areas already surged in price over the last year, and the prices continue to increase.

The early retirements are a cause of the labor shortage many businesses face, and that is likely to become worse. Another loss to businesses is that the older workers who normally mentor and train newer employees are leaving the work force.

Perhaps some of these workers will come back to the work force as the economy improves or if the markets take a dive.

Data cited in The New York Times indicates that a lot of the early retirements were involuntary for those 64 and younger. They lost their jobs during the pandemic and might be interested in returning to work.

But for now, it looks like the average retirement age is decreasing, reversing a pattern of the last two decades when the average retirement age gradually increased.

The End of the Trading Floors

The CME Group, the successor to the Chicago Mercantile Exchange, recently said it would permanently close most of its floor trading operations in Chicago, also known as the open-outcry trading pits.

Many people received their first exposure to the trading pits in the movie Trading Places. Others saw these and other trading floors on the financial news cable channels.

Before technological advances, the trading floors and pits were the most efficient way to bring together buyers and sellers from across the world. Trading orders would be communicated to the authorized floor traders. The traders would execute the orders among themselves on the floors, usually putting their own capital at risk.

The major stock exchanges went primarily electronic some years ago. Few trades actually occur on the trading floors. Many stock trades, in fact, take place without involving the exchanges.

In the 1990s, I was able to visit the trading floor of the New York Stock Exchange (NYSE). That was when the floor was crowded with traders and their assistants. Some stayed near their posts while others rushed about. We had to crowd on to the floor and be careful to avoid getting in the way of those doing business.

The New York Stock Exchange wasn’t as much of an open-outcry market as the CME. Often, the floor traders agreed to transactions involving thousands of shares (or more) with just a few hand signals and head gestures.

The demise of floor exchanges makes transactions faster, less expensive and more transparent.

A downside, however, is that there aren’t market makers or similar functions. There is no entity ready to buy when there’s a surplus of sellers. Often, the traders could keep a floor under prices or slow the decline in prices in all but the most extreme circumstances. That was known as maintaining an orderly market.

Today, when a lot of people want to sell, the prices decline until they are low enough to attract some buyers.

The Data

Manufacturing growth decreased a little in New York, according to the Empire State Manufacturing Index.

The index was 24.3 in May, which is down a little from the all-time high of 26.3 in April.

Home builder confidence remained solid in May, according to the Housing Market Index from the National Association of Home Builders (NAHB). The index was 83 in May, unchanged from April.

Yet, housing starts declined in April by 9.5% from March’s level. Over 12 months, starts increased 67.3%. The 12-month increase is dramatic, because most of the industry basically was closed in March and April 2020 due to the pandemic.

Single-family home starts declined by 13% from March’s level.

It is likely that the recent decline in starts was caused primarily by the scarcity of building supplies. In addition, increases in the cost of materials and mortgage interest rates priced some first-time buyers out of the market.

New unemployment claims continue to decline. In the latest week, there were 473,000 new unemployment claims, down from 507,000 the previous week. For a little context, average weekly new claims were 218,000 in 2019.

The total number of people receiving some form of unemployment assistance is down by about three million to 16.9 million.

The Producer Price Index increased by 0.6% in April, about twice what economists expected. That makes the 12-month increase in the index 6.2%, the largest increase since the index was initiated in 2010.

The core index, excluding food, energy and trade services, increased 0.7% for the month and 4.6% over 12 months.

Retail sales were unchanged in April from March’s level. But March’s sales increase was revised upward to 10.7% from 9.7%.

Industrial Production increased 0.7% in April, while March’s jump was revised higher to 2.4% from 1.7%.

The manufacturing component climbed 0.4%, and March’s manufacturing increase was revised higher to 3.1% from 2.7%.

Consumer Sentiment for the first part of May, as measured by the University of Michigan, declined to 82.8 from 88.3.

Both the current conditions and expectations components of the index fell. Economists were expecting a modest increase.

Expectations of higher inflation increased substantially, and that was the main reason for the decline in confidence.

The Markets

The S&P 500 declined 0.55% for the week ended with Tuesday’s close. The Dow Jones Industrial Average lost 0.52%. The Russell 2000 gained 0.31%. The All-Country World Index (excluding U.S. stocks) rose 0.70% and emerging market equities nosed up 0.09%.

Long-term treasuries lost 0.44% for the week. Investment-grade bonds declined 0.07%. Treasury Inflation-Protected Securities (TIPS) added 0.25%. High-yield bonds fell 0.23%.

In the currency arena, the U.S. dollar declined 0.41%.

Energy-based commodities declined 1.28%. Broader-based commodities lost 1.09%. However, gold gained 1.60%.

Bob’s News & Updates

My latest book is “Where’s My Money: Secrets to Getting the Most out of Your Social Security.” It tells you clearly what your benefit options are in different situations and how to determine the best choice for you. You can find it on Amazon.com or Regnery.com.

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