As we enter a new year, Peter Mallouk and Jonathan Clements discuss what risks could await investors in the year ahead – inflation, market volatility, and overconfidence – and why having an investment plan that’s based on your needs is key to weathering the unknown. Plus, they offer a reminder to proactively monitor your portfolio taxes and identify opportunities to harvest losses throughout the year.
Listen to Peter’s and Jonathan’s recap of 2021: https://creativeplanning.com/education/podcast/episode-33-the-financial-lessons-of-2021/
Learn more about tax-loss harvesting: https://creativeplanning.com/education/article/explainer-video-tax-loss-harvesting/
Hosted by Creative Planning Director of Financial Education, Jonathan Clements, and President, Peter Mallouk, this podcast takes a closer look into topics that affect investors. Included are in-depth discussions on financial planning issues, the economy and the markets. Plus, you won’t want to miss each of their monthly tips!
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Jonathan Clements: Hi, this is Jonathan Clements, Director of Financial Education for Creative Planning in Overland Park, Kansas. With me is Peter Mallouk, President of the firm, and we are Down the Middle. Another year is in the books. Stocks are up, bonds are down, inflation rose, the Fed reversed course, and cryptocurrencies did pretty much everything imaginable.
Along the way we all expanded our financial vocabulary, adding phrases like meme stock, SPAC, and non-fungible token (NFT). So what does 2022 hold? Here at Creative Planning, we aren’t in the prediction business. We are in the business of managing risk. Today’s topic: What risks await investors in the year ahead? Today’s topic number one: inflation. The last report for the Consumer Price Index put it at 6.8% for the past 12 months. Peter, for investors in stocks and bonds, how big a risk is inflation? And who do you think it’s a bigger issue for: bond investors or stock investors?
Peter Mallouk: What’s interesting, [Thomas] Hoenig was with the Federal Reserve, actually out of Kansas City, had a very long article about his thoughts around this in USA Today last week. It was fairly ominous. He really views the Fed as having really overreached with the way it flooded the system with money and lowered rates far longer than he felt was necessary. The point of the Fed is to interfere, to manipulate the economy, to help propel us out of problems so that we have modest inflation. They want there to be modest inflation, around 2%, and they want there to be full employment, meaning most people are working, 96% of people are working.
Well, we have those things, yet we still have very intense spending at very, very low rates. His concern is as they begin to unwind this, and as they begin to do things to take money out of the system and raise rates, that the bubble won’t lightly diffuse, instead it may pop. There are people on the other side that think that doesn’t matter what the Fed does, that there’s so much technological innovation controlling prices. People being replaced by artificial intelligence in many ways that it kind of doesn’t matter what the Fed does. The answer is no one knows; we’ve never done this before. We’ve never had a situation with this much spending coupled with this low of rates, which is why you have very diverse opinions.
We have a couple facts. We know that when you keep interest rates very low, it inflates asset values because if interest rates are low, the same monthly payment, you can pay more for a house. You can pay more for a business. You can pay more for commercial real estate. We also know when there’s more money chasing the same amount of things, prices go up. So we know what the Fed is doing is inflationary, there’s no question about that. We know with technology and innovation that that does control inflation somewhat. If everybody needs to have a higher wage, but some of those people are replaced by artificial intelligence whether it’s in the finance industry or McDonald’s, it does put a control on prices. What we don’t have is the perfect recipe of how these two things work together. This is brand new. The only thing we can expect is… as we have been, to be surprised and for it to be very, very bumpy.
And this is why, as we talk about predictions today, it should always come back to the investor’s plan. That’s what we’re going to end today with, because no matter how much conviction you hear people talk about both sides of this; to me, conviction means you don’t really know the issue very well because it’s just got too many variables.
Jonathan: So, when we think about bond investors and inflation, and we know every increase in the inflation rate is a pure loss for bond investors. If you’re getting $10,000 in interest every year and inflation rises 5% or 6%, that’s a dead loss and you’re not going to make that money back. For stock investors, it’s more uncertain. We don’t know how stock investors will react to the inflation that we have in the year ahead in these steps that the Fed has taken. The Fed is told us what it’s going to do. It is told us it’s going to taper bond purchases. It’s told us that there will be increases in short-term interest rates. So if somebody believes the market is reasonably efficient, I would assume that the market has already priced this in, but maybe not. What do you think, Peter?
Peter: I think the market’s priced in both sides of this issue, but we don’t have clarity yet. So I think the way to think about this is, let’s assume that there was a very high probability risk of, of an attack. The market would price it in, but every hour that goes by the odds go up or down of the attack until eventually one happens or doesn’t happen. The market’s not perfectly efficient until the very last second. Right? So I think that the bond market and the stock market are telling us different things. The stock market’s saying, “Hey, look, prices are going up