Dear Sandbox Clients, Friends and Family,
2022 continues to be one of the most challenging investment environments in the past half century. Stock and bond markets have seen violent moves lower and there has been nowhere to hide. Even those holding cash are still losing significantly to inflation (“real return”).
- August YoY Inflation Rate = 8.30%
- Avg. Bank Savings Accts Rate = 0.13% *Sept 7 bank rate survey
- Avg. Bank Savings Accts Rate (inflation adjust) = -8.17%
We’ve maintained a cautious tone coming into the year but the velocity of the price swings and the persistence of record high inflation have everyone scratching their head. Our stance continues to be while inflation remains high, Central Banks and the U.S. Federal Reserve (“The Fed”) will need to aggressively hike interest rates to slow demand, to slow inflation, and all at the risk of an economic recession.
We have turned away new cash deposits for many existing clients, stressing the importance of holding larger than usual cash reserves in this environment, but we believe there may be a turning point coming soon, which we cover below.
- How we got here?
- Why do Higher Interest Rates Slow Inflation?
- Investment Account Changes in 2022
- Outlook & When do we Become Buyers?
How we got here?
U.S. Consumers have been blessed with low inflation for most of their adult lives. Over the prior 20 years, fiscal and monetary policies coupled with the supply chain bottlenecks from the pandemic and the war in Ukraine have created a far stickier inflationary environment than most had forecasted. A large imbalance in "Supply" vs. "Demand" will create a dramatic price change where the value of an asset can become extremely expensive or cheap. With short supply and high demand, we now have high inflation or higher prices.
Unfortunately, policy makers cannot immediately increase supply to help resolve inflation, this takes time… for example, there is a shortage of microchips impacting manufacturing of computers and automobiles. There is a shortage of homes for sale or rent (low inventory), a shortage for qualified labor to fill job openings, and the list goes on.
Why do Higher Interest Rates Slow Inflation?
The Fed’s strategy to slow inflation is to aggressively raise interest rates in their attempt to slow demand. If borrowing money is more expensive, then you have less borrowers (ie. Car Loans, Credit Cards, Mortgage Rates) because fewer consumers can afford, at higher rates and higher prices. If consumers also feel less wealthy because their investments are down, then they may be more frugal with their spending. If bank account balances decline because the cost of living increases (inflation) than all of this adds up to less demand, and the potential to see inflation soften. As a result, the Fed is aggressively hiking interest rates (see chart below).
Investment Account Changes in 2022
For investors, we raised cash balances earlier in the year. Hindsight is 20/20, we wish we had raised more, but few forecasted such a violent move in financial and investment assets. Remember that if returns on cash or investments are below the inflation rate, it creates a more expensive predicament. We continue to hold an overweight to cash, we have dramatically decreased bond exposure in lieu of cash and also reduced stock exposure, shifting current holdings from growth to value, leaned towards areas that can hold up with inflation (ie. Real estate, private investments) and began buying interest paying investments to generate some passive, investment income for portfolios.
READ: Get Paid Interest Rates of 2% to 13% *revised and updated on 9-23-2022
Note: While these changes were broadly applied, they may not be specific to each client account. Some clients may be holding larger cash or interest paying holdings based on client discussions, recent deposits or account consolidations. Please talk to your Sandbox Financial advisor for more specifics on your account.
Outlook & When Do We Become Buyers?
Inflation is still enemy #1 and until CPI + Core inflation numbers go lower, the Fed will remain aggressive, trying to slow demand. Hiking rates by 3% in the last 6 months is very aggressive monetary policy, and we have not seen the impact of these moves yet, in the real economy. The concern is policy makers are reactionary and there is the potential they oversteer the economy into a recession next year.
With the recent swoosh down in investment markets and the re-test of the June lows, the contrarian in us starts to become more optimistic. As Warren Buffett said, “be greedy when others are fearful” and we believe that market valuations are starting to approach levels, even with higher interest rates, will be great entry points for those with at least a few year time frame. We are not traders, we are not market timers and we don't know when or where the market will bottom. However, every recession, correction and bear market eventually ends and the path forward (or next business cycle) begins.
At Sandbox, or goal is to provide educated and rational investment guidance and management to align with your financial and lifestyle goals. At some point soon, we believe that we’ll have a great opportunity to deploy some of the cash raised earlier in the year, cash on the sidelines or cash in bank accounts into productive investments that generate income or future returns. Hang in there, this is not easy and we are here to talk anytime.