Congratulations to Jim Stack — the money manager's Stack Financial Management was just ranked #38 on Barron's 2020 list of "Top 100" Independent Financial Advisors. Meanwhile, here's a look at some recent commentary from his InvesTech Research newsletter.
The Federal Reserve’s renewed pledge to keep the monetary spigots open has increased both investor enthusiasm and speculation. And market sensitivity to this overly aggressive Fed policy has become evident in today’s volatility – particularly in the tech-laden Nasdaq Index.
Inflation has been historically low over the past decade, as technological advancement and high debt levels have soaked up a lot of otherwise productive capital like a deflationary sponge. So why even worry about inflation today?
Inflationary forces have shown broad reemergence in recent months. Yet, at its Jackson Hole Economic Policy Symposium last month, the Fed took a bold step in giving inflation a longer leash. The Fed will now seek to achieve an inflation rate that “averages” 2.0% over time — allowing inflation to run hotter than 2.0% if it balances out a period of lower inflation.
This means that in the future the Fed will not be as quick to raise rates to keep inflation and a hot labor market in check. This important change was approved unanimously and FOMC members have quickly fallen into line to now tolerate inflation well above 2.0%.
By signaling its willingness to allow inflation to rise above the level at which they would have previously taken action, the Fed is effectively attempting to ease policy further. However, history shows that giving inflation more room to run is a dangerous proposition, and the Fed should be careful what it wishes for.
So let’s see where inflation stands today — the economic shutdown earlier this year in response to the COVID-19 pandemic caused the rate of inflation to drop like a rock; however, the monetary response to the crisis could be highly inflationary.
Inflation, as measured by the Core Consumer Price Index (CPI), remains low on an absolute basis (year-over-year) at 1.7%. However, this Index just experienced its largest two-month increase since 1991.
Consequently, monthly releases are starting to make headlines. It is important to note that the CPI appears to have bottomed much sooner relative to the past two recessions, and it is starting its rebound from a higher base.
Time will tell if this is a sustainable rise in inflation or simply a bounce from a very depressed level. However, the Fed’s recent actions compel us to keep a close eye on inflation at a time when many investors are looking the other way.
The risk of inflation has increased significantly with the Fed’s unprecedented response to the pandemic, and the Central Bank opened the door wider to an inflation scare with their most recent policy change.
In addition to the fiscal and monetary stimulus, disruptions caused by the pandemic are unleashing pockets of inflation in our economy, and this could continue if supply/demand imbalances persist or exacerbate.
There is a serious risk in the Fed giving inflation a longer leash. For now, they are willing to tolerate increased inflation risk in an attempt to keep interest rates lower for longer and achieve a nominal growth target.
We question if everyone else will be as tolerant, given that true inflation experienced by most Americans is higher than what is measured by decision-makers today.
Regardless, we are vigilantly watching inflation as it lurks behind the scenes and believe it will be imperative to continue protecting your portfolio from an inflationary outcome in the current environment.
Despite the underlying risks and pockets of speculation in stocks, there are reasons to give this bull market the benefit of doubt. The tailwinds provided by the Fed’s quantitative easing policies are undeniable.
Although current monetary policy puts us in uncharted waters and raises risks going forward, there’s truth to the saying “Don’t fight the Fed.”
Bottom line, there are opportunities to invest in this bull market, but it is important to maintain a safety-first approach. To make your portfolio more defensive, stock investors should consider taking partial profits in over-valued momentum stocks that have been the market leaders.
Valuations are anything but cheap. Bellwether stocks are saying, “Be careful!” Our focus will continue to be cautious as we strategically allocate our portfolio for alternative outcomes. Remember — it’s better to be defensive early, than sorry later.
