Signal From Static: The Chairman’s View

Daniel P Wiener

Chairman

Adviser was founded in 1994 because investors demanded an independent, uncompromised view on the markets, the economy and their finances, delivered in both words and actions. We have tried to live up to those demands and have been rewarded with fantastic clients and a terrific team of people to help them.

One of our fundamental beliefs echoes the slogan of a 1960s retail phenomenon named Sy Syms, who said, “An educated consumer is our best customer.” All of us at Adviser believe that an educated investor is our best client and partner. We have always been “The Adviser You Can Talk To.”

Whereas Sy Syms was selling men’s suits that, not surprisingly, went out of style and lost their fit over time, I believe many of the fundamentals of saving, investing and planning for your financial future are timeless and never wear thin. That is one reason why we also review these financial fundamentals in our weekly email missive to you.

In Signal From Static, a new monthly feature, I’ll try to take a broader view on issues and questions of finance, cutting through a lot of the noise and keeping an eye on how events impact our company’s most important stakeholder—you. I hope what I have to say will be of interest, and if I ever fail or miss a particular topic you want me to focus on, please email me at signal@adviserinvestments.com.

An Inflated Perspective: Why 2%?

Consumers, as well as investors, have become obsessed with inflation (the media certainly has helped). I’m not surprised. After decades of prices rising at a snail’s pace, the measure has shot higher, with the headline consumer price index (CPI) hitting 9.1% in the year ending in June. (It has since fallen to 8.3% but that’s not a win as yet.) The monetary policymakers at the Federal Reserve have begun to battle inflation with interest-rate increases, and their goal is 2% inflation sometime in the next two years.

You might wonder where that 2% figure came from. It was only in 2012 that the Fed agreed to publish a target for its policymaking. Prior to that decision there was disagreement about whether it should target anything. The 2% figure, which is based on the headline personal consumption expenditures (PCE) measure rather than the CPI, has become an international standard of sorts, according to researchers at the St. Louis Federal Reserve. Several countries have adopted 2% as their inflation targets as well.

As investors, we need to put the Fed’s target in perspective. I believe they are setting an unrealistic goal for policy. Inflation at 2% would be significantly lower than Americans have seen, on average, for decades. In fact, I believe the only reason many of today’s pundits think a 2% inflation level is the “right” target is because they are suffering from recency bias. Since the end of the Great Recession in June 2009, PCE inflation has averaged 1.87%, inclusive of 2022’s recent inflationary spike. Ignore the past 12 months and the Fed’s favored inflation measure has averaged just 1.53% since 2009.

Inflation has been abnormally low for more than a decade. This gives the Fed cover for its 2% figure. Why do I say that? Because since the PCE was first calculated in 1960, inflation has averaged 3.27% over more than six decades. A goal of 2% inflation may be laudable, but that doesn’t mean it’s obtainable.

Investors and consumers must recognize that even if inflation doesn’t fall to 2% the economy will not go into a tailspin, and we won’t be forced to buy generics to keep our household budgets under control. Incomes are rising and bondsA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. are paying much higher rates of interest today than we’ve seen in over a decade. Forward-looking inflation expectations are reasonable, but they aren’t at 2%.

Investors are often biased by recent experience. If the markets have been strong, they expect them to remain strong. If they’ve been weak, that weakness is expected to continue as well. Those are the biases we must contend with. The same applies to inflation. We may have been through a period of below-average inflation; now we’re faced with a period of well-above-average inflation. The pendulum is already swinging back in favor of lower price increases. Will inflation reach 2%? I have no idea, but I’m not going to hold my breath.

In the meantime, as with stocksA financial instrument giving the holder a proportion of the ownership and earnings of a company., the only thing we need now is patience.

Until my next static-clearing signal…

Dan Wiener