The Worst Investments During Inflation? Transcript Pod 434

by | Mar 22, 2023 | Asset Management, Blog

The Worst Investments During Inflation? Podcast 434 Transcript

worst-investments-during-inflation-transcriptWelcome back to the Mullooly Asset Management Podcast. This is episode number 434.
This is Tim Mullooly once again here with Tom Mullooly.

Tim:  We have a couple articles that we want to dive into today. Tom, firstly, how you doing?

Tom:  I’m good. So, we have a big coffee mug at home. It was something that I actually won in a sales contest over 20 years ago at Morgan Stanley. They were bringing out a new internet fund. It was called the 21st Century Fund. I know we still have it on the top shelf, at home because it is our bacon grease catcher.

Tim: Right.

Tom: But we’ve kept this ugly mug because no one wanted a drink out of it.  We use it to catch, to capture our bacon grease.  It’s important because it is a reminder for me. Whenever we get a hot theme in investing, a lot of firms will race out – they’ll move as fast as they can to get a new product out on the street. And so the theme for the last almost 12 months now has been inflation protected products, whether they’re mutual funds or ETFs. I mean, your mailbox is jammed with them, so are mine.

Tim: It definitely is the, the “product du jour” for these companies to be just kind of slapping buzzwords in front of a new fund and rolling it out there and getting billions of dollars in assets because people are worried about inflation. They’ve been worried about inflation for…

Tom: …ever!

Tim: …the better part of it almost 15 months now. It’s funny to see all of these different products being rolled out, and they all have similar type names. Uh, “inflation protection,” “interest diversification,” all of those different things. Just buzzwords that they know that people are worried about that will catch their eye and be like, oh, I need that.

Tom: So, just a tip, that I’ve picked up over my career. When you’re starting to see a deluge of new products all with the same theme, like right now it’s inflation protection …it’s probably the time to do the opposite. And you know, now we’re starting to see headlines about inflation coming down.

Tim: Right. Well, yes. And this article that we’ll link to in the show notes from the Wall Street Journal pointed out that they’re not even working. They’re not doing what they’re supposed to be doing. Which to, to your point, if there’s a saturated market now of inflation protection ETFs and mutual funds, it’s probably not the time to be buying them.

Tom: Right. So the internet stocks in 1999, most internet related funds, returned upwards of 80, 90, 100%. This was during 1999. In the first quarter of 2000 when the new 21st Century Fund came out, it raised billions of dollars. Along with — every other firm on the street did the very same thing. So I’m not picking on an old firm. However, those funds were down somewhere in the vicinity of 80, 90% in the first 12 months that they were out there. Most of these funds have closed and gone away. I would expect that some of these inflation related mutual funds and ETFs will take the same route.

Tim: The ones that don’t catch enough assets in the first year or so will likely close. I also think that we have consistently talked about being able to understand what the funds that you own do and the, the purpose of them. I would venture to say that almost everybody who owns something like this can’t really explain the methodology behind it because a lot of these are firmly entrenched in complicated derivatives, different types of investing strategies that normal everyday people don’t really understand. First off, if that’s the case, if you look at this and you can’t really tell us what exactly it’s doing, that’s your first red flag that you probably shouldn’t own. It.

Tom: Just a historical footnote. When I was at Shearson Lehman, this was prior to the 1987 crash, they had a market strategist, this woman Elaine Garzarelli. If you were watching Financial News Network — at the time the forerunner to CNBC, she was on there like every, or every other day. Sort of like the way Mike Wilson is on Bloomberg every morning, it seems talking about how we’re going to zero.

Shearson Lehman capitalized on the fact that Garzarelli made a prediction the week before the crash that we could have like a 20% drop in the markets. So they quickly rushed out in the first quarter of 1987 and the nickname was the Garzarelli Fund (correction: early 1988). It was basically, you know, she would identify different strategies and different markets to be moving into, long this, short that. Uh, you know, know using options, futures and commodities.

And the problem they ran into, after it was open for a year — it went down, they lost a lot of assets. People just said, “ah, this, this isn’t working.” They also ran into a serious tax problem because they were trying to do futures and options in mutual funds, and they weren’t able to pass through all of the tax benefits to the mutual fund shareholders.

So, like you were saying, Tim, a lot of these new funds and new ETFs that have come out take a strategy that will work — on paper or with an individual trade — and then they try and package that into a product. And that’s kind of where the wheels fall off.

And like you also said, trying to get an individual investor to explain how their fund or how their ETF works… it’s honestly, it’s like watching a comedy show. Just sit back and get the popcorn.

Tim: I also was thinking about it as I was reading this article from like a high level, inflation protection. I was trying to take that concept and, and think about why people — or the benefit of that. And obviously inflation has been historically high for this year, last year. But the thing about it is that the Fed is never going to let inflation run at these levels for a sustained period of time long enough for these investment strategies to work well enough to justify position in your portfolio.

Talking to long-term investors here, not the day traders. Inflation is always going to be going up and down. And trying to protect against this once-in-a-four-decade high in inflation… it’s already coming down. Yes, it might not be coming down as fast as people are expecting it to, but you know, at some point inflation is gonna be back down to normal levels. And then what do you do with the investment?

I just feel like they’re designed to work while inflation is at super-high levels. So while inflation is coming back down the other side, they’re naturally not going to work as well as they would when inflation is on the rise and at a sustained high level, which it rarely is!

Tom: Usually these products are still in registration with the SEC before or while you could really use them!

Tim: Exactly. There’s a very short window of time where these inflation protection securities are peaking in value.

Tom: They’ll usually be a good sales pitch to have these things around, over the next year or two. Even as inflation goes down, you know that at some point in the next year or two, we’re going to have a quarter — or maybe two quarters — where inflation ticks up again (and then comes back down). And then we’ll have all of the inflation hawks out there again talking about why you should own TIPs…Treasury inflation protected securities, or some derivative of that.

Tim: In the same way that last episode we were talking about people from the depression were forever scarred financially in that way. There are people that are still scarred from the housing crisis in 2007-08. And every time something creeps up, that causes a downturn — or their stocks and portfolios to lose value — people are going to be afraid of that, moving forward. So yeah, if inflation or interest rates rise again, the next time these things come back, after this all subsides, people are going to be like, “oh, not again! This burned me once.”

Tom: That’s why we still have people who invest in gold ETFs and gold mutual funds. Because they remember 41 years ago what happened to the price of gold. I’ll say that again. Forty-one years ago. 1981. Come on guys.

So interesting point. The Bloomberg Tips Index last year, while inflation was spiraling pretty much out of control — to heights we hadn’t seen in 40 years — how did the Bloomberg TIPS Index do last year?

Tim: Well, as I read in this article, it had one of its worst years in the last couple decades. Which is funny because inflation has been the highest it’s been in decades. So you would hope that an inflation protected security would do its job the one time that inflation is actually super high.

But another thought that I had was they didn’t really specify what does “work” mean?

You know, the the tips security that we’re talking about was down 12% last year. Compared to plenty of other things, it “relatively” outperformed. You know what I mean? It wasn’t down as much as technology stocks, or the stock market in general. So does that count as working?

Tom: It’s a point that I share with long-term clients when we’re talking about how the markets are doing. Nominal performance is great when the markets are going up. (Meaning) “my investment did better than yours.” But when the markets are going down, nobody cares about relative performance. The stock market went down 20%. This thing that we’re in went down only 12%, so you actually did better than the market. You know what, you still lost money. Nobody cares.

Tim: Stop it from going down. I don’t want to lose money. I don’t feel good that I lost. Yes, I lost less money than the guy next to me, or lost less than another investment strategy or another fund out there. Whether that’s fair or not.

Tom: And that may not be fair. And maybe this is just an editorial note, but in the article they talked about how “historically” investors have turned to treasury inflation protected securities (TIPs) to lock in bond income while escaping inflation risk. What, wait a second. Is that historically?

Tim: What does that mean? Historically.

Tom: This bond index and tips have been around for 25 years. That brings us to 1998. I mean, the highest inflation rate — prior to last year was, I think we had a year where we had 4% inflation, right? Four.

Tim: So, they “historically turned to this product, during times when inflation is”…super low! I guess before this last year, when inflation would tick up to 3% instead of 1.8%, relatively, that seems like a big move. Now put it in the context of where we have been over the last couple years. It doesn’t seem that that high, but yeah, it’s funky to hear that! It’s like, “well, inflation’s the highest it’s been in 40 years.” We heard that every single day of last year. They turn to this product every time that inflation gets high? Like, when was that?

Tom: Yeah, when was that?

Tim: So they’ve never turned to it?

Tom: In fact, going back over the last 30 something years …I know, in 1990, the rate of inflation was 5% that year, and that was a fluke. But it led to the recession that we had at the time seemed like a bad recession. Especially here in New Jersey. Some people didn’t make money in real estate. Some people lost money on the value of their homes in late 1990, 1991 into 1992. But that was 5% inflation and the Fed, Greenspan, pushed us straight into a recession. But other than that, I have a hard time remembering when inflation was above 5%. You have to go back to the early eighties when it was on its way down. It’s a problem that we haven’t really had to deal with a lot.

Tim: You know, we, we haven’t talked very highly of these inflation protection securities and ETFs, mutual funds. That doesn’t mean you don’t need to protect against inflation in general. So if these ETFs and mutual funds are kind of just a salesy way to capitalize on people’s fear; how do people properly hedge against inflation or protect against inflation?

Tom: That’s a good question. I think a lot of people go to the last level or the final level of their investments, to make that decision. Meaning, “well, I should own Newmont Mining,” or, “I should own a gold fund, or a gold company, a mining company instead of something else.” That may not necessarily be the best way to do it. I want you to just go back another ring…

Tim: zoom out.

Tom: Yes. And, and take a look at this and see what your allocation looks like.

Tim: It’s really from a high level, more important from a conceptual level than getting nitty gritty about what securities you own during that time. I think just having a proper investment allocation and remaining invested is one of the best ways to hedge against inflation. Your money can’t outpace inflation if it’s sitting in cash. So just remaining invested, which also works in tandem with having a proper investment allocation that you can remain invested with that on from a high level, I think is the best way to hedge against inflation.

Tom: Funny story. Before we move on. I had a conversation with a client. He’s still a client. But this goes back to 1999 and 2000. We had put money into one of these internet funds. We did really well in 1999. And then in 2000, we gave it all back. When we sat down together at the end of 2000, the beginning of 2001, he said, “well what, what else could we have done?

And I said, well, now, again, different environment. “You know, the short-term money market rate was 6% last year.” And he sat back in his chair and he was like, “why didn’t we just do that? Instead of taking these losses.” And I was “because we wanted to have some long-term growth in the account. So yeah, we’re gonna take more risk. We have to identify, and that is really the point, we have to identify which dollars are gonna be allocated for long-term growth. And which are gonna be allocated for short-term, short-term no risk.

Tim: And we talked about that last week too. You know, having that money that you’re gonna be using, or needing in the short term for whatever. Whether it’s in retirement or whether it’s not in retirement, but you’re gonna need it for projects, or life or in general. Having that set aside. You could also make that same point that, that you made, that the money market is earning 6% back then. Now some money markets or online savings accounts, things like that, are earning a couple percent, 4%, 5%.

Tom: …an actual rate of return. Not zero.

Tim: But you also have to take into account that inflation is still up above 6%. So nominal yield versus real returns. Having money invested in the stock market and remaining that way, will always be the best way to get ahead of inflation.

Tom: When we talk about inflation, I mentioned this just a moment or two ago. We had inflation in 1990 of 5%, Greenspan raised rates to put us into a recession to basically squash inflation. Where is this recession that everyone, everybody has predicted will be here by now? Where is it?

Tim: Depends on who you ask. It’s difficult because I think we’ve been using past recessions and past economic environments to predict what’s gonna happen this time and rightfully so. I mean, that’s really all we have to go on. No one knows what’s gonna happen in the future. But I think that this time around, it seems there are different aspects to it — that is making things not happen as quickly as people anticipated — or not happen at all.

Different areas and different factors are changing the timeline here. And there’s an article in the Wall Street Journal — we will also link to in the show notes — and the headline is talking about why the “recession is always six months away.” And it kind of feels that way. Like I said, it depends on who you ask. It seems like the goalpost or the starting point for this recession has always been moving. Yes, we were supposed to hit a recession at some point last year. Then it was the beginning of 2023. Now it’s the middle of this year. And the author said that at this rate, people will be expecting it in the beginning of 2024 — or the end of this year. So I don’t know. It seems like there’s a bunch of different economic data, other areas of of the economy are stronger than people are expecting. Others are weaker and it just, it’s not going the way people thought it was going to go.

Tom: What we’ve been pointing out to folks is that while we’re all “sitting around waiting for the recession to get here,” the clock continues to tick. And people are getting closer to retirement. They need to put money away. They need to get on with their lives. And so we have to continue to invest and build plans for clients. We can’t just sit around and wait for a recession to show up to kind of be a “reset button.” It just doesn’t work that way.

Tim: If you sit around and wait for recession to do …fill in the blank… whatever you’re waiting to do. What happens if it doesn’t show up? Then you are like the people from 2008 who never got back into the market because they were waiting for the next shoe to drop. Waiting around for things to happen is not the right way to go about financial planning and investing. And one of the main things that we stress to people is that recessions, and down years in the market, and different economic cycles, they’re all baked in to all of the plans that we make for people. We’re not assuming straight line growth without any hiccups or recessions along the way. So you kind of just have to formulate a plan that works through all of this.

Tom: According to the National Bureau of Economics, the average length of a recession is, …do you know?

Tim: Isn’t like two quarters? It’s like six months?

Tom: It’s actually 11 months. So it’s less than a year. But the definition…
Tim: That’s what I was thinking of!
Tom: The definition of a recession is two quarters of negative GDP. And so you’re not going to know! If an average recession is less than a year, and you need two quarters to identify whether you’re in a recession or not — (then) you’re halfway through a recession when you find out you’re actually in one.

Tim: And I think this time around too, there’s those textbook definitions of recessions. But this economic environment seems “anything but textbook” when you consider the backdrop of how we got here. Through the pandemic, something that we’ve never experienced before. All of the drastic measures that were taken to stimulate the economy and keep people afloat during the pandemic are now working its way through the economy. And potentially they’re having unintended consequences, or “intended” consequences. Honestly, at the time they had to do whatever they had to do. So yeah, I just think that the word of the last few years has been “unprecedented.” But it seems like it’s one of those scenarios where maybe we shouldn’t be relying on all of these textbook definitions – because we’ve never been in this situation before. So they don’t necessarily apply.

Tom: And they may not work.
Tim: Right. Exactly.

Tom: If the economy continues to expand, then we can’t logically be going into a recession. And recessions tend to begin regionally and spread nationally. And so we saw a housing crisis on the west coast, and in southwest US, that began in 2006-07. And that spread across the country. So right now, 50 states, all but six states are still showing broad economic growth. So there are six states and they’re all scattered around the country – six that are not in recession, but are actually just a period of no growth.

So how are we going to get into a recession? Just it doesn’t work this way.

And then if you look at it from a business level, the consumer is still sitting on $1.7 trillion of cash that they got in covid relief. Banks are flush with cash. Their balance sheets have never looked this good. And certainly nowhere near heading into a recession. And businesses, this is the best balance sheets that I’ve seen in 40 years of looking at them. So I don’t see a recession.

Tim:  Yeah. I mean, things can, could definitely change. It depends on a number of different things. But it seems like, especially when it comes to inflation, the thing that the Fed is — they’re using the tools that they’ve used in the past. And the timeline of how quickly things are are working might not be what people were expecting. I know in the article they were outlining how past recessions — or past inflationary periods — have been largely caused by, you know, spending on credit, lending and borrowing. So, you know, raising interest rates has a pretty quick effect on stuff like that. But this time around, like you said, the consumer — and people in general, are sitting on cash. So raising interest rates isn’t necessarily hurting people in businesses the way that it has in the past. Because they’re sitting on all this cash. They’re not relying on lending and credit cards, things like that, to sustain their lifestyle. So the, the average person isn’t getting as beaten down by these interest rates as people were anticipating. I’m sure there is a breaking point — at some point. But it’s not as quick as people have been anticipating. So we might reach a point where we find that recession — if they push things hard enough, I’m sure we could probably get there. It’s just a matter of how quick — or how long — is it going to take.

Tom: And I tend to agree with that because one of the things that I’ve said, in past episodes, is that when the situation changes in the economy the Fed will typically move the goalposts.

And so you get a lot of people on the financial media, whether it’s Bloomberg, CNBC, you name it. They go on every morning and they say, if the Fed raises interest rates too far, we will go into a recession. Don’t you think the Fed knows that?

And don’t you think the Fed will want to avoid going into a recession? Let’s put this all in perspective. It was a year ago — this week — that we’re recording this podcast, that the Fed raised rates a quarter point for the very first time, last year. It was March of last year. And so interest rates went from, they always give you a range, from zero to a quarter. Now they went from a quarter to a half. That was just one year ago.

And then it wasn’t until June, July, August where they started really accelerating these. Now we’re at 4.5% to 4.75% on short term rates. It looks like we’re going into the fives. But I just want to remind everybody that we went from essentially 0% to 4.5% on short term rates. And we all lived. We’re all here to talk about it. The economy continues to expand. I mean, everybody, everybody out there expected the economy to collapse if this were to ever happen.

Tim: That’s definitely a good point. I also think that it’s, like I said before, it depends on your timeframe. I just think people are expecting, “oh, the rates got increased that quickly, that means that the economy is going to collapse that quickly.” I think we’re at the point now, and they mentioned it in the article, where the pace of these rate hikes is going to slow down — because they raised them so quickly — they need time to study the data and study all the numbers to see what the actual effect is. And that makes sense to me. You know, it, it’s not gonna happen overnight and it doesn’t mean that things are going to collapse. It means that things might take more time to slowly come back down. And that’s not a bad thing.

Tom: It’s a sign of a strong economy.
Tim: So in general, I think just you need more time than people are allowing it to have.
Tom: So, Tim, when we read about, you know, interest rates and inflation and the looming recession that has yet to show up on our doorstep.” What does that do in terms of changing our asset allocation and our plan?

Tim: I don’t think it does. Like I said before, we build these plans with recessionary periods, expansionary periods, everything in between. We know that the economy is cyclical. It’s gonna go through cycles. And over the long term for, for people, it’s gonna be decades long. You’re gonna experience bull markets, bear markets, recessions, expansions, everything in between. So I think if you have a good plan in place, you shouldn’t really need to make that many adjustments — potentially just minor tweaks along the way. But yeah, you shouldn’t need to go back to the drawing board. And if you did, you probably didn’t have the right plan in place to begin with.

I think that’s a good place to wrap up this episode. Thanks for tuning in and we will see you next week.

Tom Mullooly is an investment advisor representative with Mullooly Asset Management. All opinions expressed by Tom and his podcast guests are solely their own opinions and do not necessarily reflect the opinions of Mullooly Asset Management. This podcast is for informational purposes only, and should not be relied upon as a basis for investment decisions. Clients of Mullooly Asset Management may maintain positions in securities discussed in this podcast.

Listen to the podcast episode 434 here.

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