August Recap - Inflation and Compounding
In this edition, we’ll cover Inflation and The Power of NOTHING
Index Update (As of 07/31/2021 from Yahoo Finance)
S&P 500 (Large Cap): +17.99% YTD | +37.39% YOY
Russell 2000 (Mid, Small Cap): +13.29% YTD | +50.32% YOY
Global Market – ex US: +7.84% YTD | +27.97% YOY
What we do at Cedar Wealth: We work towards creating lifetime and multi-generational wealth through the use of diversified portfolios. We make no attempt to time the market or out-smart the market, and we continuously refine our portfolios to match our client’s financial priorities.
This newsletter consists of our thoughts and insight about the top few questions and topics that have come up with clients and prospects over the last month. We want to keep our clients up to date with our latest thinking about financial trends and market news. Some of these opinions may play into our specific investment strategy, but not all will directly apply.
1. Inflation Concerns: This topic has been covered for 4 months in a row, so more information will be listed later from prior newsletters. Questions keep coming up, so I’ll keep commenting. Much of the same data points still apply from month to month, but let me update some information.
For a simple and broad overview of the current inflationary period in the US, please read this article from Bloomberg.com, about a 5 minute read. We align with Bloomberg’s comments and share their opinion that inflation will be higher this year but will gravitate toward to the long-term average in future years.
The BIG PICTURE message regarding inflation summed up in this example. Let’s say you need to buy a new refrigerator and before Covid that refrigerator cost $1,000. The company selling that appliance plans on making 20% of a profit margin, so roughly $200. Well today that same refrigerator costs $1,100, the increased price is a mix between supply chain demands as well as a greater consumer demand. Regardless, the company selling this refrigerator still has a 20% profit margin target, so with the new price of $1,100 they plan on making $220 from selling that same refrigerator. So yes, that appliance cost you 10% more, but the company selling it also made 10% more in profit. For any investor of profit-seeking companies (like clients of Cedar Wealth), the more profit the company reports the higher the share price is going to climb. This is a simplified example or mental exercise and is far from scientific. However, we feel that while prices are higher for all of us who buy goods and services, our investment accounts will also be higher because of the share price growth associated with higher company profits.
Information/Data from prior newsletters:
According to Deloitte, M2 (money supply) is up 23% from just a year ago Deloitte Article. We believe M2 to be among the most significant factors in predicting inflation.
When M2 increases, like it has from a year ago, inflation typically increases as well.
M2 reduces when good and services are bought – put simply, the money is spent
Economics 21 shared “As the economy reopens… boosting consumption… The spikes in M1 and M2 will reverse.” Meaning the 23% increase in M2 from 2020 should reduce because of this activity. Our opinion is, in this case, inflation should be held in check.
We are starting to see M2 dip down as Economics 21 suggested may happen in the above point; this is a figure I’m watching closely to see if the trend continues. (Source: Scott Grannis)
The number we’re referring to when we talk about inflation is created by looking at the difference between Real and Nominal Treasury yields. At the beginning of April 2021, this spread was about 2.3%. This aligns with the position of Fed Chairman Powell, who commented in 2020 that he’s satisfied with inflation going above 2% for an extended period of time to get the long-term trend line closer to 2%, which is the Federal Reserve’s target. (Sources: Scott Grannis & CNBC)
Inflation should be held in check if these trend lines continue. Inflation being held in check has historically been good for investment markets.
A final word on inflation, and any prognosticating on the future, it is of course impossible to predict. I want our clients to know we’re monitoring inflation rates and how this may impact our strategies moving forward.
Additionally, this is a great example of why we rebalance our portfolios on a weekly basis. We don’t know which assets will perform better or worse; consistent rebalancing is a way to buy low and sell high at regular intervals while keeping true to the original portfolio design.
2. The Power of doing NOTHING – the information below is from Yahoo Finance and Standard and Poors
S&P 500 1971
Earnings were $5.70
Dividend averaged around $3.10
Index value of 99.17
CPI value at 41.10
S&P 500 Today / Current Consensus
Earnings of about $190
Dividend of about $60
Index value close to 4,400
CPI value at 274.30
To summarize the past 50 years
Earnings are up about 34x
Dividend is up about 19x
Index value is up about 40x
CPI is up about 6.6x
d. In Real Terms if you invested 100k in your IRA (no taxes) back in 1971 in the S&P 500, and you simply kept reinvesting the dividends, would it surprise you to know that your value today would be close to 18Million??
So what did you have to do to appreciate this type of wonderful return over the past 50 years? You guessed it… NOTHING or close to nothing. Simply do the following
1. Reinvest the dividends
2. Never interrupt the compounding
Doing the two aforementioned items are easy to write, but they are much harder to execute on. In 1974 the S&P 500 dropped close to 48%, then in 2002 it dropped again another 49% and again in 2009 it dropped 57%. During these moments of significant downward movement, keeping your money invested is terrifying. However, after every market downturn I just mentioned, the market has turned and marched to new highs.
It is with great joy that as I meet with clients I get to commend them for doing “nothing,” for purposefully acting on the custom financial and investment plan we have developed and implemented.
In closing: We of course cannot control what the market does from here and we cannot predict when the next market downturn will occur. But we can control our behavior to these outside events and continue to stick with our long-term investment strategy.
As always, thank you for your trust, if you have any questions/concerns please contact me.
-Dave
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David Hobbs, CFP®, CLTC | Wealth Advisor | Founding Partner
Offices in Indianapolis & Terre Haute
Office: 317-559-2940
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Email: D.Hobbs@CedarWealthPartners.com
www.CedarWealthPartners.com
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