Rate Hikes & Inflation –
We Here Last?
Financial media has identified a period that many Americans lived through, the 1970s, as the standard for an inflationary environment and how to position your investments. While the easy money policies of the U.S. in the 1970s were a major player in the game, what we found different about the 1970s is that inflation rose out of a weak economic backdrop. In 1969, Nixon inherited a recession with mild inflation from a decade-long economic expansion. The economy needed a healthy cooldown. Instead, the government injected an influx of cash to help prevent a downturn. Consequently, the economy was not positioned to support a new demand surge and price began spiraling out of control. This forced some of the most aggressive interest rate hike policies in history.
We see some clear similarities in the inflation story today and what we saw in the 70s: oil issues, government over-stimulus, etc. But there’s an often-overlooked period in American History that we believe draws even deeper parallels to today’s environment, and gives us hope that not all is lost in this market.
During WWII, the globe was on lockdown. Countries closed off their borders to traveling foreigners, stressed the self-sustainability of their economies for the purpose of national security, and placed strict price and spending controls on their citizens and businesses by limiting the sales and purchases of goods and services. Companies stopped manufacturing their goods and instead manufactured supplies for the war effort. Sound familiar?
Substitute WWII with COVID in the previous paragraph and we see that the parallels are astonishingly comparable. Entire industries were shut down for months, if not years to fight the war against COVID. Manufacturers in the U.S. shut down assembly lines to produce masks and ventilators in the spirit of the COVID war effort. International travel and supply chains ground to a halt. What would follow WWII is even more like today’s environment.
When the war came to an end and citizens could finally travel and spend as they pleased, the U.S. saw the largest peacetime inflation boom as non-government spending rose roughly 40% in the year that followed. Government spending fell off a cliff – dropping from 55% of GDP to 16%. By 1946, prices of agricultural goods costs rose 12% in a single month and continued at a blazing pace of 30% by year-end (compare to today’s grocery price inflation). In that same year, corporate profits grew over 20% and wage growth took off as labor unions began to form and demand more wages (one Amazon warehouse and individual Starbucks locations voted to unionize last month). All of this occurred before the global supply chain had a chance to re-establish itself from a wartime shutdown. Companies
needed time to retool investments and production before they could handle incredible demand surges. The result in 1946? 8.33% inflation. 1947? 14.36%.
But here’s some good news, inflation did not last forever. By 1948 inflation began to slow and came in at 8.07%. In 1949 the country experienced a drop in inflation of -1.24%. Prices were on the decline! Inflation rapidly expanded in the first two post-war years and then subsided. What are we seeing today? A rapid two-year inflation expansion. Our hope is that interest rate hikes and supply chain fixeslead to a 1949-like market recovery. After the initial inflation scare, markets would bottom in 1948, and by 1949 the market was off to the races again with double-digit positive returns 6 out of the next 7 years (see chart below).
What does this Mean for My Portfolio and Investments?
Both inflation scenarios in the 40s and 70s led to aggressive rate hikes, interest rate controls, equity market turbulence, and an economic slowdown. We believe there are clear parallels that the causes and backdrop of today’s inflationary pressures draw more meaningful comparisons to post-war era inflation vs. the 1970s.
Polaris is Using this Knowledge to Your Advantage
While markets seem bleak, Polaris is hard at work identifying opportunities positioned to outlast inflation and rate hikes. So, what exactly has the investment committee done? We’ve screened over 1000 equities in the U.S. and international stock universes for interest rate sensitivity so we can better understand how interest rate movements affect their price. We’ve portioned off a section of our portfolios for agricultural machinery providers and increased our energy exposure. We’ve uncovered opportunities in companies working to repair supply chains. We have increased cash exposure in our clients’ portfolios to lessen the downside volatility.
Wrapping up, the bottom of a market is never easy to identify but one thing we know stands the test of time is that long-term returns are not strongest by timing the market, but by spending time in the market. The investment committee is prepared for inflation scenarios like the 40s and 70s alike. When this market rebounds Polaris is ready to get your money to work in some attractive buying opportunities available in the marketplace today.
Brett Miller, CFA, CFP®
Senior Financial Analyst