There is good news and bad news.
Good news is about progress against COVID. As of today, over 60% of US adults have had at least their first dose of vaccine[i]. New cases and deaths are falling precipitously. The CDC acknowledged that vaccinated people do not need masks or other precautions (although they are still hedging a bit). Large companies are announcing a return to office and plan to stop requiring masks soon.
The bad news: the return of the Tapir.
With the rapid reopening of the economy, the Fed mentioned in their April meeting that “a strong pickup in economic activity would warrant discussions about tightening monetary policy.”[ii] You will recall the last time the Fed hinted at “tapering back its support for the bond market” the market reacted harshly in what was called the “taper tantrum.” Well, here is the hint, it may be coming soon.
The reopening appears to be accelerating and surprising people, including the Fed, and we are starting to hear real concerns about inflation. For example, Warren Buffett sees substantial price increases in what his companies buy and what they sell.[iii]
Mohamed El-Erian suggests the Fed has backed itself into a corner, insisting it will continue its $120 billion monthly purchases of bonds and mortgages until it sees real inflation and full employment. Well, full employment may take some time, but inflation is here now.[iv]
The Fed has also been saying it expects inflation to pick up temporarily, then cool off as the reopening economy “works the kinks out.” Others, as you can read in the articles we linked, are not so sure. Once the inflation genie escapes the bottle, it may not be so easy to get him back in.
So what do we do now?
In an interview I recently did with CNN Business, I suggested that investors worried about inflation should think internationally.
But I was not suggesting a market call or some tactical move; I was pointing out that international and emerging markets equities give you exposure to foreign currencies and economies, which is why we have them in our portfolios. They provide diversification. If we get serious inflation in the US, we could see a declining dollar, rising commodity prices, and declining bond prices as yields rise. Some of these things could benefit foreign equities, even as a taper tantrum might cause a decline in US equity prices.
As always, we emphasize the unpredictability of all this, which is why we adhere to our asset allocation strategies with discipline. Rebalancing over the last year or two has meant selling the big tech winners (which dominate the major equity indices) and adding to bonds and other equities to stay on target.
Since last November, we have seen a “rotation” into value and small stocks, which we emphasize in portfolios. And if inflation and related problems arise this year, we expect our diversification to mitigate against the risk of being concentrated in the recent winners.
The only thing we really know (aside from the inevitability of death, taxes, and innovation, per John Bussel’s recent letter) is that we will have some surprises, changes that can happen fast and move markets quickly. There is no magic bullet to protect against inflation except a well-diversified portfolio.
[i] Ratner, N., 2021. [online] Available at: <https://www.cnbc.com/2021/05/19/covid-19-cases-deaths-vaccinations-daily-update.html> [Accessed 23 May 2021].
[ii] Cox, J., 2021. [online] Available at: <https://www.cnbc.com/2021/05/19/fed-officials-said-rapid-progress-in-economy-could-lead-to-lowerng-asset-purchases.html> [Accessed 23 May 2021].
[iii] Li, Y., 2021. [online] Available at: <https://www.cnbc.com/2021/05/03/warren-buffett-says-berkshire-hathaway-is-seeing-very-substantial-inflation-and-raising-prices.html> [Accessed 23 May 2021].
[iv] Daniel, W., 2021. Mohamed El-Erian says inflation is here to stay and won’t be ‘transitory’ like the Fed claims. [online] markets.businessinsider.com. Available at: <https://markets.businessinsider.com/news/stocks/how-bad-inflation-get-mohamed-el-erian-transitory-federal-reserve-2021-5-1030380375> [Accessed 23 May 2021].
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