Hi. This is Michael Joyce with Agili, Your Personal CFO. And as you can see, I broke out my seersucker jacket, which can only mean one thing…. It’s time to share our thoughts and viewpoints for the Summer of 2021.
Economic Headwinds on Horizon
As I’m recording this video, the US stock indices are at an all-time high. And investment returns have been fabulous. But there are some storm clouds on the horizon, so it remains to be seen whether we get downpours from these storms or whether the storms never really amount to anything.
Good Economic News First
So let’s start off by talking about the positives, of which there are many. We’re coming out of a pandemic and the economy is reopening and there is all sorts of pent-up demand that’s being unleashed at this time and the aggregated demand curve for the economy is certainly shifting out. And this is all being led by the consumer. As an aside, with the development of the vaccines, with the distribution of the vaccines and the effectiveness of the vaccines, in essence, we beat the plague in about a year. And that is an amazing accomplishment and says a lot about innovation in the economy, which I think bodes well for the future.
As we have also talked about, there’s still a lot of money on the sidelines, which could get deployed into the markets. There’s still over $4.5 trillion sitting in money market accounts. I read a report earlier this week from Goldman Sachs that said there’s so much money sitting on corporate balance sheets; a lot of that is going to be used on stock buy-backs. Add that will also add support to the stock market.
Economic Headwinds: Inflation and More
But there’s also some headwinds – most notably, higher inflation and the prospect of higher taxes on investors. We’re already seeing some of this higher inflation. And Jerome Powell, who’s the head of the Federal Reserve, has introduced a new word into our lexicon and that is “transitory”. He uses this word all the time to discuss inflation. He says it’s transitory, transitory, transitory. He’s saying it’s just temporary and it’s going to go away. But I think it’s important for us to look at the prospect of maybe the Fed has misjudged the persistence of inflation and we have to look at that as well.
And why is higher inflation bad? Well, with stocks, for example, right now the stock market is pretty richly valued. And the reason it can have such a high valuation is because interest rates are low. We’re discounting future cash flows and earnings at a very low discount rate. But if inflation moves up, longterm interest rates move up, and then the discount rate moves up. So, that means we can’t support price earnings rations the way they are right now. So we could be in a situation where earnings are expanding because of our expanding economy but price earnings ratios have come down – and have kept a lid on stocks.
For bonds, inflation is the arch enemy. If you think about it, if you put a certain amount of money in bonds today, you’re going to get paid back that same amount at some point in the future, but it’s not going to go as far at that point. So the higher the inflation, the worse that is for bond holders.
And even for real estate, most commercial real estate is valued using a method called capitalization of net operating income. And this capitalization rate is a discount rate, so it’s the same thing. If inflation goes higher, interest rates go higher, this capitalization rate goes higher and that means lower valuations.
Review Your Investment Policy Statement to Align Longterm Goals
So through all of this, we are keeping an eye on our clients’ longterm goals and objectives. A lot of what we’re talking about is more near term. But we also have to think about the longterm. But we are being careful. We know there are cycles and we are being careful – in some cases, even defensive. As certain investments are reaching full valuation, we’re pruning them — and at the same time, looking for opportunities.
As we approach midyear, especially considering how much portfolio returns have been, it’s a good idea to look at whether you’re still invested in a way that is congruent with your objectives, with your time horizon and with your risk tolerance. At Agili, we use investment policy statements. Most individuals, most families, they don’t have investment policy statements. But this is quite common for institutional investors like foundations, endowments, and pensions. And at Agili, our investment policy statements do point out what the investment objectives are, what the time horizons are, what is the risk tolerance, and what are some of the unique circumstances or constraints on portfolios. It’s a good time of year to get together with your financial strategist at Agili and go over this investment policy statement. Make sure everybody’s on the same page. It’s not a legal document, but it’s always good to make sure that everybody’s on the same page.
So I’m very pleased to share our thoughts and viewpoints for the summer of 2021. In the words of Sergeant Phil Esterhaus from the iconic TV show, Hill Street Blues, “Be careful out there.”