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Tag: federal reserve

Jeromeggedon and Calamity Janet

Written by Ailie Carlene Elmore , John Heneghan

“Guess what guys, it’s time to embrace the horror! Look, we’ve got front-row tickets to the end of the earth!” This month’s collapse of Silicon Valley Bank (SVB) had many of their well-heeled venture capitalist depositors and customers metaphorically reliving this scene from the 1998 movie, Armageddon. SVB’s downfall had people questioning if we are headed for another epic crisis in the banking system like that experienced in the 2008 Global Financial Crisis punctuated by the failure of Lehman Brothers. On March 8th, SVB announced a $1.8 billion loss on its investments in long-term treasuries prompted by depositors withdrawing funds. Withdrawals soon snowballed as general partners at venture-capital firms began pulling their money out of Silicon Valley Bank and urged their portfolio companies to do the same. Hours later, Moody’s downgraded SVB Financial triggering its stock price to crash sending shockwaves reverberating throughout the banking system. $52 billion in the market value of JP Morgan Chase, Bank of America, Wells Fargo, and Citigroup was lost as panic spread about the safety of banking deposits, particularly deposits over Federal Deposit Insurance Corporation (FDIC) insurance limits of $250,000. Two days after the initial announcement, the FDIC took control of SVB after depositors attempted to withdraw $42 billion. On March 12th, the New York Department of Financial Services regulators announced the 3rd largest bank failure, Signature Bank.  Signature Bank was one of the few banks accepting crypto deposits; some believe this made them an easy regulatory target. SVB’s failure prompted Signature Bank customers to move their depository funds to larger systemically important banks, like JP Morgan Chase and Citigroup, as concern rose surrounding its portfolio which was very similar to SVB’s.  Systemically important is the code for “too big to fail banks” that the Federal government will likely step in and save in a full-blown crisis.

Panic and concerns surrounding the U.S. banking system sent shockwaves from large banks down to your local community bank known for giving out lollipops for new deposits or transactions. $165 billion in losses of market value were experienced among the 10 biggest bank stocks and $108 billion in losses were incurred among small bank stocks according to the Federal Reserve. Concerns began to arise that we were in for another collapse of the banking system as the closure of SVB marked the 2nd largest bank collapse ever and the largest since the 2008 Global Financial Crisis.  Many experts wondered aloud whether SVB was analogous to a Lehman moment within the technology sector centered around Silicon Valley and San Francisco.

Image Source: Fox Business

The Downfall of Silicon Valley Bank

So where did SVB go wrong? As the name suggests, Silicon Valley Bank was a preferred bank for many tech start-ups and venture capital firms. The bank saw substantial growth during the pandemic as the technology sector was booming and venture capital money was raining down on VC startups, minting hundreds of Unicorns – VC startups valued at $1 billion or more. SVB invested the flood of deposit funds into treasury bonds, mortgage-backed bonds, and other long-dated assets which provided SVB with a larger interest spread over the interest SVB paid to its depositors in the low-interest rate environment during the pandemic. The Federal Reserve monetary and interest rate policy decisions and long-term guidance encouraged this behavior as Fed Chairman Powell labeled incipient inflation “transitory” in 2021.  But as inflation continued to rise into 2022, the Federal Reserve was ultimately forced to hike interest rates very aggressively.  The yield curve eventually inverted as long-term interest on 10-year treasuries fell below those offered on 2-year treasuries.  Consequently, the long-duration securities that SVB purchased to back its deposits fell substantially in value, something on the order of 25%. In accordance with accounting rules and the regulatory framework for banks, SVB had counted on the fact that they would hold their investments until maturity and did not recognize the mark to market impact of higher interest rates in its financial statements.  These held-to-maturity securities were carried at cost on their balance sheet until they could no longer be “held.”  Sophisticated depositors caught wind of this shadow accounting issue with SVB’s announcement of a $2 billion equity capital raise.  Deposits were rapidly withdrawn causing a forced sale of these long-term securities and creating large realized losses.

SVB had also been facing a general slowdown in the venture capital funding cycle and deposit taking. Venture capital investments are far less attractive when the cost of capital rises with interest rates.  It’s far easier to finance these ventures that do not cash flow for several years, maybe a decade or more, at zero interest rates, but it’s a completely different ballgame with the Federal Funds Rate at 5.0%. Funding across the venture capital space slowed meaningfully and deposits to the preferred depository institution began to shrink massively.  Moreover, these cashflow-burning startup enterprises continued to rapidly withdraw money for payroll and operational expenses. The Federal Reserve’s wild misjudgment on inflation and subsequent unprecedented rapid hiking campaign fomented the destructive conditions for a life-or-death decision between the safety of deposits and SVB’s insolvency, or Jeromeggeden.   The Federal Reserve had effectively financially engineered this textbook run on Silicon Valley Bank by its policies. Many sophisticated investors had long ago concluded that the Fed would keep hiking interest rates until they broke something. Technology-sector concentrated SVB proved to be the weak link and the first domino to fall.

The big question is how many other banks will be caught swimming naked on interest rate risk management now that the banking deposit tide is going out. This banking cycle is a foreseeable consequence of Fed monetary policies. Remember under quantitative easing (QE), the Federal Reserve printed dollar reserves and used those reserves to take U.S. treasuries and other government-backed securities out of private hands. These excess reserves generated by QE are now trapped in the U.S. banking system. Depositors are being rational economic actors and withdrawing bank deposits and buying money market funds that hold U.S. treasuries.  With money market funds yielding 4.3% today, this deposit withdrawal cycle may be largely irreversible.  The Fed should be accelerating its wind-down of its U.S. treasury holdings to soak up the wave of private demand for treasuries.

The Federal Reserve’s Response

The fears around the financial stability of the banking system had investors and consumers alike calling for a slowing of Federal interest rate hikes. Investors and banks alike had already been questioning Chairman Jerome Powell on the timing (too late to start the hiking cycle) and pace (too fast hiking because playing catchup) of their policy decisions. Judgment day came on March 22nd when the Fed announced another 0.25% rate increase making it clear their priority was combating inflation despite growing fears about the stability of the banking system. The rate hike prompted banks to lose further equity value both domestically and in Europe, causing unease that the Fed’s decision could cause additional damage to the already wounded banking system. Mr. Powell said that “depositors should assume that their deposits are safe” as the government plans to impose further regulations on an already heavily regulated industry. This “watch and see what happens” approach was small comfort and hasn’t given bank depositors in non-systematically important banks that warm and fuzzy feeling about the safety of their deposits. Deposit withdrawals at regional and small community banks continued apace.

Will the Large Banks Keep Getting Larger?

The resulting crisis has depositors and banks alike looking to the FDIC and U.S. Treasury Secretary, Janet Yellen for guidance. Yellen commented at a Capitol Hill hearing that the FDIC will cover the uninsured deposits (excess of $250,000) of both SVB and Signature bank, yet there is great uncertainty if this policy decision would apply to other bank depositors in the future. Yellen publicly said shortly after the SVB collapse that the FDIC could cover depositors whose funds exceed the $250,000 limit.  However, when questioned if all banks would receive this treatment at the Congressional hearings, Yellen’s response appeared to suggest that small and midsized banks would be left out. The calamity caused by Yellen’s comments was highly disruptive for many smaller banks as it prompted businesses and individuals to contact their local community banks about transferring their depository funds to larger banks that Yellen said would be protected.  This was a surprisingly dismal show of confidence from the U.S. Treasury Secretary who once proclaimed in 2017 as Fed Chairman “I don’t see a financial crisis occurring in our lifetimes.”

From March 8th to March 15th, $110 billion flowed out of small banks into larger banks. Small banks account for just 34% of deposits in the U.S. banking system; however, they account for a substantial portion of commercial real estate loans sitting at 74% of total loan activity. Like the iconic Bailey Building and Loan from It’s a Wonderful Life,  these small community banks lend out deposit funds to Main Street America borrowers for local commercial real estate projects or businesses. If deposits to small banking institutions continue to contract, then this would reduce capital available for commercial real estate lending. Small banks often work with borrowers whose needs are more specialized or whose funding needs are too small in size for the larger banks in America to consider. For example, according to the American Banking Association, a majority of agricultural lending is done by small and mid-sized banks that have deep roots in their rural communities. Farm loans require specialized analysis and training that not many large banks possess. If depositors pull their money from these small institutions, this could affect the availability of capital for agricultural lending, small business lending, and lending to underserved/underbanked communities.

While concerns surrounding the U.S. banking system have merit, the situation Silicon Valley Bank found itself in was somewhat unique. Nationwide, 45% of all deposits in the United States banks are uninsured; however, at SVB almost 94% of their deposits were uninsured. To stem this evolving bank liquidity crisis, the Fed created a new program to administer additional funding called the “Bank Term Funding Program,” (BTFP). Through this program, banks would be loaned funds if they pledge U.S. Treasury securities, mortgage backed securities, and other collateral. The result would be potentially transferring the risk of bank losses from the bank to the federal government. Through BTFP, the Federal Reserve apparently will provide liquidity to the borrowing bank may give loans based on the par value/cost of the securities rather than its depreciated market value.  In other words, they moved the shadow accounting for unrealized losses to the Fed’s balance sheet.

Safety of the US Banking System

Despite ongoing concerns surrounding the stability of the U.S. Banking system and another potential banking crisis similar to 2008, most economists believe that the U.S. Banking system is sound. On a broad scale, U.S. Banks are solvent overall and are not at a high risk of systematic failure or collapse. While rapid interest rate hikes have caused more severe fluctuations in capital flows in higher interest rate sensitive sectors of the economy, like technology and banks concentrated on that sector, we would expect that most large banks have well-risk-managed investment and lending portfolios and show more of diverse depositor base among sectors. Silicon Valley Bank appears to be a unique case of a large bank that did not properly manage the interest rate or duration risk of its investment holdings and Federal regulators were found asleep on the job again. Small community or regional banks may struggle to diversify their portfolio from a geographic standpoint however their focus gives them the ability to lend to a wide array of small businesses such as farms, retail, commercial property, and others. The investment portfolio of these smaller banks is closely watched by bank regulators as they serve such a large percentage of the total loan volume.

Policy actions and statements from the Fed’s Jeromeggedon and Treasury’s Calamity Janet have many Wall Street economists forecasting the U.S. will be in a full-blown recession by the second half of 2023, potentially forcing the Fed to pivot and begin lowering interest rates. Servant Financial client portfolios continue to stay overweight cash and fixed-income securities relative to strategic risk targets. The Federal Open Market Committee’s (FOMC) decision to raise the Fed funds rate by 25 basis points last week shows that the Fed is prioritizing its “stable prices” mandate over financial stability. We believe this policy decision will ultimately lead to increased financial instability while heightening inflation risk.  As such, we are maintaining underweights to equity and credit risk and healthy portfolio allocations to precious metals and other real assets.

Based on the FOMC’s subsequent actions, we plan on adjusting risk allocations once financial instability and recession risks have been fully repriced.  We expect the Fed will be forced to abandon its inflation fight and lower interest rates materially in the coming quarters. For now, we are advising clients to remain the rational actors that all economists expect us to be. For our portion, that means getting paid to wait by holding excess cash in money market funds with better yields from short-term investment-grade bonds. For example, the Fidelity Government Cash Reserve money market fund (FDRXX) yields 4.3% as compared to just 0.7% more in yield (5.0%) for a high-quality bond fund with a 6-year duration.  This short-term positioning greatly reduces the risk of taking a wait-and-see approach to the rapidly evolving macro, policy, and market backdrop.

Keep it simple with money market funds for your liquid savings as well or keep it local if you can.   Consider maintaining savings accounts or bank certificates of deposit (CDs) of 6 to 12 months at multiple local banks in support of your community. CDs, like checking or savings deposits, are only FDIC-insured up to $250,000 but are now offering rates from 4% to 5%. Ultimately, it is important to do business with people you trust and places you know will be there when you need them. Have conversations with your local banker to find out how protected your money is. Shop around, this is a saver’s dream after nearly a decade of near-zero interest rates.

Disclaimer: This is not investment advice and should not be used in the context of forming an investment portfolio. See your investment advisor or talk with Servant Financial today about how these factors affect your portfolio.

 

 

Twelve Themes of Christmas

Written by Ailie Carlene Elmore

Contributions made by: John Heneghan & Michael Zhao

 

‘Twas the week before Christmas, when all through the financial house, not an investor was resting, not even a DC louse. 2022 brought investors increased market volatility and a wide array of risks and uncertainties remain, yet some opportunities may lie hidden under the Christmas tree. From inflation worries to geopolitical risks, we have been on a wild sleigh ride this past year. But whether you landed on the naughty or nice list this year depended on your ability to navigate the economic whiteouts caused by the likes of the Federal Reserve, Vladimir Putin, and Sam Bankman-Fried.

 

Tis’ the Season for Interest Rate Hikes

On the first day of Christmas, Federal Reserve Chairman stuffed my stocking with 7 rapid interest rate hikes. The Fed has been hiking the benchmark Federal Funds Rate at an unprecedented pace to combat high inflation which is causing concern among investors and consumers alike. As the cost of borrowing increases, whether it’s for a mortgage, car loan, or credit card, it impacts the affordability of goods and services for many households.  People tend to hunker down on spending and are less likely to take on new debt, which impacts aggregate consumer spending and business investment. Recently, the Federal Reserve raised its benchmark interest rate from 4.25% to 4.5% in its final policy meeting of the year. This marks the seventh consecutive increase in just nine months to the highest benchmark interest rate in 15 years.

The Federal Reserve has signaled its desire to keep interest rates higher through 2023 with the potential of rate easing, not until 2024. As a result of the Fed interest rate hikes, mortgage rates have reached 20-year highs, interest rates for home equity lines of credit are at 14-year highs, and car loan rates are at 11-year highs. Savers, on the other hand, are seeing the best bank deposit and bond yields since 2008. The 10-year U.S. Treasury yield hit a 12-year high in September at 3.93% causing foreign investment to flock to U.S. treasuries and spurring strength in the U.S. Dollar. After several years of low-yielding bond investments, investors are busily re-balancing their investment portfolios so they can much more safely jingle their way to their investment objectives.

Source: Statista

 

Dashing through Inflation

Santa’s pocketbook may be feeling a bit squeezed this gift-giving season as inflation continues to rage at the North Pole, particularly for the basic foodstuffs like milk and cookies. The Bureau of Labor Statistics reported earlier this month that the U.S. Consumer Price Index (CPI) saw a 7.1% increase year over year during the month of November, down from annual CPI of 7.7% in October and lower than the 7.3% increase forecast by economists. Importantly, the November monthly increase slowed to 0.1% and was driven into positive territory primarily by rising food (0.5%) and housing costs (0.6%). The PCE Prices Index due this Friday is the last consequential data release for the year. Other data this week mostly focuses on the housing market where home sales have slowed down, but actual prices continue to rise. Still rising housing costs are a problem for the Federal Reserve as “shelter” expenses account for the largest share of CPI. Housing cost increases have been slowing down and many economists believe gauges for both home prices and rents will start to show declines in the coming months.  The Fed’s owner’s equivalent rent measurement is a notorious lagging factor and when this statistic rolls over it may take a substantial bite out of headline inflation.  Supply chain backlogs, rising costs, government spending, labor shortages, and increasing demand have all played a part in elevating inflation to its current levels. As a result, these inflation trends have been the principal driver of the Federal Reserve’s aggressive hiking policy which has economists, investors, and consumers appropriately worried that a Fed-induced recessionary winter storm might be brewing as the Fed overshoots on the hawkish side.

 

Baby, it’s Looking like a Recession

Current economic pressure really can’t stay, baby, it’s looking like a recession. Recession fears are rising as investors lose confidence in U.S. economic performance in the face of an unprecedentedly rapid and yet unfinished Fed hiking cycle. Despite relatively strong economic growth in the third quarter of 2022 and a still low unemployment rate of 3.7%, the Federal Reserve has lowered its forecast for next year’s U.S. economic growth in light of its rate hikes and expects the unemployment rate to rise by the end of 2023 as well. Some believe that the current widespread concerns about a recession may help us avoid one, as caution leads to less risk-taking and borrowing, potentially cooling the economy enough to reduce inflation and the need for further interest rate hikes. Lagging inflation statistics remain elevated and central banks globally are continuing to raise interest rates to destroy demand and slow economic growth in the coming year. More real-time inflation measures, like the Cleveland Fed’s “Inflation Nowcasting” measure, show inflation moderating. Inflation Nowcasting’s fourth quarter run-rate CPI is at 3.5% and Core CPI (excluding food and energy) is at 4.7% suggesting the Fed is “fighting the last war” rather than anticipating what will happen next.

 

The U.S. Dollar All the Way

Santa’s reindeer are taking a new launch angle this year along with the U.S. dollar by soaring to new heights in 2022. The US Dollar Index, a measure of the dollar against a basket of other major global currencies, had been on the rise throughout 2022 but started to taper off in late November and December. Other central banks have joined the competitive rate-hiking game and compressed interest rate differentials. The strong dollar is beneficial for American consumers who purchase foreign goods, as it makes them cheaper in U.S. dollar terms. However, it can be an earnings headwind for American businesses that export goods or have multinational business operations such as McDonald’s and Apple. McDonald’s reported that its global revenue fell 3% this past summer due to the strong dollar as the rising costs of Big Macs have foreign consumers turning to other options. The strong dollar is also a reflection of the relative strength of the U.S. economy compared to other advanced economies, such as those in Europe (Euro) and Japan (Yen). Foreign investors flocking to higher and arguably lower-risk U.S. treasury yields only bolsters the dollar further.

U.S. Dollar Index; Source: Google Finance

Eat, Drink, & Spend like Consumers

U.S. consumers found themselves on the nice list in this year of profligate government spending. The US government gave consumers several nice stimulus checks due to the COVID-19 pandemic.  While some consumers used these relief funds to pay for day-to-day necessities, others have been able to enjoy new furniture, electronics, and vacations that have them saying “Mele Kalikimaka”.  Economists predict this holiday season may be the last fling of spending toward luxury brands and exotic travel. The current level of consumer spending is projected to dwindle towards the end of next year as recessionary fears manifest and unemployment levels grow as the Fed’s aggressive hiking policy takes hold.

 

It’s Beginning to Look a lot like a Labor Shortage

Santa may be having a bit of trouble finding enough elves to manufacture toys in his workshop this year. The COVID-19 pandemic brought about many changes to people’s lifestyles, and many re-evaluated their lifestyles as they were challenged with their mortality. Across the nation businesses in every sector are feeling the pressure to find enough skilled labor to meet the growing consumer demand for goods and services. In 2021, 47 million workers quit their jobs in what is referred to as the “Great Resignation.” The industries hurting the most are food services, manufacturing, & hospitality. Workers have signaled a desire for better company culture, work-life balance, and compensation. Some believe the labor shortage will work itself out if a recession were to occur.   However, others argue that this is just the beginning of secular labor shortages as declining birth rates in the U.S. and other developed nations have economists worried that we are not restocking the world’s workforce fast enough. Maybe Santa will be nice enough to supply us with some of his highly productive elves to bridge this gap until intelligent robotics develop further.

Source: US Chamber of Commerce

 

How Vladimir Putin Stole Ukraine

At the top of most of the world’s Christmas wish list is for the Russian-Ukrainian conflict to be resolved. Not only did the invasion of Ukraine in February bring about economic disruption but it has brought devastation to the Ukrainian and Russian people. It is estimated that close to 7,000 civilians in Ukraine have lost their lives in the conflict. The power-hungry, Russian Grinch Putin, is committed to overtaking Ukraine for strategic access to important trade routes and resources. Currently, Russia is occupying several major port areas along the Black Sea.  The Ukrainian defense has been putting up a strong fight with the help of $32 billion and growing of financial support from U.S. taxpayers.  Several trade restrictions and sanctions have been put into place to hurt Russia financially.  However, since Russia is the global largest energy supplier of natural gas and oil, these sanctions are only putting more extreme pressure on energy prices worldwide. Ukraine is also a large exporter of agricultural products, and the conflict has caused several production and logistics issues for Ukrainian farmers. Commodity prices have climbed as a result, particularly for wheat. While the conflict today looks unresolvable, maybe Grinch Putin’s heart will grow three sizes and he’ll decide to shower Who-ville with presents instead of artillery.  “Fahoo fores dahoo dores!”

Photo Source: Behance

Source: Wikipedia

 

Making Energy Bills Bright

As the war between Russia and Ukraine rages on, energy bills for people around the world continue to climb. Oil and natural gas prices have soared in 2022 with Europe being hit hardest by the jump given its deep dependence on Russian natural gas. In August, gas futures hit a record high of 350 euros creating immense pressure for European nations to set price limits on natural gas. Household electricity prices from natural gas-fired plants have increased in Europe by 67% in just one year, stopping some Europeans from lighting their Christmas trees this year. The European energy ministers imposed an electricity price cap this week to help lessen the burden on consumers. The United States has also felt the brunt of high energy prices as power prices rose almost 16%, the highest increase in 41 years. Consumers also felt the pressure at the gas pump as the average price of a gallon of gas rose to $4.96. Maybe in 2023, we can be like Santa and his reindeer-powered business model by running more of our economy on renewable energy.

 

Cryptocurrencies Roasting on an Open Fire

Cryptocurrencies roasting on an open fire, Sam Bankman-Fried nipping at your confidence. One of the largest cryptocurrency exchanges and hedge funds, FTX, filed for bankruptcy this November after information was released about its risky holdings and clandestine relationship with its affiliated hedge fund Alameda Research spooked many of its exchange customers. Several exchange customers sought to withdraw their crypto holdings from the FTX exchange, prompting the bankruptcy filing of the company.  It turns out FTX was another Ponzi scheme or con game with apparently none of FTX’s well-healed venture capital investors doing any due diligence or demanding a role in corporate governance. The price of Bitcoin has fallen 65% in the past year with investors losing confidence in an asset class imputatively regulated by the SEC and Commodities Futures Trading Commission (CFTC).  The CFTC has defined bitcoin as a commodity, but a turf war has continued with SEC creating regulatory uncertainty and ample opportunities for miscreants.  FTX was a Bermuda-based firm regulated by the Securities Commission of the Bahamas.  The SEC could have required crypto exchange registration and reporting and U.S. domestic incorporation.   Former FTX CEO, Sam Bankman-Fried, has agreed to extradition and will now be answering to the Justice Department and SEC for violations of wire fraud, money laundering, securities fraud, commodities fraud, and conspiracy to violate campaign finance laws. The once shiny wrapped package that was FTX Digital Markets now looks like a lump of coal.  Expect the naming rights for FTX Arena, home of the Miami Heat, to become available soon and most of FTX’s liberal political contributions to be returned to the bankruptcy court. Bernie Madoff will look like a petty thief compared to SBF.

 

Dreaming of Student Loan Forgiveness

About 43 million Americans received a nice Christmas present from President Biden this year, with forgiveness for part of their $1.6 trillion student loan debt. President Biden announced the plan earlier this year sparking both joy for recipients and scrutiny from every other U.S. citizen. The plan would eliminate $10,000 in federal loans for individual borrowers making less than $125,000 per year or couples earning less than $250,000 annually. Pell Grant recipients, which account for 60% of current student debt holders, could receive upwards of $20,000 in forgiveness. However, this largesse begs the question of where the money for this forgiveness will come from as the US government already is $31 trillion in debt.  Biden’s Executive Order faces many legal challenges in Congress and the Supreme Court to overcome and move this profligate effort forward.

 

All I Want for Christmas is Farmland

The bright star on top of the investment tree this year is an asset class that has been at the top of many institutional investors’ Christmas wish lists all year, U.S. farmland. Farmland hasn’t always been seen as an accessible investment option.  However, farmland funds such as Promised Land Opportunity Zone Fund and others have been formed to allow investors access to in this durable, inflation-beneficiary asset class. Iowa State University recently reported farmland values in Iowa were up 17% in 2022 which comes on top of a 29% increase in 2021. Similar stories have been reported throughout the Midwest as strong commodity prices fuel farm incomes and transacted land values. The COVID-19 pandemic had people re-evaluating what is important to our world with basic human needs, like food, at the top of the list. While consumer preferences and social trends may change, people will still need to eat, making farmland one of the most durable asset classes through time. This has many investors saying “All I Want for Christmas is Farmland.”

 

We Wish You a Diversified Portfolio

At Servant Financial, our goal is to help you navigate these turbulent times and help you make the best decisions for your investment portfolio. We understand increased market volatility may be causing investor unease, but it is times like these that the basic investment principle of portfolio diversification proves its mettle.  With inflation still a concern and US treasuries on the rise, we are paying close attention to iShares 0–5-year TIPS Bond ETF, STIP. With low management fees (.03%) and a 30-day SEC yield of 5.84%, its 2.5-year duration could be an ideal addition to a blended debt and equity portfolio.  The principal value of TIPS (upon which the stated interest is paid) is adjusted semiannually as inflation rises, as measured by CPI.  STIP holds a variety of U.S. treasuries with maturities of less than 5 years protecting you against rising interest rates and inflation.  STIP is a core holding of Servant’s risk-based client portfolios.

 

Happy Holiday’s from your friends at Servant Financial and we wish you a globally diversified portfolio.  

Instead of holiday cards or gifts, Servant Financial will be making an annual contribution on behalf of clients and friends to Mercy Home for Boys & Girls.

May this holiday season be a time of rich blessings for you and your family.

Source: Pinterest

Wild Turkey Inflation Run

Written by John Heneghan

Equity and bond market investors have a very busy week ahead of them after giving thanks with friends and family this past week.  The Federal Reserve also has its work cut out for them on the inflation front.  Unfortunately, a lackadaisical Fed Reserve has let inflation go on a wild turkey run. The latest Consumer Price Index (CPI) reading for October 2022 came in at a roasting annual increase of 7.7%.  As usual whenever inflation is an issue, it’s typically driven largely by the necessities of human existence.  Energy prices increased most of the CPI measurements at 17.6% followed by food increases of 10.9%.

According to the University of Illinois, 46 million turkeys are eaten each Thanksgiving.  The American Farm Bureau Federation estimated that the average cost of this year’s Thanksgiving holiday meal for ten people increased 20% to $64.05 from the 2021 average of $53.31. America’s collective Thanksgiving spending increased more than $225 million for just the turkey and not counting side dishes (46 million times $4.97 AFB price increase for turkey). U.S. Secretary of Agriculture Tom Vilsack had previously warned all Americans of a large turkey shortage. Free-market Austrian economists chortled that Secretary Vilsack had neglected to count the docile turkeys at the Federal Reserve and in leadership in the executive and legislative branches of the Federal government.

All kidding continued, let’s talk turkey about inflation. The greatest economic uncertainty and focus for investors seems to be whether the Federal Reserve gaggle is succeeding in reining in inflation or not. Stock market bulls are feeling a little more confident that the Federal Reserve is moving closer to ending its tightening program after “minutes” from the November policy meeting showed “most” of the Fed herd favored slowing the pace of interest rate hikes “soon.” According to the Fed minutes, some turkeys even warned that continued rapid monetary policy tightening increased the risk of instability or dislocations in the financial system.

Most Wall Street experts predict the central bank clucks will raise the benchmark rate by 50-basis points at its upcoming December 13-14 meeting following four consecutive 75-basis point hikes. The most important inflation updates this coming week will be the PCI Prices Index on Thursday and the November Employment Situation on Friday. Investors are also anxious to hear Top Cockster Jerome Powell discuss the US economic outlook during an appearance at the Brookings Institute on Wednesday afternoon. Powell recently crowed that the Fed could shift to smaller rate hikes next month, but, like all two-handed economists, also squawked that rates may need to go higher than policymakers thought would be needed by next year. Stock market bears maintain that the more important issue is how high rates will ultimately need to go and how long the Fed will hold them there.  All of which is of course dependent on how fast inflation comes down. This is the key question being debated among economists, business leaders, investment advisors, and investors.

For their part, the Fed members generally see inflation coming home to roost rather quickly.  The range of Fed member projections from their last dot plot exercise in September, 2022 are as follows – 2022 (5.0% to 6.2%), 2023 (2.4% to 4.1%), and 2024 (2.0% to 3.0%).  This Federal Reserve has lost an incredible amount of market credibility by being stubbornly beholden to its “inflation is transitory” mantra in 2021. It’s prudent for all economic actors, particularly low- and middle-income consumers and workers who arguably suffer the greatest hardships during inflationary periods, to at least consider that the turkeys at the Fed are once again being too optimistic on inflationary trends.  If the moral sense of the global working-class population is that inflation is a secular trend, it may likely become a secular trend. Look for striking workers and protesting citizenry in the U.S. and globally.

I believe it was Founding Father Patrick Henry of “Give me liberty or give me death!” fame that also counseled, “I have but one lamp by which my feet are guided, and that is the lamp of experience.  I know no way of judging the future but by the past.”  Thankfully, the investment professionals at Research Affiliates (RA) have examined inflationary eras of the past in their recent article, “History Lessons: How “Transitory” Is Inflation?” RA examined a meta-analysis of 67 published studies on global inflation and monetary policies.  Their key conclusions from their study were as follows:

  • The US Federal Reserve Bank’s expectation for the speed of reverting to 2% inflation levels remains dangerously optimistic.
  • An inflation jump to 4% is often temporary, but when inflation crosses 8%, it proceeds to higher levels over 70% of the time.
  • Reverting to 3% inflation, which we view as the upper bound for benign inflation, is easy from 4%, hard from 6%, and very hard from 8% or more. Above 8%, reverting to 3% usually takes 6 to 20 years, with the median of over 10 years.
  • Those who expect inflation to fall rapidly in the coming year may well be correct. But history suggests that’s a “best quintile” outcome. Few acknowledge the “worst quintile” possibility in which inflation remains elevated for a decade. Our work suggests that both tails are equally likely, at about 20% odds for each.

As Fed Chair Jerome Powell remembers well because he lived it, the last secular inflationary episode in the United States was in the 1970s and 1980s.  If Shakespeare is right that “What’s past is prologue,” here is a summary of the return performance of various major asset classes in the 20-year inflationary period from 1970 (CPI breached 6% in 1969) to 1986 (CPI declines to 1%) to illuminate the darkness of an unknown investment future.

Source: Data complementary of the TIAA Center for Farmland Research

The best risk-adjusted return profiles from this secular inflationary period were high quality fixed income instruments of varying maturities and farmland. Note that farmland and bonds were negatively correlated over this period so may complement each other rather nicely in a portfolio positioned for secular inflation.  REITs and gold provided similar annual returns but at much higher levels of volatility/standard deviation.

In bowling, three strikes in a row is called a turkey. In economic parlance, that’s the triptophanic effect of the sleepy leadership at the Federal Reserve and in the executive and legislative branches of the Federal government.

Almighty Dollar

Written by Ailie Carlene Elmore

Current Status of US Dollar

What do George Washington, Abraham Lincoln, and Benjamin Franklin have in common? These three American icons found on the $1, $5, and $100 bills have been getting much stronger the past several months. The U.S. dollar is undergoing one of the longest periods of almost steady appreciation in several decades impacting domestic and foreign economies alike. The ICE U.S. Dollar Index, the most widely adopted currency index, measures the international value of the US dollar against other major fiat currencies with a weighting of Euro (58%), Japanese Yen (14%), British Pound (12%), Canadian Dollar (9%), Swedish Krona (4%), and Swiss Franc (4%). The buck’s value is currently up 22% since the start of 2022 with little end in sight.

Source: Wall Street Journal

The rise in the dollar’s value is unsurprising as record inflation in the United States has prompted the Federal Reserve to aggressively raise interest rates over the past several months. Just last week, the U.S. central bank decided on another .75 percentage point increase, the third consecutive rate hike. This pushed the implied Fed funds curve higher, with terminal Fed funds now expected to peak at 4.6% and remain above 4.0% through the end of next year. The yield curve inverted further with the 2-year versus 10-year treasury spread at 50 basis points (0.5%).  These changes in the risk-free U.S. treasury rates are driving the cost of capital higher for all risk assets and significantly impacting equity and currency markets. While the stock market has experienced significant losses, the dollar has been benefiting from increased capital flows due to rising treasury yields. The U.S. 10-year treasury note is at a multi-year high, yielding over 3.5%. Rising U.S. interest rates have foreign investors flocking to higher-yielding U.S. treasuries and pulling capital out of lower yielding, perhaps riskier currencies, bond and equity investments in other countries. This trend is particularly visible in energy dependent jurisdictions like the European Union, China and Japan.

Impact of the US Dollar on the Global Economy

Efforts to combat inflation through interest rate hikes have been counteracted by the strengthening dollar, fueling cheaper imports for the American people. However, the rest of the world has felt the brunt of this change. The economies being hit hardest by the punch of the U.S. dollar, are some of the U.S. largest trading partners: China, Japan, and Europe.

On September 26th, the British pound hit its lowest value ever against the U.S. dollar, sending U.K. bond yields soaring. Emerging economies have also declined in value relative to the dollar with currencies in Egypt, Hungary, and South Africa falling by 18%, 20%, and 9% respectively.

Not only are rising U.S. interest rates impacting these economies, but geopolitical concerns between Ukraine and Russia have Europe in an economic war of its own with Russia. Combined with surging inflation and the aftershocks of the COVID-19 pandemic, the war between Russia and Ukraine has Europe in an energy crisis, only furthering their currencies’ devaluation. Energy prices have skyrocketed while supply dwindles as Europe, particularly Germany, was very heavily dependent on natural gas imports from Russia for its global manufacturing base and winter heating. As European countries are forced to look to the U.S. and other markets for alternative oil and gas imports, the devalued Euro currency is only deepening the economic damage as most imports are traded in U.S. dollars.

Domestic companies with international operations are also being squeezed by the strong dollar. McDonald’s reported global revenue fell 3% this past summer while Microsoft stated that the changes in foreign currency values cut their revenues by close to 1% in the last quarter. According to a report by CBS news , companies comprising the S&P 500 receive 40% of their revenues from foreign countries. This has only added fuel to the downward spiral of the stock market as earnings expectations are lowered due to foreign currency translation losses and inevitable demand destruction. Domestic and foreign companies alike are pointing at the U.S. monetary policy as the root cause of the dramatic economic slowdown globally.

Investment Opportunities

In every market scenario there are winners and losers, and the current strength of the U.S. dollar is no different. While the U.S. stock market has entered a bear market with 20% declines across most major stock indices, treasuries and corporate bond yields have been on the rise in recent months as outstanding bond prices have declined in response to Fed interest rate hikes. Moody’s reports Aaa corporate bonds are currently yielding 4.65% which is up from 2.60% just a year ago while Baa bonds are currently yielding 5.78% on average, up from 3.26% a year ago.

Source: Bloomberg

The looming energy crisis in Europe has some adventuresome investors looking to clean energy options to capitalize on potential long-term secular growth. Even though the energy crisis is worse in Europe, the U.S. has still experienced stubbornly high oil, gas, and electricity prices over the past few years, contributing to the high inflation rate. Last month, we told you about the iShares Global Clean Energy ETF (ticker: ICLN) and the First Trust NASDAQ Clean Edge Green Energy Index Fund (ticker: QCLN) with assets under management of $5.5 billion and $2.4 billion, respectively. Each ETF has demonstrated strong 10 year returns and the government has deepened its commitment to clean energy through the Inflation Reduction Act, meaning this strong performance is likely to persist in the future.

One way to make a contrarian play on the strength of the U.S. dollar waning, or mean reverting over time, would be to invest in a basket of emerging market currencies which for the most part are energy and resource rich.  We explored these alternatives on Research Affiliates Asset Allocation Interactive website seeking a fixed income alternative that is expected to pay a real yield (nominal yield less expected U.S. inflation of 4.0%) and an attractive Sharpe ratio (return per unit of risk).  Perhaps the best alternative was Emerging Market Cash asset class.  As of August 31, 2022, Research Affiliates expects EM Cash to generate a real return of 2.4% (real return in excess of U.S. dollar cash of 4.6%, ie. real loss of (2.2%) holding U.S. dollar) with volatility of 7.2%. This compares to a real return of (0.4%) with volatility of 3.8% for U.S. Treasury intermediate bonds.  Of note, Research Affiliates’ risk and return metrics for the EM Cash asset class were derived using a variety of information, including using the J.P. Morgan ELMI+ index as a representative example.  Servant Financial portfolio models generally include an allocation to the J.P. Morgan EM Local Currency Bond ETF (EMLC).  EMLC yields over 7% and is comprised of mostly investment grade (72%) sovereign debt obligations in local currencies.  The top 4 currencies represent 38% of its holdings – Indonesian Rupiah (10%), Chinese Renminbi (10%), Brazilian Real (9%), and Mexican Peso (9%).

As you might expect, the price of EMLC has been declining in line with the U.S. dollar strength this year.  We rebalanced the model portfolio last week and at much earlier juncture in 2022 where EMLC was among the list of buys both times.  Rebalancing is a prudent investment practice whereby investors buy more of their losing positions and sell winners to get back to overall targeted asset class allocations. Research Affiliates recommends modest allocations to EM Cash of 2% to 4% in conservative to aggressive risk models.

Conclusion

2022 is turning out to be one for the financial record books as inflation, geopolitical pressures, and the bear market has George Washington, Abraham Lincoln, and Benjamin Franklin being stretched in every direction in our wallets. Global recession concerns are rising as the Federal Reserve’s high conviction battle with inflation is affecting consumers and markets all over the world. As participants in a global economy, we need to remember the words of the man found on the $5 bill. “The money power preys on the nation in times of peace and conspires against it in times of adversity. It is more despotic than monarchy, more insolent than autocracy, more selfish than bureaucracy. It denounces, as public enemies, all who question its methods or throw light upon its crimes.” -Abraham Lincoln.

The ubiquitous strength of the almighty dollar and resultant market mayhem suggest the Jerome Powell led Federal Reserve is currently playing the role of Lincoln’s “money power.”  The Fed is wielding economist Adam Smith’s “invisible hand” with brass knuckles as it tries to break the back of inflation.  The potential collateral damage of the Fed’s heavy-handed approach include the domestic and global economies, the credibility of the Fed, and the almighty dollar’s dominance as the sole global reserve currency.

The Rollercoaster Market

Written by Ailie Carlene Elmore

Disclosure: This is not investment advice. Consult your investment advisor to make decisions appropriate for your portfolio and life circumstances.

Current Status of Financial Markets

Financial markets have twisted and turned throughout much of 2022 as investors react to inflation, interest rate hikes, and looming concerns from the COVID-19 pandemic. The year-to-date graphs of market indices mimic a rollercoaster heading down a sharp drop before leveling off prior to its next unknown feature – steep ascension, another drop, or into a nauseating barrel roll.  See Figure 1. Ironically, the oldest roller coasters are believed to have been the Russian Mountains, specially constructed ice hills located in St. Petersburg. As in any time in financial history, there are a variety of interlocking factors impacting markets and bringing about recessionary fears. Current circumstances may drive some investors to get off this rollercoaster market, but more seasoned investors will understand the importance of sticking to the long-term plan and riding out the volatility.

Figure 1: Market Indices Performance Year-to-Date

Source: Wall Street Journal

In February, we discussed the impact rising inflation was having on the global economy and since then inflation pressures have remained high. The U.S. annual inflation rate slowed slightly in April to 8.3% from 8.5% in March with the largest inflationary pressure stemming from the energy and food sectors. That comes as no surprise considering the U.S. average gas price is at $4.60/gallon, up from $3.04/gallon just one year ago. Escalating inflation prompted the Federal Reserve to adjust its monetary policy by raising interest rates 0.50% on May 4th, the biggest increase in two decades. Based on Fed Chairman Jerome Powell’s remarks after the decision, more 50-basis point rate hikes should be expected to curb inflation. The Federal Reserve’s policy actions prompted 30-year fixed-rate mortgages to rise to 5.27% on May 5th.   Home sales are starting to slow as financing becomes more expensive and house ownership less affordable for consumers. Americans are beginning to wonder if there is an end in sight to rising costs and fluctuating financial markets.

Another factor causing inflationary pressure for consumers is ongoing supply chain issues. It has been more than two years since the start of the COVID-19 pandemic; however, the U.S. supply chain continues to struggle to meet demand. Recently, supply chain woes have especially impacted families with infants due to the baby formula shortage caused, in part, by bacterial contamination in Abbott Nutrition’s factory in Michigan. Abbott accounts for 40% of the market share for baby formula and the resulting plant closure has decimated the supply of baby formula. Supply chain shortages continue to be an issue in every industry from car manufacturing to food production. Not only is there a shortage of raw materials, but labor shortages have become a mounting problem. Shortages in truck drivers and warehouse workers are greatly impacting the manufacture and delivery of raw materials and finished goods.

On top of all this, geopolitical issues are straining global financial markets as the desire for socioeconomic justice persists. The Russian invasion of Ukraine has caused the U.S. and several other countries to place economic sanctions on Russia. The U.S. has focused its efforts on sanctioning Russian banks, bans on Russian oil and travel, and asset confiscations for Russian oligarchs, among other things. The European Union (EU) has responded similarly to the U.S. and is now proposing a complete ban on Russian oil which would likely put further pressure on global oil and gas prices. The EU, particularly manufacturing powerhouse Germany, is highly dependent on Russian natural gas and oil.  Looming geopolitical pressures between China and Taiwan have also sparked more volatility in financial markets as President Biden said on May 23rd that the U.S. would defend Taiwan if China invaded. An invasion of Taiwan could bring about enormous economic disruption between the U.S. and China, causing more supply chain and inflation problems as China is the United States’ largest trading partner.

Bear Market Territory

The recent stock market drop from nose-bleed valuations was incited by unabated inflation and the Fed’s untimely interest rate hikes to “rail in” its excessively accommodative monetary policy. The Fed is playing catchup after continuously assuring markets that inflation was transitory. Unfortunately, markets have suffered from this adjustment, and bear market worries have ensued. Technically, a bear market occurs when an index or individual stock takes a roller coaster-like plunge of 20% or more from a recent high. The S&P 500 has been hovering near bear market territory as it is down -17.8% year-to-date. The Nasdaq is already in bear market territory down -28.0% year-to-date.  The Dow Jones Industrial index has experienced a tamer ride, down -12.1% year-to-date. These metrics have investors on this monetary policy-induced joy ride wondering if they need to be concerned with a longer-term bear market and a potential recession or worse. Experts at Moody’s analytics and the Wall Street Journal say that the chance of a recession is around 30% and will increase if inflation is not subdued.

Seasoned investors know that bear markets are inevitable, and they don’t last forever. See Figure 2. The most recent bear market in the S&P 500 was prompted by the COVID-19 pandemic and economic fallout from government-mandated lockdowns which caused the index value to fall -34%. However, this steep drop was followed one month later by an epic ascension. See Figure 3. Other recent bear markets such as those associated with the Global Financial Crisis and the Tech Bubble burst lasted 17 and 31 months, respectively, before climbing back into a bull market. While this graph might shake younger, trade-oriented investors, seasoned investors understand that this is another cycle that the market must take.

Figure 2: Historical Bear Market Cycles

Figure 3: Historical Bear Market Events

Market Performance of Non-stock Market Investments

Although the broad stock market has been descending since January, other sectors have experienced positive returns. For example, the energy sector has been profiting from the runup in overall energy prices and Bloomberg reports the sector is up 1.9% this year. This is the second-best sector performance behind consumer discretionary spending which is up 3.0%. Not only is traditional energy investing trending right now but more investors, particularly, ESG (Environmental Social and Governance) investors are allocating more capital into the alternative energy space. Rising oil prices have both investors and consumers realizing the United States needs to evaluate its dependence on fossil fuels and how the transition to renewable energy sources could be managed more smoothly and strategically.

Another industry experiencing favorable returns year-to-date is the agricultural industry. The COVID-19 pandemic and rising inflation only highlighted the importance of a stable, secure food supply and that regardless of what is happening in the global economy, people still need to eat. Farmland, which historically has a positive relationship with inflation, has experienced strong returns throughout 2021 and 2022. Farmland values have soared 20-30% this year alone with the largest gains seen in the Corn Belt of the Midwest. Strong commodity prices are bolstering returns as corn, soybean, and wheat prices have been surging due to the geopolitical uncertainty in Russia and Ukraine, both large producers of bulk agricultural commodities. While the U.S. growing season is just getting started, strong grain prices are making for favorable market dynamics and improved farm profitability.

Riding the Volatility Spins

The volatility in the stock market may have some investors worried about their portfolio security.  If market history has taught us anything, it’s those long-term investors that get in and stay in that realize the best investment performance.  Trying to time the market’s natural gyrations is generally a fool’s errand.  Staying the course with a sensible asset allocation and enjoying the ride has proven itself time and time again.

The S&P 500 has a 20-year total return of 9.5% and as investors allocate more to stocks and less to bonds, their return potential rises. See Figure 4. Allocating more to stocks also historically means more volatility.  Figure 4 also shows that the longer the investment horizon, the lower the overall risk. Investing just 1 year in any asset can give any investor significant exposure to risk but as their investment horizon lengthens, they can smooth out much of that volatility associated with shorter time horizons. If we compare the recent year-to-date graphs of market indices (Figure 1) with the long-term performance of each of these indices we see that while there are periodic dips, in the long run, the market proceeds on a steady upward trend. This comparison leads to the conclusion that the best thing to remedy volatility, is time. The same goes for riding a rollercoaster. While on the rollercoaster, you may be tempted to want to stop the ride on that nauseating barrel roll. But if you roll with the changes and ride it out to the end, you may realize the thrill and enjoyment and find yourself back on the ride again.

Figure 4. Historical Returns Through Time

Going, Going, Gone! Is Inflation Running Away with our Money and our Investment Returns?

Written by Ailie Carlene Elmore

On the field that is the U.S. economy, currently loading the bases are looming interest rate hikes, the value of the U.S. dollar, and rising Treasury yields. On the mound, is Federal Reserve Chairman, Jerome Powell, and everyone from investors to consumers are waiting to see what will happen next with monetary policy and the economy. Early in the game, the COVID-19 pandemic threw a curveball, and ever since, the economy has been dribbling a series of weak grounders from persistent unemployment, to supply chain disruptions and a declining labor force participation rate. Will Chairman Powell toe the rubber to strike out runaway inflation and imperil economic growth or is the US economy in for extra innings?

How did inflation get so out of hand?

The U.S. Bureau of Labor Statistics reported that in January 2022, the consumer price index rose 7.5% from January 2021, the highest rate of inflation since February of 1982. Some of the industries seeing the largest price hikes are the energy, gasoline, housing, and food sectors which is of no surprise for anyone who has bought groceries or visited the gas pump lately. Even with the rise in prices, it hasn’t generally stopped consumers from spending. The Commerce Department reported that retail sales are up 3.8% year over year with large gains reported in vehicle, furniture, and building supply purchases. Home sales have been on the rise as well with the National Association of Realtors citing that home sales in January were up 6.7% from the previous month. This comes as home buyers are trying to secure financing at lower interest rates before the anticipated Federal Reserve rate increase next month.

Source: SpringTide US. Inflation Trends

While this level of inflation is unlike anything Americans born after the 1970s and early ‘80s have ever experienced, many economists are not surprised by this spike in the CPI. The federal government has shelled out more than $3.5 trillion in COVID-19 relief funding in the form of stimulus checks, unemployment compensation, and the paycheck protection program. The figure below shows the allocation of this spending with more spending earmarked through 2030 as the government continues to combat the aftershocks of the pandemic. The excess liquidity in the market, combined with the supply chain disruptions and labor shortages, has created the perfect cocktail for inflation to brew. While this spending was necessary to keep the economy out of a recession, some argue the federal reserve hasn’t been aggressive enough in unwinding its pandemic era policies to combat rising inflation. The Federal Reserve has announced that rates will start to rise in March, but by how much? Experts, such as economists at Citibank, are predicting anywhere from a 25 to 50-basis point hike with the later end of the spectrum becoming more likely as inflation rises. They are then expecting three to four more 25-basis point hikes by the end of 2022. Economists feel this could help slow inflation by the end of the year, but supply chain disruptions and incipient wage inflation risk still loom.

Source: CNBC analysis of Treasury data compiled by the Pandemic Response Accountability Committee

Is 2022, the new 1980?

The survivors of the last battle with inflation in the 1970s and 80s know all too well what runaway inflation looks like.  It has some questioning whether we are in for a blast from the past in 2022. Inflation peaked in 1980 at 14.8% and while we haven’t hit those levels yet, the jump we have experienced has people on their toes for a line drive heading for them. Inflation in the ’80s was driven by a variety of factors from unpredictability in interest rates to soaring oil prices. Most economists believe that this time is different than the 1980s as recent inflation has been caused by COVID-19 aftershocks of excess liquidity and supply chain issues. These factors are expected to normalize over time.

Examining our Investment Strategy

Markets have been off to a shaky start in 2022 with inflation and geopolitical risks in Russia & Ukraine driving the recent volatility. Economists and investors worry that if war broke out between Ukraine and Russia, it could cause more supply chain disruptions of commodities which could prolong inflation. While the Federal Reserve’s announcement of a March interest rate increase has curbed some concerns about more inflation, these new geopolitical risks could overshadow efforts to reduce inflation through monetary policy. As a result, investors are watching markets closely in addition to exploring inflation-protected physical assets such as gold or farmland. Below is the historical correlation between several asset classes and the consumer price index using returns data from 1970-2020. The CPI has historically had a positive relationship with bonds and precious metals but a negative relationship with equities.

Source: Data supplied by the TIAA Center for Farmland Research

Physical assets such as precious metals and farmland have taken center stage the past few months with gold values up 5.3% year to date and farmland values up 22% in parts of the Midwest since this time last year. While these physical assets have been investors’ go-to during high inflationary periods in the past, investors have also been allocating more of their portfolios to cryptocurrencies as well. Cryptocurrencies have a relatively short history compared to traditional assets which makes it difficult to analyze their performance with inflation, however, some investors are calling it “digital gold.” Even Mr. Wonderful, Kevin O’Leary, claims that his portfolio has more holdings in cryptocurrencies now than gold. Crypto enthusiasts cite its ability to be shielded from the effects of government money printing and spending largesse.

Servant Financial has been keeping tabs on inflation and has updated its investing strategy accordingly based on investors’ risk tolerance. While we are still allocating a portion of portfolios to equities and fixed income instruments, we’ve had a higher portfolio tilt towards allocation to precious metals, real assets, and Grayscale Bitcoin Trust (BTC) as protection for client portfolios from inflation. INFL, Horizon Kinetics Inflation Beneficiaries ETF, has recently been added to the portfolio as well. It is an actively managed ETF designed to capitalize on growing inflation trends. Currently, INFL has $896 million assets under management with holdings in transportation, financial exchanges, energy and food infrastructure, real estate, and mining companies. While INFL has a diverse group of global holdings, its top holdings are in PrairieSky Royalty (Oil & Gas), Archer Daniels Midland (Food & Agribusiness Processing), and Viper Energy Partners (Oil & Minerals).

While inflation has threatened investors’ portfolio returns, an adjustment in investment strategy for the purposes of inflation hedging will help investors score in the performance game in the later innings of this economic cycle. A watchful eye must be kept on key economic signals such as changes in interest rates, inflation trends globally, and the supply chain normalization. If you would like to discuss your asset allocation so you can do well in all facets of the investment game like the alert and observant Willie Mays, the Say Hey Kid (Say who. Say what. Say where. Say hey.), contact Servant Financial today.

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