What could today’s spiking inflation mean for you?

“Those who cannot remember the past are condemned to repeat it." — George Santayana.

 

Stock, bonds and real estate markets could be profoundly hurt by rising interest rates. The Federal Reserve is caught in a terrible predicament. It must quickly raise interest rates to stop today’s unanticipated rise in inflation without bursting the stock, bond, and real estate market bubbles. Not since the double-digit inflation in the late 1970s, has the Federal Reserve been so wrong.  

 

The massive monetary and fiscal stimuli of the last two years are driving today’s spiraling inflation. Likewise, in the 1970s, spending on the Vietnam War drove an inflation spiral resulting in a steady rise in consumer prices or CPI from 5.7% in 1976 to 13.5% in 1980. 

 

To quell the uncontrollable inflation, then President Jimmy Carter appointed Paul Volcker in 1979 to chair the Federal Reserve. Led by Volcker, the Federal Reserve raised the Fed Funds Rate — the rate banks borrow from each other for overnight loans — to 22% by December 1980. This led to destructive bear markets for stocks and bonds. In 1982, money markets yielded 18%, 10-year U.S. Treasury Notes yielded 15% and mortgage rates were over 15%. 

 

If inflation spirals higher and the Fed does not successfully tame inflation, interest rates will move meaningfully higher. Further, if the Fed tightens too quickly, equity markets could decline 30% to 50%. This market resembles both 1987 and 2000, when both periods experienced sharp parabolic rises that led to 33.5% and 52% declines in the S&P 500, respectively.

 

Interest rates have declined for 40 years and have been a boon to stocks, bonds, and real estate prices. Today’s rising inflation suggests we are entering an inflationary period. Reducing interest rates risk by selling long duration assets like bonds and growth stocks makes sense. Long term bonds are a potential serious risk. Interest rate guru James Grant wryly says, “Bonds are interest free risk.” Most think bonds are risk free interest. 

 

While inflation, interest rates and the market may not experience meaningful change, the equity markets are likely to change leadership. By emphasizing inflation beneficiaries like value stocks, commodity stocks, emerging markets, and precious metals — pretty much everything which has not experienced a massive rise in the last seven years — investors could reduce portfolio risk and prosper. In stark contrast, the S&P 500, the NASDAQ 100 index and FAANG+ stocks, could see sharp declines due to their parabolic runs and rich valuations. 

 

Unfortunately, man is a herd animal who assumes that what has worked in the past will work in the future. We are in the midst of a generational reversal in interest rates trends. 

 

Consider these prudent ideas:

 

• Investors should seriously review their financial plans and discuss with their financial advisor protecting their assets should market conditions change. 

 

• Home buyers should lock in low interest rate mortgages. Homeowners should consider refinancing their mortgage especially if the mortgage is over 4%. If your mortgage is a floating loan, you might want to convert to a fixed-rate mortgage.

 

• Pay down your credit card debt or any debts which are not fixed.

 

Tyson Halsey, CFA, has been in Barron’s, The Wall Street Journal, routinely published on Seeking Alpha and manages a Daniel Island-based investment advisory. He has managed investment advisories and hedge funds and commenced his Wall Street career on the New York Futures Exchange in 1984.