Power Up Wealth podcast – Blindfolded – Driving a 25 Trillion Economic Machine – Episode 18 transcript:
Sharla Jessop 0:00
The Federal Reserve has over 400 Ph.D. economists trying to drive the $25 trillion US economy. Find out why they may be driving blindfolded with my colleague and guest, James Derrick.
Welcome to the SFS Power Up Wealth Podcast, where we provide impactful insight and expert opinions on timeless financial principles and timely investment topics, preparing you to make smarter decisions with your money.
James, thank you for joining me today.
James Derrick 0:47
Happy to be here.
Sharla Jessop 0:48
James is the Chief Investment Strategist at Smedley Financial Services. He holds a CFA and Behavioral Finance Adviser designations. James, the Federal Reserve Chair and committee have a huge responsibility when it comes to guiding the direction of the US economy. One would think that they might have all the answers. Explain some of the challenges that they’re facing.
James Derrick 1:09
Well, the Federal Reserve has two mandates, and that is to seek full employment and keep inflation low. You know, in the tease you mentioned that it’s like driving a car blindfolded. And that is a saying it’s like driving a car blindfolded while getting instructions from somebody sitting in the back looking through the back window. I mean, it’s a very difficult job. And they can only look at the data in the past and try to extrapolate it into the future and take their best guesses at what the future is going to look like and how they need to make adjustments. So it’s quite a difficult job that they have.
Sharla Jessop 1:44
What are the two driving components of the Federal Reserve?
James Derrick 1:48
So they want to get full employment. And it’s debatable what that number is. But typically, anything less than 5% is considered full employment because there’s always people looking for jobs, people switching jobs, that kind of thing. And so it’s not actually zero, zero employment, but probably 5%, unemployment is considered full employment. And then low inflation, which you know, the optimal inflation rate is probably about 2-2.5 percent, something like that. And so, they need to focus on both of these at the same time. And they’re kind of competing goals.
Sharla Jessop 2:20
I think that we have been conditioned to think of low unemployment as a golden ticket to a successful economy, but it may be perpetuating the problem they’re trying to fix.
James Derrick 2:31
Well, last year, they had their focus very much on employment. Coming out of 2020, they wanted to get everybody back to work. And I think that’s a really good goal, obviously. So employment was coming down and the things were doing really well in the economy, and people were feeling good about it. And just then prices started increasing. We had a disruption in supply. There was huge amount of demand from Americans who had plenty of money, after 2020 and 2021 handouts and demand was high, supply was was cut off and so prices started increasing. And I think that employment, the focus on employment by the Federal Reserve delayed them in making changes.
Sharla Jessop 3:16
So they were a little slow in the beginning to make the changes that they should have made.
James Derrick 3:19
Totally slow. And in hindsight, you know, they don’t want to admit that there was a mistake made but in reality, knowing what we know now, because again, they have a very difficult job. But knowing what we know now, they definitely misjudge the situation. And so now we’ve got extremely high inflation, the highest inflation since the 1980s. And it may be a problem that’s going to be sticky. And that’s the big thing that we worry about. Because the low unemployment has caused wages to go up, as employers try to keep the people they want to keep and get new employees working for them. So they raise wages, and then that just increases the amount of money people have, then they can spend more so then demand stays high, and prices continue to rise. And so it’s it’s sort of a self-perpetuating issue that we’re dealing with, and the Federal Reserve now has shifted from almost completely focused on employment. Now they’re almost completely focused on stopping inflation.
Sharla Jessop 4:19
What can we look forward to as they’re focusing on stopping inflation? What does that mean for investors?
James Derrick 4:25
Well, stopping inflation is, you know, something that they’re very good at. So they’ve got all the tools they need to handle this. But that doesn’t mean that it’s going to be easy. It’s not like a surgery. I mean, this they have very blunt tools, very powerful but blunt tools and they really just need to crush demand in a bad way. Sometimes we use crush as a good word, they’re going to crush it in a bad way they need to bring it down. What they’ll do, the main tool they’re going to use is interest rates. They raise their interest rates. People will ask me, James, what does that mean? Do you know is that like the rate on my credit card, because my mortgage is fixed? Well, it’s really the rate that they charge banks to borrow money. But it trickles down and indirectly begins to affect all interest rates, especially shorter-term rates. But even at the longer end, like a mortgage gets affected by what the Federal Reserve is doing. And so we’ve seen interest rates rising, which makes it more expensive to borrow money. And then that causes people to delay purchases. So we’re just beginning to see the Federal Reserve raise the rates, and that means we’re just beginning to see the slowdown in demand.
Sharla Jessop 5:38
You know, I think sometimes people equate interest rates to what am I getting at the bank, when I put my money in my savings account or my CD. And while those rates might increase, which feels good, it has really still a negative impact, because all of the other rates are continuing to increase.
James Derrick 5:55
With the rates for savings going up, I mean, they’re still not going to keep pace with inflation. The big impact is going to be the other rates, the rates for borrowing money. So if you consider like a mortgage, we’ve got homes at all-time higher values, on average, and we’ve got mortgage rates that have more than doubled in value over the last 18 months. So the net effect is it’s just like something has to give those two things should not coexist; all-time high prices, with a doubling of the interest rate. It just doesn’t make sense. So something’s gonna give. And it’s it’s not going to be the Federal Reserve because they’re not going to blink, because inflation has not stopped yet. And I don’t think it’s going to for a while, it could come down a little bit, but it needs to come down quite a bit before the Federal Reserve decides that they’re not going to raise interest rates anymore. So I expect the Fed to keep moving forward, and I expect it to begin to have a major impact on the US economy, we’re just beginning to see it.
Sharla Jessop 6:59
And that’s going to impact when we talk about the economy. A lot of people are thinking about my investments, my 401k, or my trust account or other investments. Those are driven by what’s happening with companies. How are these increased interest rates impacting companies and their profitability?
James Derrick 7:17
It’s a complicated question, because as prices are rising, a lot of companies are able to raise their prices. And, you know, they kind of pass on the inflation to their customers, and it may not have an effect on the company. The major problem that begins to affect everyone is when demand comes down because then all of a sudden, the profitability will come down, almost across the board. And that’s something that I think that we are just beginning to see the profitability is beginning to come down, the economy is just beginning to slow. A lot of us are just beginning to notice it. So it’s going to continue to happen. And it’s going to become more and more obvious to everyone that there’s a slowdown.
Sharla Jessop 8:04
I think we’ve in some areas, we’ve already been seeing that as when you look at pandemic stocks, and things that have done very well during the pandemic. And as everything’s coming back to normal, and we’ve got the pandemic under control, and people are moving more freely about the country and not stuck at home. Some of those things that were pandemic-related companies have we’ve already seen a shift in those.
James Derrick 8:26
Yes. And it’s funny, you say normal, because in my household I’m always saying, This isn’t normal. That’s not normal kids. This is not normal. This has never been like this before. You know, and I think they get tired of hearing me say it, but it’s been become my catchphrase in 2022. At home just there are so many unusual things going on. And what we need is for some of these to come back to normal, as you’re saying, and it’s absolutely going to happen. Whether it’s the stock market, whether it’s corporate profitability, or home prices, you know, things need to return back to normal.
Sharla Jessop 9:09
You know, it seems like we’re always focused on something. As long as I’ve been doing this in this industry in the same with you, we’ve faced so many different challenges. And every time we think, boy, this is so unusual. This is going to impact everything for a long time. And it does but not always negatively for a long time.
James Derrick 9:28
Yes, and a lot of people are weathering the storm just fine. A lot of people have had jobs where their wages have increased, and they’re doing okay. Other people have a lot of savings built up and maybe even more savings today than they had three years ago. And so that’ll help with the higher prices they’re being forced to pay when they go to fill up their car with gasoline or go to the grocery store, whatever, you know when they go out to eat I mean the savings will help them to insulate them and it’ll insulate the entire US economy.
Sharla Jessop 10:02
And I think also, it’s important to remember this isn’t long term, you know, when we’re when we face challenges, like what we’re experiencing now with inflation, increasing interest rates and things like that, it’s going to change. This isn’t going to be the direction thus going forward forever.
James Derrick 10:17
No, as I mentioned, the Federal Reserve has great tools for this. I mean, this isn’t the first time that they’ve faced inflation. In fact, they’re very focused on it now. And so I don’t anticipate this is going to be a situation like the 1970s and 1980s, where it goes for a long time, I think they’re very committed to bringing down inflation. And so I don’t think I really, I really think they’re going to take care of it. I don’t think it’s going to last a long, long time. I think a year from now, inflation should be a lot lower than it is right now. And right now it’s over 8%.
Sharla Jessop 10:46
Seems unbelievable. A few years ago, if you would have asked me if inflation would be an 8%? I don’t think I would have said yes,
James Derrick 10:52
No, it felt like those days were in the past. In fact, the aging demographics and technology, globalization, all three of those things point to low inflation. And those seem like solutions that are here to stay. It’s very possible that those forces are powerful enough to bring inflation back down in the long term.
Sharla Jessop 11:13
I appreciate your positive outlook, James, it helps keep investors in with their plan and staying in the market long term.
James Derrick 11:22
If I can transition into a discussion on what you just mentioned, which is long-term investing, and compare it to inflation, I have a very interesting example that I got from Max McQuiston of the Capital Group is he shared it with me and a group of clients that we’d gathered together. But back in 1973, of the Ford F 100, which I think was the equivalent of an F150 truck back then, cost $2,889. So about $3,000, for the Ford truck. And today, the least expensive F150 is listed at $41,185. And that’s an incredible increase of 1,326%.
Sharla Jessop 12:05
Unbelievable!
James Derrick 12:05
Which is a lot. I mean, it is. I think it’s hard. And if you know, for those of us who have been alive during this time period, I mean, that’s a huge jump to go from $3000 to $41,000. But the reality is, is like, you’re not even gonna find a truck for that much. I mean, Max, Max sarcastically said, Well, I mean, some people are going to want seats, and windows. So I decided to look it up. And I did a search on Ford’s website within 20 miles of the office here to see what I could find. And the only truck available was listed at just over $80,000. Still an F 150. That compared to the $3,000 truck in 1973, is an increase of almost 2,700%. You think about that? That is incredible. I mean, it seems like an incredible investment to. And so the question that I would ask you is can the stock market compete with that? And since you’re in the business, I know, you know. The answer is yes. The S&P 500 Index was at 103.3, back in 1973. And today, it’s around 4000. So that is a stunning rise of 3,772%. So about 100% more than the Ford truck, even at the higher number for the Ford truck, the $80,000 number. So the answer is yes, the stock market can help keep ahead of inflation. It has in the past, and I think it will in the future. And so that I mean, that is really for the investors out there listening, I mean, that is the message, just stick with it. And I know that it’s it’s going to be rough. Inflation is a double-edged sword when it comes to investing, because it can be good at some levels. But a slowdown is never good. So I think there’s going to be some trying times, but stick with it. Because there were trying times in the 1970s in the 1990s in the 1980s. I guess the 1990s were mostly good. The 2000s. And, and so there’s there’s always challenges, as you mentioned, but the stock market has really helped investors stay ahead of inflation. And that’s really goal number one.
Sharla Jessop 14:20
I love that comparison. And I love that you’re going back to 1973 because we have seen a lot of market volatility since then. And we’ve seen a lot of inflation, different inflation numbers during that period of time. And so when we get caught up in recency bias and think this is never going to change, this is horrible. It’s never been this bad. It’s never going to get worse. The truth is, it’s always been better. And it’s always been worse. It will always change. And I love the idea that by investing you can outpace inflation. I think when we get into volatile markets like this, people tend to want to rein in and become more conservative and avoid market volatility by getting out. And the reality is you will not be able to keep up with those inflation numbers you just shared if you’re in a savings account.
James Derrick 15:05
You want to stick with it. And doing what feels good can often lead you down the wrong path when it comes to investing and, and that’s something that’s difficult to grasp. But the reality is, is that when you feel scared just stick with it, stick with it. You’ve you’ve probably already laid out a plan for yourself. It’s a long-term plan and you stick with it. You’ll be alright.
Sharla Jessop 15:30
James, thanks for those words of counsel. Thanks for joining us.
James Derrick 15:33
Thank you.
Shane Thomas 15:33
Thank you for joining the Power Up Wealth podcast. Smedley Financial is located at 102 S 200 E Ste 100 in Salt Lake City, UT 84111. Call us today at 800-748-4788. You can also find us on the web at Smedleyfinancial.com, Facebook, Instagram, Twitter, and LinkedIn.
The views expressed are Smedley Financials and should not be construed directly or indirectly as an offer to buy or sell any securities or services mentioned herein. Investing is subject to risks, including loss of principal invested. Past performance is not a guarantee of future results. No strategy can assure a profit nor protect against loss. Please note that individual situations can vary. Therefore, the information should only be relied upon when coordinated with individual professional advice. Securities offered through Securities America. Inc., Member FlNRA/SIPC. Roger M. Smedley, Sharla J. Jessop, James R. Derrick, Shane P. Thomas, Mikal B. Aune, Jordan R. Hadfield, Lorayne B. Taylor, Registered Representatives. Investment Advisor Representatives of Smedley Financial Services, Inc.®. Advisory services offered through Smedley Financial Services, Inc.® Smedley Financial Services, Inc.®, and Securities America, Inc. are separate entities.
