Power Up Wealth podcast – Is High Inflation Over? – Episode 37 transcript:
Sharla Jessop 0:00
Is inflation finally leveling off? If so, what’s next? I’m Sharla Jessop, President of Smedley Financial and today my friend and longtime colleague, James Derrick, will share his thoughts on what we might expect over the next year.
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, I’m so glad to have you here with me today. Yes, it’s an honor to be here. James is our Chief Investment Strategist and holds a Certified Financial Analyst designation. James, you study and research many economic indicators. What do you find fascinating about what’s happening right now?
James Derrick 1:05
Well, we are at a time where there’s a divergence going on. And we’re not sure exactly what direction the economy’s going to take. How we got here I think is a really interesting story. And I’d like to tell it in the context of Hunt’s ketchup, which is owned by a company called Conagra. And their CFO, David Marburger did an interview, and he talked about their changes to ketchup. About a year ago, things were getting more expensive wages were getting more expensive for employees, supplies, the supply chain, transportation, everything was getting more expensive. We all know this. So they raised the price of Hunt’s ketchup by 8.6%. And what they found was that consumers were willing to pay it. Now, that is not going to surprise anybody. But if you’ve been paying attention for a while, coming out of the 2008 recession, companies were terrified that if they raised prices, consumers would stop buying. And so for years and years and years, companies have been worried about it. So this has been a major shift in the way consumers think and act. And we’ve witnessed it in just the last two years. So then Conagra decides to raise the price of ketchup again in the second quarter, and it goes up 13.2%. Then in the third quarter, they go up to they go up 14.3%. And then finally in the fourth quarter, they raised the price 17%. Well, this is where it gets interesting for Hunt’s ketchup because consumers actually begin to notice, and they’re buying less. And at first inflation for a company is not a major problem. If they can pass the extra costs on to their customers, they’re actually making more money because their fixed costs stay the same. And they raise the price on the ketchup, and therefore their margins go up a little bit, their profitability is improved. And so at low levels, inflation is really not a major problem. But when people stop spending as much money, then there’s a real problem. And so it’s not surprising that Conagra said that they are no longer going to be raising prices in 2023. They’ve reached the tipping point. So I think the whole economy is going to deal with something similar.
Sharla Jessop 3:29
So if we’ve reached a tipping point, where do we go from here?
James Derrick 3:32
Inflation is going to come down. I mean, it already is. It got up over 9%. The latest number is 6.5%, which is still really high. It’s way beyond the target of normal, which is two. And remember, we want to get to low inflation so that people can just go about their lives and not worry so much about prices. Go to work, do your job. And you don’t want prices to be the focus. And the Fed has said, hey, at 2% that’s about the level where it encourages spending and growth in the economy, but it’s not distracting people from living their lives. So we’re shooting for 2%. We’re a 6.5%. But we’re coming down. I kind of see three different scenarios playing out here. The first two scenarios like the hard landing and the soft landing, and in both of those cases, inflation comes down. And then the third would be the no landing. Meaning that inflation actually doesn’t make it down to 2%.
Sharla Jessop 4:32
Well talk to us about the differences. Share with us the differences between these three different scenarios.
James Derrick 4:38
So the soft landing is probably the best-case scenario. This is the one that everybody’s hoping for. It seems to be what stock investors and bond investors are pricing in at least at the time that we’re recording this. And that is inflation coming down probably below 4%, maybe even to 3% by June. So really quite fast. And then at the same time, the unemployment rate stays relatively low. So we are currently at 3.5%, despite all the layoffs that major companies have announced, and it appears right now like that is a possibility. I actually think that that would be good for stocks. I think it would not be good for bonds because if we get a soft landing and the economy is fine, then the Federal Reserve does not need to lower interest rates. And so interest rates will probably stay up at about the levels that they are at. That means that you know, mortgages, car loans, credit card loans, all those interest rates that are relatively high right now will stay relatively high, because the Federal Reserve will not need to lower rates. And they might not want to take the chance that it might increase inflation. So tough, tough for bonds that have already priced in a lowering of rates. Good for the stock market. And that is the soft landing.
Sharla Jessop 6:10
So a hard landing sounds a little bit like a plane crash, which doesn’t feel really comfortable. Tell us a little bit about a hard landing.
James Derrick 6:17
It is kind of like a plane crash because this is inflation coming down. But it’s coming down because the entire economy is coming down. So we’ve seen a lot of layoffs, Google, Microsoft, 3M, which is, which is not a tech company, which is interesting. We’ve seen it at investment banks, a lot of layoffs. So in the hard landing, unemployment becomes a problem. As I mentioned, we’re at 3.5. I mean, if that goes up to 5%, or 6%, that would be a major problem not only for the people who have lost their income but then it also it begins to feed on itself, less consumer spending and more layoffs. In the hard landing scenario, the Federal Reserve will eventually see that inflation is no longer the major concern, but the economy is. And the Fed has a dual mandate to keep prices stable and to seek full employment. Right now, they’re 100% focused on inflation because employment is fine. If that flips, then they will look at lowering rates, it’s probably going to take them some time, emotionally, to be ready to do that. The markets seem to be pricing in that the Fed will lower 50 basis points this year. And the Fed has openly said repeatedly they have no intention of lowering rates this year. So it’s kind of a game of chicken. The bond market is pricing in the hard landing right now. The stock market seems to be pricing in a very real possibility of the soft landing.
Sharla Jessop 7:51
You’ve also coined a phrase that we haven’t really heard anywhere else before, but the no landing. What could no landing include?
James Derrick 8:00
This just means that maybe inflation will never get down to the 2%. Now, there’s a lot of reason to think that it will. And I think that it will, however, that possibility is real. If let’s say that the economy is very resilient, and it does well. And the Fed thinks that they have won the fight against inflation. What could happen is that consumers continue to do what we’re doing, which is spend. And going back to the ketchup example. I mean, what if everybody just feels like, you know, what, I don’t care how much the ketchup costs, I want ketchup on my burger and my fries, and you know, with everything else, and so spending goes right back to where it was. And inflation comes right back up again. That is exactly what happened in the 1970s. We had inflation come up in the year 1970. The Federal Reserve raised interest rates, inflation came down substantially. I mean all the way back to almost normal, and then it shot right back up again. In 75 the Fed then thought they had want again, lowered rates and inflation went up again, headed right into 1980. So this was a mistake that the Fed made and we look back at Arthur Burns, who was the Fed chair and I think that history is a little unfair to him, because of what happened with those three bouts with inflation over that decade. And we revere Paul Volcker, who came in in 1980, and put an end to inflation once and for all by raising rates and holding him up. And so our Fed today says that they’re going to be more like Paul Volcker of the 1980s and end inflation once and for all, but to me, I don’t want to be unfair to the Fed of the 1970s. They were probably pretty smart too. And maybe it’s just human nature to do what they did and to do what Americans did. And if that’s the case, the no landing is a possibility, again, it’s not my base case. But it’s a possibility.
Sharla Jessop 10:05
Interesting, even though we have more tools than they had back in the 70s, and we consider ourselves to be wiser, because of the lessons that have been learned over that period of time, it still doesn’t guarantee a certain outcome.
James Derrick 10:18
No, because we’re human. Consumers tend to operate with sort of, like a narrative in our minds, you know, and for a long period of time, people were spending big, you know, I think that the year 2000 to 2002 surprised people. 2008 and with that recession really surprised people. And I think that it brought in kind of a new era of thrift. And I believe that that’s passed us now. We’re in a new era with a new narrative, a new feeling. And part of that is, people are very open to spending. And they love their big logos you know, you look at the brand names on the cars and on the shirts and everywhere, and we’ve got these massive logos that we are showing off. And it’s just part of, it’s fun. And it’s part of the world we’re living in right now. And it’s very different than where we were 15-20 years ago.
Sharla Jessop 11:11
Good information, food for thought as we navigate what’s going on in the next year. How do you think that impacts investing and planning?
James Derrick 11:19
Well, I don’t think it’s a good time to be aggressive. I don’t think it’s a good time to roll the dice and and take big risks with your investments. That being said, buy and hold has always worked in the past. And I think it’ll continue to be fine, I believe in America, and I think we’re going to make our way through this. And it’s going to be fine in the long run. But it’s also not a bad time to reduce risk some. The other advice I would give would be in your personal spending. If your personal cash flow is going well, it’s a lot easier to endure the ups and downs of the market. So with your personal cash flow, it always makes sense to take a look at your expenses, even if you’re a high-income earner or if you’re a low-income earner, our expenses tend to rise with our income and so take a look at that and you will never regret saving a little bit more for the future.
Sharla Jessop 12:14
Great advice, James. Thanks for joining us.
James Derrick 12:16
Thank you, Sharla.
Shane Thomas 12:22
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, 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.
