Power Up Wealth podcast – 5 Acts of the Economic Play – Episode 57 transcript:
Sharla Jessop 0:00
Just like the acts of a play, the economic cycle has a structure. I’m Sharla Jessop, President of Smedley Financial. Today, my guest and colleague, James Derrick, will tell us who the actors are in this play and which act we’re watching now.
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James recessions are not new to the US economy. In fact, you had mentioned we’ve had over 50 in US history.
James Derrick 0:54
Yeah, I was surprised by that number. I started thinking about this years ago when my grandmother started talking about all the recessions she had lived through. And some of them she couldn’t even remember because they were smaller, or did not have as big of an impact on her. And I got to thinking, wow, it’s amazing how each feels like such a panic. And yet, they’re such a normal part of life. I mean, 50, over 250 years, that’s about one every five years. So that’s really quite often. And what we’ve seen in recent years is that they’ve kind of stretched out. The times of growth have stretched out. And the recessions have been shorter.
Sharla Jessop 1:32
And it seems like people remember the recessions based on how hard they are on them individually.
James Derrick 1:38
Sure and each one is a little bit different. They have different causes. And they’ll hit different industries, some harder than others. And so we will remember certain ones more than others.
Sharla Jessop 1:49
James, you mentioned that the economic cycle has a structure just like a play. So tell us about this play. Is it a drama or a comedy?
James Derrick 1:58
Well, I would probably call it a drama. But you know, if you think of it as a comedy, it might help you cope a little bit better. Because you really cannot control everything. I mean, we can only control ourselves. And I think throughout this discussion, I hope that people think about that, like, well, what can I do, knowing what I know about the bigger picture. So normally, when you look at the economic cycle, you’d think of four stages. Writing it as a play, I’ve done it as five acts. And so I’ve included the number four is something that you don’t typically see. But let’s begin with number one. Number one I called send out the invitations. This act begins with doubt and low-interest rates. Good investments here would be bonds, because rates are low, and stocks, although people would be very skeptical of stocks at this point. But by the time this act ends, there’s a lot of optimism. And it’s become clear that the economy is improving, unemployment is going down, people are able to get jobs and things are getting a lot better. Act Two is get this party started. Which is, I think, a good name because people begin to really recognize that things are good. By the time it ends. Inflation is a concern, think of the free money given out in 2021. And how at that point in time, Americans were flush with cash. And they knew the economy was good. In fact, it was very hard for employers to find people to fill all their jobs, especially retail jobs.
Sharla Jessop 3:29
And at that time, the government still giving free money.
James Derrick 3:32
And they were still giving out free money, which, you know, I think in hindsight, it is very clear that that was a mistake to keep doing it. So the Act two ends with inflation as a concern. Now, it doesn’t always have to be a 9% inflation like we saw recently. Back in 2005/2006 I think inflation was closer to around 4%. But still, that was high enough that the Federal Reserve jumped in. And so the Federal Reserve, they are tasked with taking away the punchbowl just as the party is getting started. That’s a famous line. And so I’ve titled Act Three take away the punchbowl and its stars, the Federal Reserve.
Sharla Jessop 4:13
Sounds like a party is going to come to an end.
James Derrick 4:15
Well, you know, I mean, obviously, their goal is not to end the party, but they do want to keep it under control. They’re tasked with two things. They want stable prices, and they want full employment. And so as inflation rises above their long term goal, their long term goal is about 2%. They think that that is a level where we encourage economic growth, but price increases don’t become a major concern. So they pick 2%. Everybody keeps asking, are they going to move away from two and maybe go to 3%. And so far, Chairman Powell has said that they have no plans on changing the target. So it’s two. So they take away the punchbowl by raising interest rates. And right now they’re doing something else called quantitative tightening. Prior to 2008, there was no such thing as quantitative tightening, or the opposite, which was quantitative easing. But what happened was with each cycle, now we’re going down the rabbit hole. But with each cycle, the Federal Reserve is going to try to stretch out the periods of growth and shorten those periods of recession. And so they’re coming out with more and more tools, or using their tools more and more to do that. And so they started quantitative easing in 2008, which had never been done before, like that. Ben Bernanke, and the Fed started buying bonds, and the Federal Reserve balance sheet, which was very low, less than $1 trillion, began to grow. And now suddenly it’s 8 trillion dollars. So anyway, by taking away the punchbowl, they raise interest rates, and now they’re letting those bonds roll off their balance sheet. And the goal of both of those is to bring down prices. And so Act Three ends with higher interest rates. Now, as rates rise, bond prices go down, in theory, and in reality, that tends to be pretty true. And so in Act Three bonds get very volatile.
Sharla Jessop 6:20
Which seems like we experienced that last year. We had and the beginning of this year, because bonds were extremely rough last year.
James Derrick 6:28
Yeah, last year was the worst year ever in American history for bonds. So it was it was quite negative. And it was the first time we’d had back to back years. And now in 2023, we’re looking at a possibility of back to back to back negative years and bonds. And if two had never happened before three is is certainly a lot more than most of us would have expected. And so it just goes to show the unusual circumstances we’re in. Then we get to Act Four party on. This is where we are right now. And we’ve been stuck here for a year. And I think we want to slow down the discussion here to kind of talk about where we are at and why we are here. Last year was so brutal. The Fed raised interest rates from zero to about 5%. And to almost 5%. And it was faster than they had ever raised interest rates before. Some people would say that was a mistake. I think that the mistake was made earlier, a couple of years earlier, and that the Fed was probably just doing what they had to do. They were dealing with inflation of over 9%. So they raise rates very quickly. And many of us began thinking that this would crush economic growth, the rise in interest rates. It looked like we were headed in that direction. Investors started piling into bonds, as a result, hoping that if the Fed raises rates too fast, then they will cut off economic growth. Then we get a recession, and then the Fed lowers rates. And then bonds make money. So let’s buy bonds. And you can see, as I run through that, even if you’re not following each step, investors were skipping ahead. The Fed raising rates is not good for bonds. It’s bad for bonds, and you don’t want to be loading up on bonds yet. And granted, like the market can do anything from day to day, week to week, month to month. But the but the big moves are determined in this way. And as too many actors jumped ahead to a recession, they lowered interest rates. And when you lower interest rates by buying bonds, then the economy is okay gain, because rates are lower. And so what we had is we had the Fed rate high at around 5%. But then we had long-term rates closer to three and a quarter. And we call this an inverted yield curve. And it’s not normal, but it does happen prior to many recessions. Typically, though, long-term rates should be higher than short term.
Sharla Jessop 9:06
That makes sense if you’re going to if you are going to lock your money in you would expect if you lock it in longer, you’d get a better rate than if you lock it in for a shorter period of time.
James Derrick 9:14
Absolutely. I mean, it would be very strange if a 30-year mortgage had a 5% rate and a 15-year mortgage had a 7% rate. So we saw some of this imbalance. And so we’re still kind of stuck in this Act Four where we’re waiting for interest rates to slow down the economy. And what we saw beginning in July was interest rates beginning to really rise for long-term bonds, and we moved up closer to the short-term level. So the 10-year Treasury Bond moved up to about touched 5% twice, so up to about 5% Which brings it close to the shorter-term rates, and that move up in interest rates then means we are either moving on from Act Four, or we’re getting really close to moving on. And Act Five, I titled clean up and start planning, because the party’s over. It’s Act Five that rates do fall. And bonds are generally a better place to be. Throughout all of Act Three, Four and Five, we see greater volatility in the financial markets as well. So all of that is, you know, has gone on or is about to happen. And this is the Five Acts to the economic play.
Sharla Jessop 10:43
And right now we’re in Act Four, hoping to step into Act Five.
James Derrick 10:47
Yeah, I mean, I think that a lot of people are hoping that we there is no recession, or that it will be very mild. The fact is, is we just don’t know whether it’ll be a bad recession or a mild recession. My personal opinion is there will be one, because higher rates will have an impact eventually, on everybody.
Sharla Jessop 11:09
We’re already seeing that in the housing market. We’re seeing it with credit card interest rates, which you had provided a chart that I saw the other day that had showed what was happening in credit cards, and the delinquency rates that were climbing.
James Derrick 11:24
Yeah, the rates are so high that if you fall behind in your payments, you’ll just never catch up again. Because we’re talking about rates that are in the high 20s. I mean, who can afford interest like that? It’s crazy. Mortgage rates are high, car loan rates are high. Now, many of us have locked in low rates on our mortgages. Many businesses locked in low rates. And so this is actually really helped to keep the economy growing even with higher rates. There is however, one entity that did not lock in low rates, and that was the US government. They are paying record amounts of interest. And that does have me worried when Act Five comes. I don’t know how much firepower the government is going to have, we’ll see. I fully expect they will do what they always do, which is try to stimulate the economy. Right now they’re doing a lot of deficit spending. They’re kind of working against the Fed right now. The Fed is trying to slow the economy. And the federal government is still trying to spend, spend spend. And so they’re working against each other. And I think that it’s a recipe a very poor recipe. And so we’ll see how it plays out. But it would be much better if they were working together.
Sharla Jessop 12:37
Yes, absolutely. And I think it’s important for people to understand we don’t really go from Act Four to Act One, we have to have Act Five. At some point in time, we have to, things have to slow down. And we started out this conversation by talking about recessions. What do we need to know about these cycles in recessions?
James Derrick 12:54
Well, you know, I conclude my my article in the recent Money Moxie by saying we may learn that the only thing scarier than completing a cycle is not completing it. And what I mean by that is that there’s a lot to learn from these cycles. And there’s a lot that of good that will come. As a result, we obviously we all recognize that there is a lot of economic growth and progress that takes place during the good times. During the bad times we’re kind of cleaning up the mess, though. There are a lot of American adults out there who don’t even know what it’s like to have a recession. We have not, I don’t count 2020, we’ve not had a real recession since 2008. And so there’s a lot of people who just don’t know. They think that the key to success is aggression. And so there’s a lot of people out there with a lot of debt. There’s a lot of businesses with a lot of debt, and the country has a lot of debt. And a full cycle that completes with Act Five, will help clean up some of that. And I would argue that 15 years is probably too long to go without cleaning things up. As Warren Buffett always says, and I’ve quoted many times on the podcast, when the tide goes out, you find out who’s swimming naked. Well, the tide hasn’t gone out for a long time. And there are some people out there who don’t even know the tide does go out. And I for one, think that allowing the tide to go out more often might be a good thing.
Sharla Jessop 14:23
Let people know there’s some guardrails. I think over the past 15 years, the spending for businesses and individuals has been epic. It’s just continued to increase and increase and increase in debt has been easy and low. And so people don’t necessarily have those personal guardrails of you know, sometimes living within a budget means I know what my monthly payment is and I can make that happen, but they don’t think what happens if I go beyond that. And now I have not only just a high monthly payment, but I have huge amounts of debt.
James Derrick 14:56
Yeah. So so easy to fall into that trap as and as we’ve gotten accustomed to low rates, many people will be caught off guard by the higher rates. Because some of the rules change. It becomes very difficult to carry a balance on a credit card, for example, when rates are in the 20s. And maybe you could have gotten away with it 10 years ago, but it’s getting harder now. And so I think you know, what all this means to, to listeners is, you know, look at your personal finances. And just remember, like any any savings you have now, you can always spend the money later. So get your house in order, because you’re going through a classic cycle right now. This is more classic than what we saw in the year 2000 to 2002. This appears to be more classic than what we had in 2008. We have you know, we had low rates than we had inflation now we’ve got high rates. And so this is just playing out just like in the textbooks and so people will thank themselves for preparing now.
Sharla Jessop 15:59
Hopefully, when this curtain goes down, everybody will be on the right side, financially stable, and in a good place. James, thanks for joining us today.
James Derrick 16:07
Thanks.
Shane Thomas 16:08
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.
