I received an email the other day from a great client of ours, a successful corporate executive. He somewhat apologetically brought up a quote by a name-brand hedge fund manager who had declared the markets couldn’t possibly move any higher, and that the end of the world (or at least the end of the market) was nigh. This article worried him. Our client then went on to express his appreciation for me, stating that I had “read the tea leaves in the past,” and that he put confidence in my thoughts on the matter. He asked me, “What do you think?:
My first thought was that I am no reader of tea leaves at all! And it struck me once again, how much faith and confidence most investors– undeservedly – place in wealth managers. People presume that we somehow can predict what will happen. We are not experts at all in predicting short-term movements of the market no matter how much credit we get for it. To make matters worse, the media perpetuates this falsehood. Yet to suggest we do have an inkling about what will happen is ridiculous. (And those investment managers who pretend they know, they are engaging in activity that I consider criminal.)
The one thing that we can do as financial advisors is to provide perspective. Because it’s perspective that keeps people grounded and allows them to overrule emotional reactions. As I love to point out, the average annual rate of return of the S & P 500 is somewhere around 10%. Since 1960, the S&P has appreciated approximately 70 times. Wow! And the cash dividends paid out by all companies within the S&P? The dividend of the index has gone up 30 times over the same period. It’s remarkable because it puts things into perspective. Many a time since the 1960’s people have felt like we are facing an “end of the world” moment in the markets (and in geopolitical contexts) – and yet here we are. Perspective is the name of the game.
One area where our clients need a ton of perspective is inflation. Today, in 2021, you can’t turn on any news channel online or offline that isn’t talking about inflation. Depending on your news source, you may get the message that things are in a terrible state, or that all this fear about inflation is overblown and that things will level off soon enough. Who knows? To provide a bit of perspective, long-term inflation is just shy of three percent annually for the US economy. But to get too fascinated with the number will result in a loss of perspective.
The important thing is not a range of inflation stats, but rather why we care so much about inflation at Beck Bode, and why we want our clients to care about it. This may very well be our moment, as a firm, to talk about inflation wherever and whenever we can, because the idea of inflation is foundational to our Strategies and the way we have built this firm.
This is where the Meatball Parmesan sandwich comes in. During my junior and senior years in high school, I worked for a restaurant in my hometown in Maine called Amato’s where the Meatball Parm sub was a popular choice. Back then, approximately around 1997, this sandwich sold for $2.50 or maybe $2.79. Today, roughly twenty-five years later, the same sandwich sells for over $6. Had you stashed your money under a mattress in 1997, that $2.79 would now buy less than half of the same delicious sandwich today. What a bummer.
The most simplistic way to explain inflation is to say that stuff gets more expensive over time. Folks understand this because most people have lived it. I often hear, “Is inflation good or bad?” It depends on your economic situation. Say you are a borrower taking out a long-term mortgage, perhaps over 30 years, and your payment is fixed at $2,000 a month for that term. Every year that goes by that inflation is present it cheapens the value of money. You continue paying the bank $2000 a month, but the bank is losing money because inflation reduces the value of its future monetary obligations.
Now take this idea and apply it to bonds. At Beck Bode, we believe that when you buy a bond, you are the bank, lending money to a corporation for a fixed rate of interest (if it’s a corporate bond). If you're buying a government-issued bond or note, it’s the same thing, except you are lending money to the US government.
Say you buy a hundred thousand dollars worth of the bond. You are giving that corporation or the government a hundred thousand dollars. And in return for that over the term of your agreement with each other (call it 10 years for this example), they're giving you a fixed rate of interest. As inflation ticks along year over year, you're getting paid the same amount of interest, but the value of the money that you receive has gone down because inflation has moved up. Hurts a little more than missing out on half a meatball parm sub.
When people wonder why we, at Beck Bode, feel so passionately about equities, it’s because we understand the detrimental effects of inflation. We know that inflation works very silently. We know that when we don’t put our dollars to work, their power erodes. We focus on equities because it is so incredibly important to make our money work as hard as possible.
We also understand that with reward comes risk. And I speak of risk in this case, in terms of volatility. The volatility we learn to live with over the short term in stocks is for the sake of the longer-term significant reward we earn. We must give up something to get the reward and the thing we give up is certainty over the short term. We don't know what's going to happen in the future for the companies in our portfolios. We know exactly what's going to happen with the bond that we invest in. The volatility of a ten-year investment in a government or corporate bond is low (provided they don’t default), and the reward is commensurately low. Factor in inflation, and the bond investor is the financial loser. The volatility of investing in individual equities is high, but the reward is commensurately high over the longer term, as we benefit from the future achievements of the company.
Inflation happens to be a hot topic today – but as far as we are concerned, inflation should be a hot topic every single day. It’s maddening to hear so-called experts predict the end of the market or the end of the world. These are the kinds of irresponsible proclamations that disturb otherwise completely rational clients and make them consider actions that are detrimental to their financial health.
Our job as financial advisors is not to hold ourselves out as experts. In the best-case scenario, in the short term, declaring expertise is a fast road to looking stupid. In the worst-case scenario, it harbors a huge amount of liability. No, our job is to put our clients in front of the full premium that the markets will produce over the long term. It may not make the evening news, but it sure does provide a whole lot of perspective.
Ben Beck is Managing Partner & Chief Investment Officer at Beck Bode, a deliberately different wealth management firm with a unique view on investing, business and life.