Volume 93 No. 3 - March 2022
If you’ve been to the supermarket lately, you’ve likely noticed that your dollar buys less now than it did six months or a year ago. In mid-February, the US Bureau of Labor Statistics reported[1] that inflation raced ahead 7.5% in January 2022, on an annualized basis before seasonal adjustments. The BLS went on to say that the prices of food, electricity, and shelter were the chief drivers behind that inflation. That 12-month 7.5% increase is the largest we’ve seen in nearly forty years. At that time, in 1982, inflation was in a declining pattern versus the inflation trend we’re seeing now.
The U.S. Federal Reserve has been watching inflation and its rising pressures too. As we have pointed out in prior newsletters, surging demand—and supply that struggles to meet it—have been driving up costs over the past several months. This, coupled with pandemic-era relief packages, have contributed to a perfect storm for inflation. Russia’s February invasion of Ukraine could also affect inflation.
Fed officials have kept the country’s main interest rate at historically low levels – between 0% and 0.25% since the early days of the pandemic. That’s likely changing soon, according to most Wall Street analysts. Recent expectations predict that interest rates will begin to rise starting this month. The Fed uses interest rates as a tool to combat inflation by attempting to slow economic growth, reducing demand and allowing the demand/supply imbalance to improve.
What else can we expect to see in a rising-rate environment? Consider that when interest rates rise, history has shown us a few things may occur:
· The market tends to favor value stocks over growth stocks
· Stock valuations are pressured
· Quality companies with strong cash flows and balance sheets are often favored
In times of volatility, change, and uncertainty, some investors will flock to perceived safety. The first thing to remember is that:
We’ve Seen Rising Interest Rates Before
When we look back on history and consider the Ford, Carter, and Reagan years, much of this may seem familiar. Prices seem to spiral upward with each trip to the store as politicians and the Fed try to find palatable solutions.
Consider this excerpt from a May 1988 edition of The Investment Letter:
“We are in a period when many investors are hard-pressed to know what to do.… Consumer prices are rising at a faster rate; interest rates, too, are moving higher… The world economy is on an upswing for a while, but rising interest rates, both here and abroad, may be expected to dampen growth rates
Or this one, from a decade earlier, in August 1977:
“Short-term rates may increase further in coming months as the Fed seeks to restrict the fast-growing supply of money as a means of dampening inflation.”
From 1965 through the early 1980s, the U.S. experienced sustained periods of high inflation. Those years presented challenges such as: wage and price controls, energy shortages, and economic recessions. This prompted the Fed to evaluate[2] many of its policies, including the ways it viewed the effects of unemployment, the last vestiges of the gold standard, and the value of good economic data when analyzing inflationary pressures.
In times like these, it is important to look to history as a guide and remember that we have been here before. The following still rings true today:
“Short-term interest rates have had a significant move upward in recent weeks as the Federal Reserve system has acted to curb the rapid increase in the money supply… Inflation is currently, and over the foreseeable future, the greatest threat to capital; selected common stocks in particular categories afford relatively the best protection for most investors.”
The Investment Letter, September 19, 1977
Proceed with Caution, But Proceed
Our strategy never falls back on rapid, knee-jerk decisions after we’ve read a headline or heard a tip. We believe in taking a long-term approach to investing.
We are positioned for rising interest rates as well. As written in The Investment Letter in May 1988,
Long-term investors should remember three things with respect to the stock market.
(1) The U.S. economy’s long-term growth (despite recessions, depressions, wars, and major changes in the political environment) has doubled, on average, every 22 years since 1878.
(2) A rising population, and innovation and research leading to new products and industries, will foster future economic growth.
(3) Over the long-term, high-quality common stocks should provide the best investment returns, based on an expanding economy and the growth of earnings and dividends (which have more than offset the decline in the purchasing power of the dollar in the past.)”
-The Investment Letter, May 27, 1988
That advice worked in 1988 and it still rings true today. High quality companies with pricing power and time-tested management have historically navigated difficult conditions well. Companies with competitive advantages that are leaders in their industries are more likely to have the ability to pass on price increases, expand margins, and continue to drive growth even in a challenging environment. In our recent research of the companies on our approved list, we see evidence of the same pipeline for innovation that has helped drive the American economy for centuries.
We are here to help. With strong balance sheets and strong financials, the companies on our approved stock list have served us well. As it has before, a buy, hold, and monitor approach gives us confidence we can get through this as well.
[1] https://www.bls.gov/news.release/cpi.nr0.htm [2] https://www.federalreservehistory.org/essays/great-inflation
Investment Counsel Inc., a Division of LaFleur & Godfrey, is a registered investment adviser. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.