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What Goes Up ...
In October and November of 2021, we at the Puck Newsletter discussed how the United States was nearing the end of the era of easy money. We predicted that asset prices would begin to fall and that we were headed for choppy waters. We have now entered the beginning of this cycle.
While the United States participates in a global economy, the Federal reserve (followed up by many of the world’s central banks) is tightening liquidity to fight inflation. But we live in a complex world, and challenges present during the era of easy money do not simply disappear as the Fed fights inflation. The US still carries massive amounts of debt, nationalism is on the rise globally, and the war in Ukraine is further exacerbating supply chain shortages. Add to this mix China’s zero tolerance policy in the face of repeated covid outbreaks resulting in total physical and economic shut down and we have even more strain on the global supply chain.
Furthermore, Covid accelerated a shift in focus from the rights of the shareholder to the rights of employees. We all knew CEO pay and wealth inequality were problems, but when people lose their jobs because of Covid, they are reminded just how vulnerable they really are, and have chosen to unionize and fight for higher wages, spotlighting failures of supply side economics that have dominated our country for the past 40 years. These changes are long overdue, but the question is how painful will these adjustments be to an already fragile economic system?
The answer is that none of us know for sure. But here is where I start from: The laws of physics. Excessive behavior in any one direction leads eventually to the opposite result. Easy credit and excessive wealth accumulation for the top 1%, has in my mind peaked. I provide no evidence for this postulation, but put forth, dear reader, my gut. See the November newsletter where we pointed out that: “When we measure the current wealth-to-income ratio in the United States, it is over 700 -to-1, the highest level in recorded history. In the past century, any time the wealth-to-income ratio exceeded 600-to-1, what followed was a material correction in asset valuation. Many experts now refer to the current financial situation as the “everything bubble.” Similarly, countries such as China have taken on tremendous debt as well, and as recently reported in the New York Times, they are suffering from a major residential housing bubble.”
Folks, the laws of physics are catching up to us. The stock market is down materially, cryptocurrencies are down from their highs, and real estate will soon follow, as interest rates increase to fight inflation. Will there be a soft landing or are we talking about entering another great depression? I wouldn’t necessarily go that far because, although history rhymes, it rarely repeats exactly. But to be clear, we avoided a prolonged recession in 2008 by printing a lot of money. This time if we do that, we literally risk German-style inflation of the 1920s. This past 20 years has been a crazy period where we thought we could avoid down turns simply by printing money. Rather than go to that extreme, let’s really learn from our mistakes this time around. I am cautiously optimistic that the Federal reserve and the world in general will take a more measured approach and although we are likely in for a period of retrenchment, I do believe we will get through this stronger and wiser.
In the meantime, buckle up, have a diversified portfolio, expect most asset classes to do poorly and, therefore, be conservative with your expenditures and investments. Be patient. You don’t want too much money in cash, as cash is decreasing in value every day because of inflation, and yet you don’t want to have all your eggs in real estate or the market if we enter a long and protracted recession. I think the best approach is to lessen your debt load so that if rents go down, as I suspect they will, you will have the cash flow to hold onto your assets.
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