By Andy Stout, CFA, CFP® - Chief Investment Officer, RAA and Allworth Financial

Earlier this month, as I flew for business over the picturesque Rocky Mountains, there was quite a bit of turbulence. Yet while the bumpy ride was far from pleasant, not once did I wish I had a parachute to use to bail out of the plane.

Understanding that turbulence is sometimes a part of the ride, I know that if I can stay focused on where I’m going, I will almost certainly get there.  

And with that segue, you may well have some understanding about where this is going.

That’s because after many years in the financial advice industry, one thing never really changes: some investors want to jump out of the market whenever there is turbulence. But, just as jumping out of a perfectly good plane is a bad idea, we believe that jumping out of the market when the atmosphere gets a little bumpy is not a good plan.

Whenever the going gets a little rough, just remind yourself that markets have always recovered from every setback in history.

The volatility we’ve experienced to start the year is typical for long-term investors. In fact, just about every two years, stocks experience a drop of at least 10%. And even though the catalyst for volatility changes, it’s often rooted in uncertainty.


One of the most significant uncertainties in today’s environment is the potential fallout from inflation. It’s not just the path that inflation may take over the next several months that’s uncertain, but it’s also the reaction to inflation by our nation’s central bank, the Federal Reserve (Fed). That is, how the Fed responds to inflation will affect the economy and the stock and bond markets.

Last month, we stated, “We expect inflation to continue to get worse for a few more months before easing later this year.” That’s precisely what’s happened so far, and unfortunately, inflation will likely be even higher when we get the February data.

The latest release of CPI (Consumer Price Index) showed that consumer inflation was 7.5% for the 12 months ending on January 31, making it the highest reading since way back in February of 1982. (Early estimates for February’s year-over-year inflation rate are around 7.8%.)

What could cause inflation to get better later this year?

Fortunately, inflation could begin to subside in a couple of months. While many of the root causes of high inflation will still be a problem, the simple fact is that the exceedingly high monthly inflation changes of March, April, May, and June 2021 will no longer be in the year-over-year numbers as the year progresses. (It’s known as “base effects” when a year-over-year number changes because data from a new month replaces an old month.)

Beyond base effects, there are a couple of other substantial reasons that inflation should improve throughout the year:

  • A Shift in Spending

While it’s too early to predict a return to normal spending habits, there are early signs that consumers are beginning to increase their relative spending on services compared to goods. For example, when the economy shut down in March 2020 for a few months, consumers immediately increased their proportional spending on goods.

Specifically, relative goods expenditures rose from 36% to 40% in just two months. This 4% move is not as trivial as it appears because that is 4% on nearly $14 trillion of annual spending, equating to more than half a trillion dollars.

In March 2021, relative spending on goods peaked at 41.6%, and service spending fell to 58.4%. But now, the most recent data shows that goods spending is at 38.8%, and service spending represents 61.2%.

This shift matters because goods spending takes a much larger toll on the supply chain, leading to a more significant supply-demand imbalance. And that imbalance results in higher prices.

  • Living with the Virus

Evidence is mounting that people are becoming more comfortable with the virus. We’re seeing this even as new cases skyrocketed to more than 1,000,000 per day in early January. Fortunately, cases have quickly fallen, hovering around 100,000.

Even as virus cases climbed over the past year, credit card transactions that required people to be present (as opposed to online purchases) were higher than what they were before the pandemic.

Another example of people getting out to spend can be found in the latest retail sales report, which showed retail sales (not including online spending) rose 4.4% last month, and they’re 18.3% higher over the past year.

Businesses have also adapted. This can be seen in capacity utilization, which measures the percent that installed capacity is being used. For example, a reading of 100% would mean that a company’s factories are never idle; they’re constantly producing goods.

By analyzing US manufacturing companies as a whole, we observe that factories have fully recovered and are operating at a level similar to a normal economic environment.

What could cause inflation to remain more elevated than pre-pandemic levels?

While there are reasons suggesting inflation will decrease, there are also reasons that inflation will not drop to the Fed's goal of 2% in the near future. Here are some of the factors that will likely keep inflation elevated (yet still lower than where we are currently):

  • There are 4.6 million more job openings than unemployed people. This spread suggests that employees have the upper hand in demanding higher wages. Currently, average hourly earnings are 5.7% higher over the past year, but certain industries are seeing more wage pressure than others. For example, hourly wages for leisure and hospitality workers are 15% higher than a year ago.
  • Russia/Ukraine tensions could keep oil and gasoline prices high. Should economic sanctions cause Russia’s massive oil supply to be cut off from other parts of the world, the cost of oil could keep energy prices elevated.
  • Housing inventory is at a record low. With so few houses for sale, sellers demand higher prices to part with their homes. Because housing costs make up 32.9% of CPI, we expect current inventory levels to keep a floor under inflation.
  • Supply chain dislocations – while better – are still present. On the positive side, shipping costs, manufacturing backlogs, and capacity utilization have improved. These are early signs of a recovery. However, on the negative side, the supply chain recovery has a ways to go. Comprised of 27 variables, the Global Supply Chain Pressure Index shows how far from average (as measured by standard deviations) the supply chain is functioning. 

Layoffs have remained relatively low over the past two months, with most of the recent releases showing fewer than 400,000 initial jobless claims. While some analysts think the Delta COVID variant could cause layoffs to increase, the fact that there are more than 10 million job openings (the most ever) suggests employers won’t layoff more people than normal because they are already having enough trouble finding qualified workers.

It appears possible that job openings will drop in the months after Labor Day because that’s when the extra $300 in weekly emergency unemployment benefits will expire in about half the states, including California and New York. If someone is making more money by not working, it’s logical that many people would choose not to work.

While the economy is poised for a strong 2021 as the recovery continues, there are risks.

Risk 1: Tapering

The Federal Reserve (Fed), our nation’s central bank, is indicating that it will soon announce that its monthly bond purchases will be reduced. The Fed is currently buying $120 billion of bonds ($80 billion of Treasuries + $40 billion of mortgage back securities) each month. The purpose is to keep long-term interest rates low and encourage consumer spending. When the Fed begins to slow down its monthly purchases, probably late in 2021 or early in 2022, there could be a temporary bout of market turbulence.

Risk 2: Inflation

Inflation is high today, but will it stay high? The most likely scenario is that inflation returns to lower levels in early 2022 as the demand from the reopening begins to dissipate and supply chain dislocations normalize. However, there is a chance that companies end up passing along higher costs to consumers, which could mean that elevated inflation stays with us for longer than expected. If that’s the case, the Fed could end up raising short-term interest rates earlier and quicker than most expect.

Risk 3: COVID-19 Variants

We are all seeing how the Delta variant is affecting the world around us. This highly contagious strain has an estimated R0 of between five and 10. This means that each infected person could spread the virus to five to 10 unprotected people. On top of that, there have been more than 100,000 breakthrough cases (those vaccinated but infected). While the vaccination rate has been increasing lately and the vaccines are holding up relatively well, there is no guarantee that will be the case for the next variant.

Risk 4: Geopolitical Tensions

Relations with China have deteriorated, and the country seems to be taking steps to squash anything that could challenge the power of the state. Examples of this include China’s crackdown on IPO listings and for-profit education companies. If tensions with China get worse, it could harm our trade with them, and China is our largest trading partner.

Risk 5: The Unknown Unknowns

This could be anything we don’t know about, and so, by extension, don’t know what the economic response would be. If you think back to late 2019, a perfect example of an unknown unknown would have been COVID-19.

While these are real risks that must be considered, that doesn’t mean the economy is about to slip into a recession. Analyzing leading economic indicators allows us to objectively measure recession risk over the next six-to-nine months. Leading indicators are data points that move before the broad economy moves.

At Allworth Financial, we’ve created a proprietary recession index that has historically flagged a slowdown about eight months before the onset of a recession.

What does this mean for you?

The good news is that the economy is on solid footing and the risk of a recession in the next six-to-nine months is low. However, things can change very quickly. It’s necessary to have your investments constantly monitored to ensure they’re appropriate for the ever-changing economic environment. That’s what the investment team does on your behalf every day. This allows you to closely work with your advisor on your personalized financial plan, which serves as a guide to and through your financial future. If you have any questions, please don’t hesitate to let us know.

All data unless otherwise noted is from Bloomberg. Past performance does not guarantee future results. Any stock market transaction can result in either profit or loss. Additionally, the commentary should also be viewed in the context of the broad market and general economic conditions prevailing during the periods covered by the provided information. Market and economic conditions could change in the future, producing materially different returns. Investment strategies may be subject to various types of risk of loss including, but not limited to, market risk, credit risk, interest rate risk, inflation risk, currency risk and political risk.

This commentary has been prepared solely for informational purposes, and is not an offer to buy or sell, or a solicitation of an offer to buy or sell, any security or instrument or to participate in any particular trading strategy or an offer of investment advisory services. Investment advisory and management services are offered only pursuant to a written Investment Advisory Agreement, which investors are urged to read and consider carefully in determining whether such agreement is suitable for their individual needs and circumstances.

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