When you read the above subject line, you might think I am talking about the “beast” of a person Russian President Vladimir Putin might be. Conversely, you might speculate that I am talking about the current market decline, and the “Bear” it might signify being the animal to fear. For the record, Mr. Putin is an utterly despicable human being and a broad Bear Market decline of 20% could occur. However, that is not the Beast to fear. The nefarious purchasing-power eroding-animal called inflation is the Beast. That Beast is the one who must be defeated because it is the only one that truly threatens a good long-term successful financial future for you.
A Note On Russia
Dismissing the first elements is certainly not done casually, but let me briefly address the lack of long-term peril behind the economic visage of these two smaller economic creatures; Russia’s entire GDP is less than 3% of the world economy[i]. It’s 20% smaller than Canada and 25% smaller than Italy[ii], countries that have only a fraction of its population. Russia might be brutal morally, and a flagrant disruptor of the global order, but it’s a country that has been on relative economic decline for 40-years. Thus, eventually the world will go around a country it cannot depend on. Still, to be fair, in the short-term Russia “matters” economically for two principal reasons: oil and gas. Roughly 14%[iii] of the worlds’ supply comes from Russia and our world remains fossil fuel based.
Less appreciated but strategically important is the ironic fact that Russia possesses critical minerals needed for less fossil fuel dependence such as nickel and lithium for electric vehicles (people need to be aware that 10%[iv] of the world’s supply of that mineral comes from Russia) or lithium / titanium (20% of the world’s supply of titanium comes from Ukraine[v], and its supply shortage is such a key manufacturing component for aircraft that Boeing just had to mention it to analysts on their recent earnings call).
A Note On Bear Markets
On the Bear markets aspect, markets go into 20% declines every 3-7 years. These declines are painful to be sure, and they cannot ever be predicted so they always come as a surprise. Nonetheless, when approached correctly and with discipline, bear markets are an inevitable part of building long-term wealth. As an analogy, everyone likes to look physically fit, but very few like to spend hours staying in shape by doing exercises or lifting weights. However, unless you commit that time and experience that pain, you do not stay in shape. The stocks of great companies around the world have always gone down… and they have always come back historically. Always. If we have a bear market, we’ll get by it too.
Addressing Inflation
Now, to address this thing called inflation. In the last year alone, I have written four letters to you addressing inflation straight on. I am certainly no genius, but you don’t need to be brilliant to know that if you take 10-pounds worth of cash and try to put it into a 5-pound bag, you are going to get inflation. Rolling out airplanes full of vaccines is generally good and pushing out wheelbarrows full of cash is generally bad.
The reason inflation is bad economically is simply due to the fact you can’t outrun it. The beast will eventually wear you out and run you down. On the other hand, economists also realize that they can’t have “deflation” or the world is also upside down and there is no good economic future.
This simple but unmistakable reality is why the dual-mandate of the Federal Reserve is SO important and why it has been affirmed SO many times:
- Maximum unemployment.
- Stable prices (and moderate long-term interest rates to accompany them)
In practical terms, the Fed targets inflation to be ~2%. Currently, we have 6.5% – 8.5%[vi] (so-called ‘core inflation (non-food and gas) and CPI, or year-over-year increases in the basket of goods). A year ago, Jerome Powell and Janet Yellen said we would not have inflation but that it would be transitory. As top policy makers, the underlying fear of inflation should have been more on their minds and that’s the core reason I fault them. A stable price level is the PRIMARY job of the Federal Reserve, and they were complacent about the fact that Uncle Sam’s COVID stimulus was 25% of GDP – the highest in the developed world. The exogenous events called Russia coupled with COVID supply chain shortages absolutely aggravated the rise of inflation, but the inflation flame had already been lit. As the famous economist Milton Friedman said: “Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”
What Does Inflation Mean For Investors?
The problem to investors is hereby expressed in a nutshell; If stocks long-term bring returns of 8%-10%[vii], but occur with large annual ups and downs, whereas inflation is a relentless 8%, that beast will catch and eat you. And therein is the essential problem; left unchecked, inflation will cause standards of living to decline, a negative effect even more inescapable for the lower income household.
Overcoming Inflation
Thus, let’s talk about the solution to the problem of inflation.
It will be overcome by two steps working simultaneously with each other:
Federal Policies
Offsetting Federal policies will put into effect, principally the increase in interest rates and the lowering of money supply. You already hear of this going on and yet “soft landings” are economically hard to achieve, and thus the recent market decline.
Private Sector
Complimenting this effort will be the private sector, capitalism by any other name. If one vendor can answer a parts shortage impacting another supplier, it will be done. There is no love in capitalism, there is only competition. People don’t like capitalism because it is loveless, but alternatively what it does is relentlessly pressure companies to capture business, or they will go out of business. These companies are currently increasing prices to account for inflation (which is why stocks are a great inflation hedge), but competitors will come in, and prices will level out. In this shortage of parts and key minerals in the world, innovation is going to get unleashed, and we will see solutions in 1-2 years we can’t even conceive of now. That’s the positive part of what a crisis delivers.
Inflation And Your Portfolio
The above recap of economics is why I have always said the greatest risk to your portfolio is inflation. It is simultaneously the reason I have said that the equities of the greatest companies in the world must also be in your portfolio. Thus is the reason that Wellspring clients own pieces of most of those great companies.
It remains my deep and distinct honor to serve you.
Patrick Zumbusch
Founder and CEO
Wellspring Financial Partners
[i] “Russia’s Share Of Global Domestic Product (GDP) 2016” (Statistic.com, April 26, 2022)
[ii] “Russia’s Economy Is Surprisingly Tiny. Here’s Why It Matters So Much To You” (Chris Isidore, CNN.com, February 26, 2022)
[iii] “Energy Fact Sheet; Why Does Russian Oil And Gas Matter?” (International Energy Association (IEA), March 21, 2022)
[iv] “Supply Of Critical Minerals Amid The Russia – Ukraine War And Possible Sanctions” (Robert Johnston, Center Of Global Energy Policy, Columbia University, April 19, 2022)
[v] -Ditto-
[vi] “Why Is Inflation So High” (Taylor Tepper, Forbes Advisor, April 12, 2022) [1] Center For Research Of Security Prices (CRSP data, University of Chicago)
