Where are we headed next? Inflation, Recession, the U.S. Dollar and the Financial Markets with Nick Stonestreet and Brian McClard

In our 12th episode we feature a discussion on the state of the economy with two members of Ronald Blue Trust’s leadership team, Nick Stonestreet, CEO and chief investment officer, and Brian McClard, head of investments. In this discussion, Nick and Brian provide insights on inflation, the possibility of a recession, the state of the economy, the financial markets, the strong dollar, and how a financial plan should anchor your portfolio. 

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The information in these podcasts is provided for general educational purposes only.  It is not intended as specific individual advice. The clients’ experience may not be representative of the experience of other clients and they are also not indicative of future performance or success. Opinions expressed may not be those of Ronald Blue Trust.

Trust and investment management accounts and services offered by Ronald Blue Trust, Inc. are not insured by the FDIC or any other federal government agency, are not deposits or other obligations of, nor guaranteed by any bank or bank affiliate, and are subject to investment risk, including possible loss of the principal amount invested.

Transcript

00:00:07:11 - 00:00:39:01

Welcome to the Wisdom for Wealth. For Life. podcast. Let's bridge the gap between your faith and your finances. At Ronald Blue Trust, we apply biblical wisdom and technical expertise to help you make wise financial decisions. Our goal is to help you leave a lasting legacy. In this podcast, you will hear inspiring stories, practical tips and encouragement from the Ronald Blue Trust family and special guests along the way.

00:00:40:18 - 00:01:02:18

Welcome to the Wisdom for Wealth. For Life. podcast. The information in this podcast is provided for general educational purposes only. It is not intended specific individual advice. The client experience may not be representative of the experience of other clients, and they are also not indicative of future performance or success. Opinions expressed may not be those of Ronald Blue Trust.

00:01:02:19 - 00:01:25:23

In this episode, we feature a discussion of the state of the economy with two members of Ronald Blue Trust Leadership Team. Nick Stonestreet, CEO and Chief Investment Officer and Brian McClard, Head of Investments. In this discussion, Nick and Brian provide insights on inflation, the possibility of a recession, the state of the economy, the financial markets, the strong dollar, and how a financial planner should anchor of your portfolio.

 00:01:26:20 - 00:01:51:16

Let's listen in now. Welcome to the Wisdom for Wealth. For Life. podcast. My name is Brian McClard, head of Investments at Ronald Blue Trust. I'm joined here today by our chief investment officer, Nick Stonestreet, and today we will be discussing the market, the economy, recession and inflation, and other topics that might be on your mind. Yeah, Brian kind of the stuff that we talk about all the time.

 
00:01:52:01 - 00:02:17:14

So it's just like having one of our chats. Just another day. I'm looking forward to our debates. Yeah, it's been a been a wild time in the economy. It's been time for people to have a little bit of anxiety. And maybe the first thing we can touch on is inflation. That seems to be top of mind for everyone. We saw some numbers come out that was a little surprising, right?

 
00:02:18:00 - 00:02:47:04

Yeah, we had actually the worst year-over-year inflation reading that we've had in about four decades. So yeah, it's a little concerning to people, I'm sure. Yeah, you get that 9.1% number as a headline and starts to look a little bit troubling and I think, you know, for our listeners, the way we think about inflation is there's a lot of talk about it.

 00:02:47:04 - 00:03:13:20

But just as a concept, it's not that hard of a concept. It's just too many dollars chasing too few goods. So if you think about inflation and, you know, the two primary causes right now, which is energy prices, we've seen that at the pump and how painful that is. And then we see supply chain. And I think supply chain is the one where people go, what, you know, what?

 
00:03:14:01 - 00:03:37:03

What are we talking about? And so why you know, why does a supply chain breakdown really drive inflation? It's, you know, say you’re a home builder and you've got, you know, houses coming out of the ground and you can't get your windows. Okay. Well, you know, there's been a lot of money for it into the economy, a lot of stimulus.

 
00:03:37:03 - 00:03:55:20

You got a lot of dollars and now you don't have windows. So what are you willing to pay for a window? Well, you know, you've got a half a million $1,000,000 house, and you're going to pay whatever it takes to get the windows, to get the house done. And if it costs 50% more, it costs 50% more, you're going to pay it.

 00:03:55:20 - 00:04:30:09

And so the supply chain shortages, because a lot of the manufacturers in China where you've been on again, off again, start, stop, have disrupted supplies and it drives up the price because of the scarcity of supplies. So when people are talking about supply chain, you know, what they're really talking about is, is scarcity, difficulty getting parts, all of these kind of issues that drive up the prices because when you need something to finish a project or you need to complete something in manufacturing and you can't get your part, you're willing to pay whatever to get that part.

 00:04:30:09 - 00:04:48:06

And that's kind of the driver here. Yeah. And nowhere is scarcity been more obvious than when we saw the run on toilet paper. Right. With the initial onset of COVID. Yeah, that's a bad that's scarcity and. Right. Well so then people want to know, you know how how long is this going to last? What's, what's the outlook for that?

00:04:48:06 - 00:05:13:01

Is it going to go down? Is it going to naturally subside or is it going to get worse? Well, I think it's hard to realize, you know, how inflation rifles through the whole economy. Um, you know, you and I were talking yesterday, you mentioned housing prices up 20% and then mortgage rates double. Okay. The cost of owning a home just went up by 50%.

00:05:13:18 - 00:05:38:18

You know, realistically. And so you see this, how how does that get wound back? Well, first of all, you know, we're starting to see the housing market seize a little bit. You know, a lot fewer purchases, more purchases falling out of contract right now. And so that's going to be a slowing to start to unwind. So oil prices have started to come down a little bit.

00:05:38:18 - 00:06:04:20

So, you know, we'll see. We'll see how that plays out. But the thing about inflation is it's so stubborn. Once it starts going through the system, it goes through every aspect of the system. And, you know, maybe you could speak to what we're seeing longer term. I know we're seeing short term right now with 9.1% and these scary numbers and supply chain and oil prices, all of that.

00:06:05:06 - 00:06:28:19

What do you what are you thinking about for longer term inflation? Well, it's a good question. And there's a lot of things that suggest that inflation should come down in time. And, in fact, if we look at market expectations, they would in fact corroborate that. If you look at longer term expectations that are priced into the market, the expectation is that inflation could come down to about two and a half percent really over the next few years.

00:06:28:19 - 00:06:48:07

So no one really expects this inflation to stick around for very long. And we're not seeing wage price spiral really cause inflation to be sticky either. And so you add that to the fact that you have a Fed is determined to kill inflation. Right. Even if they're going to kill it by demand, there's a good chance that inflation comes down.

00:06:48:07 - 00:07:13:05

For now, of course, the question is, is does it stay down or does it come back? And we have yet to see that, right? Yeah. Well, let's let's back up on a couple of things you just hit on. One is, you know, we haven't seen the wage price spiral yet. And so, you know, when inflation, when you're seeing those prints at 9.1, is like, what are you going to do for your employees?

00:07:13:15 - 00:07:39:07

And ah, is this going to drive wages up longer term? I think the answer to that is going to be it's going to start to hit with higher increases, with higher salary increases coming. But the the part that you're just bringing up, it's so interrelated, the the action of raising the interest rates and deliberately trying to slow the economy.

00:07:39:13 - 00:08:07:21

Why have we seen oil prices coming down? We're slowing the economy, we're trying to reduce demand for oil by by putting the brakes on. Well, guess what? With employment, we're going to look at slowing the economy because it's been a red-hot job market. Right. And so they're going to try to slow the economy. You're going to start to see some companies even laying off in, you know, maybe in the next six months as different sectors slow.

00:08:08:19 - 00:08:34:18

So this is this is how you know, when you say there's not going to be, you know, potentially not going to be kind of that wage price spiral, maybe you could talk more about the mechanism of the Fed, how the Fed works and what it means when they hike rates and what they're trying to do. Well, and that's exactly right, because the shift has happened that, you know, we've gone from, hey, what's happening with inflation to now,

00:08:34:18 - 00:08:57:23

what are the knock on effects to growth going to be, like you said? Right. And so the way that works is that as the the Fed hikes rates, we're talking about the Federal Reserve. That's right. The Federal Reserve targets an interest rate and that interest rate filters through the economy. And since we're a credit-based economy, the rise and fall of our business cycle is really predicated on what the level of interest rates are.

00:08:57:23 - 00:09:21:04

Right. And so as interest rates rise, things like housing, like you mentioned, you know, become less affordable. And so you just mentioned that one of the chief assets of most Americans houses have become less affordable. And that's why housing is an early cycle indicator of what the economy is likely to experience. You mentioned windows. You know, a lot of things go into making a house.

00:09:21:11 - 00:09:47:04

And so the interest rate sensitive parts of the economy like housing can kind of give us a sense for what's down the road. As you mentioned, housing is slowing slowed quite a bit. We just got the worst reading we've seen probably ever for the National Association of Home Builders and Building Index. It's declined significantly. That puts us back to mid-2020 levels and so we'll have to watch and see what happens.

00:09:47:12 - 00:10:14:04

Yeah, but it's this game of chicken, right? It's kind of this game of how high can we, how hard can we throw the brakes on the economy? You know, how much how much damage can we do and slow in the economy and then even potentially using the R-word? So you and I don't always agree whether we're in recession or not in recession, but we go kind of back and forth on that.

00:10:14:04 - 00:10:36:17

That's okay. We use different definitions, but it's it is that idea. Can you talk a little bit about the R-word? Yeah, absolutely. And, you know, recession is such an elusive thing. Right. And we're about to get a GDP reading for second quarter. And that's going to be widely publicized because it's very likely is going to come in negative.

00:10:36:17 - 00:10:57:13

And what that means is that we're going to have a second quarter of negative growth and the media is going to go crazy that, hey, we're in a recession because there is this technical definition that's that's promoted out there that a recession is when we're in two quarters. And so that and that's something to watch – and I’m going to say “Aha! I told you, we're in a recession.” And it may very well be the case.

00:10:57:15 - 00:11:17:12

What do you say? Because we have there's different there's different ways to look at recession. Yeah, right. And that's looking at this technical definition. But but yours is actually well, it's more perfect, I would say. Let's just make sure we continue to consider all the facts. There's some problems with that. You know, for instance, imageries that are more cyclical and GDP gets revised.

00:11:17:12 - 00:11:37:16

And actually, that's not the the actual determinant of what a recession is. There is a business cycle dating committee that will later decide after the fact isn't so convenient whether or not we're in a recession. But when you look at some of the other aspects of the economy, you know, the consumer is the big driver of the economy.

00:11:37:16 - 00:11:59:11

Right. So you want to watch what's happening to them. Well, what is happening to them? Well, they're their real personal income is flat to negative year over year. So we see that they're slowing. That's consistent with the recession. Their consumption rate is tied to their income, so their spending is flat to negative year over year. That's another sign that's consistent with a recession.

00:11:59:16 - 00:12:24:10

But what happens when their consumption then slows? Well, then companies have to stop producing so much. And that means that corporate earnings and corporate profits have to pull back. And once that happens, then you'll start to see hiring slow and then eventually layoffs. The reason why that's significant is because while the consumer up front is slowing, we're still seeing strong earnings and strong employment picture.

00:12:24:10 - 00:13:03:04

And we have never had a recession in the US where corporate profit margins were strong and so those dominoes have yet to fall. Yeah. And so it kind of indicates a recession, but not a deep recession, especially if employment is still strong. So we'll have to to see about that. Well, and that's why I think I would actually characterize that we're in a very slow growth and slowing growth economy that puts us in a very fragile state and makes us makes us very susceptible to shocks and then, therefore, recession.

00:13:03:10 - 00:13:29:11

So there may not be that much difference. At the end of the day between where you and I are. Yeah. Well, you know, as we look as we look forward, when you talk about kind of two and a half percent inflation, you know, out a year or two from now, which, you know, I think I think we could get back there because there's some underlying forces in the economy that have been deflationary.

00:13:29:11 - 00:13:57:10

You know, we were fighting deflation just a couple of years ago. Right. And so I don't think the forces that are pushing us towards a deflationary economy have, you know, just disappeared. Right. I think they're actually coming back and some of the themes might be coming back stronger, maybe talk about some of the big macro pieces that you see that would cause deflation in terms of productivity gains, etc..

00:13:57:18 - 00:14:19:13

Well, I think it's a great point, and I think it's something that will definitely factor into the calculus longer term in terms of where we go. But I don't think it's in view it's certainly not in the communication messages of the Fed or even Congress right now. But some of those things include these mounting debt levels that we're seeing, and we're seeing debt like we haven't seen in over 100 years.

00:14:19:13 - 00:14:47:07

And so we don't know what the impact of that is yet. But significantly, mounting debt and typically high debt like we have as a nation is more associated with lower growth. Secondly, we have aging demographics not just in the US but globally, and aging demographics as well is typically related to a slowdown. And then you have some other complicating factors that are even harder to to see what's going to happen is really path dependent on what what happens there.

00:14:47:07 - 00:15:13:08

For instance, what happens with energy policy. You know, if we try to decarbonize too quickly, you know, that's the type of thing that could be inflationary. Maybe ask Germany, how that's going, right? Exactly. Firing up their coal plants again. So, Brian, you know, we've seen kind of an unusual pullback. You know, we've seen it with equities, but we've also seen fixed income because there's interest rates raise.

00:15:13:18 - 00:15:33:23

There's been some real damage in the fixed income markets. Um, where do you think, where do you think we go from here? I know it's not a you know, we don't have crystal balls and we don't know what's going to happen next. But what do you think? First, corporate earnings and how long do you think the bond, the damage in bonds is going to be?

00:15:33:23 - 00:15:56:21

Because the projected raises and interest rates. Yeah, well, you're right that the the pain that we felt this year has really been because of the Fed expectations for hiking rates. And so it's really been because of the speed of the rates coming off the bottom as well as working from such a low of interest rates like we've not seen in modern history.

00:15:56:21 - 00:16:18:21

And so that explains how we've gotten to where we are. But now we have to look at, okay, well, what's likely, you know, the direction from here. And so so far, it's really just been a valuation hit to stocks, which means that earnings have held up, but prices haven't. And so the price decline so far has just been valuations shown.

00:16:19:05 - 00:16:48:05

The real test will be, and this is a reason we're watching corporate earnings, is what happens from a recession standpoint because if corporate earnings roll over, then you could have another leg down. If we don't have the recession show up, then we could actually be close to the bottom. So we don't know where we are yet. Typically, though, the challenge with stocks is that they are leading indicators, which means they show up before recessions do.

00:16:48:05 - 00:17:14:02

They begin their decline. And then seven months later on average is when we find out that a recession, if there is a recession, has hit because there's not always a recession in drawdowns, and then there's another five months before stocks even find a bottom there. Now, the good news is, is that after the bottom of a drawdown in stocks, the average one year return in a recessionary time is about 37%.

00:17:14:02 - 00:17:35:06

So typically, stocks have had pretty good bounce backs coming out of that. Yeah, we could see that bounce back if earnings hold up, but that's the big question. That's what we'll be watching if there's earnings pressure, then there could be another leg down. Yeah, I think the reasons, though, corporate earnings could hold up even if we do hit a recession is because profit margins are so high.

00:17:35:06 - 00:18:01:11

So they have some strength to be able to absorb some cost increases. You have consumer balance sheets that are really strong as well. And so you really have some things that really could serve to support the market from here. And I think a lot of the damage to bonds has been priced in already. So the biggest move in bonds was kind of from that 1% range to the 3% range.

00:18:01:11 - 00:18:22:22

That's where the biggest hit has been taken with, you know, when you think about bond convexity and what happens with that, that's a really good point you bring up, by the way. And I think it's it's a little technical, but I think it's worth pointing out is that the Fed has raised rates to one and a half percent, but the one-year treasury is at 3%.

00:18:23:05 - 00:18:44:20

That difference represents a cushion that the market has placed in there. And what they're saying with that cushion, where they've placed interest rates above the Fed, is that they believe the Fed will get there. But in so doing, they've inverted the yield curve, which basically is a special situation where short-term interest rates are higher than long-term interest rates.

00:18:44:20 - 00:19:09:02

That's not normal. And when that happens, that typically means they believe a recession is on the way. And so that's why that's significant. So what that means is that the market believes that the Fed is about done and probably by first quarter of next year, the market believes the Fed will be actually cutting rates. Yeah. And the pain in in for fixed income investors, the worst part of the pain has probably been taken.

00:19:09:15 - 00:19:32:18

So we're just hoping for a soft landing from here. So Brian, just as we talk about some of these big kind of macro issues with inflation, we've talked a lot about how it plays out and potential recession in the US, etc. What are we seeing on a global stage that's driving the dollar up? Some of the other major global factors?

00:19:33:05 - 00:19:57:02

Yeah, the dollar's been a really important topic this year. In fact, it's been up against most every currency, maybe except the Russian ruble. And in fact, there's you'll hear some talk about the dollar hitting parity with the euro, which in essence suggests that the dollar and the euro trading 1 to 1, whereas historically the euro has traded at quite a premium actually to the dollar.

00:19:57:02 - 00:20:18:06

And so, you know, the question is, is what's behind this? And so if you look around the world, you see that in Japan, they're implementing something called yield curve control. And that's a fancy way of saying they're holding interest rates steady. And then you go over to Europe and you see what they're doing and they're on the verge of recession because of the Russia-Ukraine war.

00:20:18:12 - 00:20:45:16

And you look in China, yeah, they've been shutting things down because of COVID. So their growth has been slower. And so what's happening in the US? Well, the Fed is raising interest rates. Well, that makes the dollar look a lot more attractive relative to all these other places. And that's really contributed to a strong dollar. The problem, though, is that the dollar is the global reserve currency transactions are settled in dollars, you've got debts denominated in dollars, you have commodity is like oil priced in dollars.

00:20:45:16 - 00:21:10:17

And so when the dollar strengthens, global growth declines. And so what that means is that corporate earnings get hit when the dollar strengthens and then the chances of a recession actually increase. Yeah, it's part of when people hear dollar strength that's not always a good thing. And so we see that as part of a troubling even recessionary picture here.

00:21:11:02 - 00:21:43:05

Some of the things you mentioned on the global stage, you know this on again, off again with China, I think people have seen what the vulnerability the supply chain is now with China, you mentioned Putin's aggression in Ukraine and how interconnected the economies are and the ripple effects that we're feeling. So nobody ever thought that there'd be a war with Russia and Ukraine and somehow that would affect food stability in Africa.

00:21:43:19 - 00:22:05:20

But with the ports and with the grain so weak, when you have these global events, you have all these knock on effects that you weren't really anticipating. The US sort of holds up, as you know, from an economy they use the expression the cleanest dirty shirt, right? And so all of these other places, the dollar strengthening because other places have more trouble and more issues than we have.

00:22:06:04 - 00:22:32:10

And it's kind of navigating that with our investors that first, fortunately, they live in a great jurisdiction where in spite of all the the infighting, there's still a place of political stability, even though it doesn't seem like it if you watch the news. But relative political stability and then an economy that's still moving forward, somewhat reasonably, in spite of a lot of what I'd consider policy mistakes.

00:22:32:21 - 00:22:58:09

But yeah, I think the dollar, as it as it strengthens, is going to continue to heighten the potential recession. But I would look for, as we get more normalized in the next couple of years for even the dollar trade to start to unwind so that we could get that pop in corporate earnings. Yeah, I think that's exactly right.

00:22:58:09 - 00:23:41:04

I think the dollar strength will really be its own doing undoing in the end. Yeah. In all of these times Brian, I mean where the, the kind of rubber meets the road for us and investment strategy committee is all of these economic themes they they end up playing out and what we end up putting in investors portfolios. I think it's good to remember that negative markets are part of the long-term experience, they're a price of admission and that having satisfactory returns longer term is really more about being in the market in time, not every time.

00:23:41:08 - 00:24:17:07

Right. And so I think that's an important piece as well as the diversification. And then the most important piece is really making sure that you don't get disoriented during these markets. And the way you do that is having an anchor. It’s anchoring your investments to your financial plan and knowing where you're going. Yeah. So Brian, I think that's such a key point is, you know, we've all seen the studies where a lot of times our instincts and behaviors as investor behavior is counter to having a productive portfolio outcome.

00:24:18:01 - 00:24:53:14

We've actually seen the Dow Bar and other studies that show that normally when there's this herd mentality and people just act on emotion rather than sticking to a plan, that they get less than optimal outcomes in investing. I mean, that's not even debatable. We we know the research. So in order to avoid that, having your plan thought out, having your cash flow picture, thinking about your cash flows over time, making sure that you have a plan, you stick to your plan, but not just like this kind of high level,

00:24:53:14 - 00:25:10:11

oh, I kind of have a plan. No. I think one of the things we do so well at Ronald Blue Trust is cash flow planning, doing the hard work of digging in and looking at what cash flows are year to year and asking the question, when do you need your money back? And when you can answer the question when you need your money back,

00:25:10:11 - 00:25:35:00

it may be next year to pay for university education for your child, or it may be in 20 years to retire. And those are two different portfolios. And so I think that time-based portfolios that we use so that we're we're allocating and selecting investments for those time-based portfolios, that's helping answer that question. When do you need your money back?

00:25:35:00 - 00:25:56:02

If we can figure that out, then we're able to structure the right portfolios and those portfolios are going to look different. And it kind of takes that element of, oh, the market's down today. Well, the market's down for sure. What market are we talking about? We're talking about U.S. equities. Okay, U.S. stock market's down, but what portfolio is that in?

00:25:56:02 - 00:26:17:01

That's in your ten year portfolio. So even if it's down, you know, from the peak 20%, which is a bear market, which is what we're in, you've got plenty of time to recover because in your ten year portfolio, maybe, Brian, you could just talk about the structuring of those different portfolios that you and your team put together. Absolutely.

00:26:17:01 - 00:26:40:04

And the reason why it's so important to have different time frames for your portfolio is, first of all, your cash flows come at different times and so when you look at when your cash flows come, there's also different risk associated with those cash flows. There's different risk for a cash flow that you need in a year than ten years from now.

00:26:40:04 - 00:27:01:23

I mean, typically the bigger risk for a cash flow that you're trying to preserve a year from now is volatility. So you're not going to want to put an investment in stocks that you're going to need in a year, because volatility is the risk. It’s usually not so much inflation. Obviously, we have an unusual situation right now. Longer term, the risk is inflation.

00:27:02:01 - 00:27:23:04

You're not so worried about volatility and so you don't want to invest in, say, short-term bonds for, say, a ten year time horizon because you would lose out in terms of purchasing power and wouldn't be able to keep up. And so that's the basis for why it's so important to match the assets in the liability, not your cash flow with your portfolios.

00:27:23:11 - 00:27:41:16

Yeah, it's so funny because I excuse me, I've heard you say so many years, you know, in the short term your risk is volatility. You know how much something bounces up and down. And in the long term, your risk is inflation. And we've been telling people this for a long time, Brian, and people would look at us like we were crazy because they were like, what's inflation?

00:27:42:04 - 00:28:08:07

Well, now, you know. So in the short term, it's volatility. In the long term it's inflation. But when you have your portfolio, when you have your plan and a portfolio based on your plan, look, you know, people get really hung up on relative return indexes like the S&P 500. Did I beat the S&P 500 book investing is not a game you're not here to win versus an index.

00:28:08:14 - 00:28:31:14

You know, if you outperform S&P 500, but you can't send your kid to college, you know what? What have you done? You beat an index, but you didn't accomplish your goal. So the number one thing that we have to think about is goal attainment for our clients and making sure that their planning ends up in these time-based portfolios that ultimately lead to goal attainment.

00:28:31:16 - 00:28:50:22

That's the key. It's not listening to this noise and listening to all the talking heads. I always think it's interesting. You see on CNBC, there's like poor people talking and they all pretend they know what's going to happen next. And but two of them are saying one thing and two of them are saying the other thing, which proves they don't know what's happening next.

00:28:51:06 - 00:29:16:13

So your point about diversification and humility and investing is huge because we don't know what's going to happen next. But we do know that having your cash flows, having a plan and sticking to your plan and diversifying is the highest probability, is the way to have the highest probability of success. That's so powerful. And there's really no better way to protect your portfolio and to do what you just said.

00:29:16:18 - 00:29:44:13

Yeah. For everyone watching and listening today, thank you for joining us. And Nick, thank you for spending time today to discuss these important matters. I hope this economic update was helpful. Thanks, Brian. Thank you so much for listening to The Wisdom for Wealth. For Life. podcast. If you're looking for financial advice, please contact us. Please visit ronblue.com that's ronblue.com.

00:29:44:13 - 00:30:08:18

Thank you for listening. Please subscribe to wherever you listen to your podcasts. Trust and investment management accounts and services offered by Ronald Blue Trust, Inc. are not insured by the FDIC or any other federal government agency, are not deposits or other obligations of, nor guaranteed by any bank or bank affiliate, and are subject to investment risk, including possible loss of the principal amount invested.