Why I Was Wrong About Inflation + The Probability of a Recession

Taylor Schulte: Prior to invading Ukraine, Russia provided one out of every 10 barrels of oil to the world.

But, that’s changed now that the U.S. and other countries have banned oil imports from Russia. As a result, the global oil market is facing its biggest disruption since the 1970s.

You see, the price of oil was already rapidly increasing due to the pent-up demand from the pandemic and the related shutdowns. For context, the price of crude oil was around $30 in the middle of 2020. Last week, it almost hit $130, an increase of over 300%

Now, I’m not here to talk about our dependence on fossil fuels or how to solve this energy crisis or whether or not our leaders in Washington are making the right decisions. There’s enough of that circling around at the moment.

What I want to focus on is what the current situation means for YOU, for your retirement plan and YOUR investments and what to potentially do in response.

To start, inflation was already a hot topic after reaching its highest level in four decades. But with a war breaking out and a looming energy crisis, inflation is getting worse and the trend is likely going to continue. Some trusted experts suggest that we’ll likely see double-digit inflation numbers this year, which is the opposite of what I had suggested during my 2-part inflation series last month.

I had shared that commodity prices were starting to flatten and all signs pointed towards a low likelihood of runaway inflation. In fact, I shared that it was becoming pretty clear that the COVID stimulus caused a giant spike in prices and those prices were finally beginning to normalize with the world returning to normal and we would see inflation numbers start to drop come summertime.

But then the world didn’t return to normal. Russia invaded Ukraine. And commodity prices shot up. Now, in a vacuum, commodity prices increasing isn’t necessarily an alarm bell. The problem is that we already had pent-up demand coming out of a pandemic that was causing inflation to spike, and now we have a major supply issue on top of that pent-up demand. Low supply, and high demand means we’re likely going to see higher inflation and CPI readings in the coming months.

In fact, we already saw a spike last week, when the monthly CPI number came in at 7.9%. As a reminder, that number was reported last week, here in the month of March, meaning it’s comparing the time period from February 2021 through February 2022. We will see the impact of the events happening here in March, early next month, and in April.

So, I was wrong. And my comments from last month about inflation prove to be a good reminder that predicting the future is impossible, and things can change very quickly. Which is why we want to be careful about acting on predictions and making changes based on what we think might happen in the future.

You’ll notice that in my inflation series, while I provided an educated opinion about where we might be headed, I never once suggested that you make changes to your plan or investments in response.

As I’ve said countless times here on the podcast, your investments shouldn’t change unless your investment policy statement changes. And your investment policy statement shouldn’t change unless your financial plan changes. Examples of your financial plan changing include things like, retirement is around the corner, an inheritance was received, a job was lost, a business was sold, a death or divorce in the family occurred.

A spike in inflation or Russia invading Ukraine or commodity prices spiking are not examples of your financial plan changing. Yes, these events cause uncertainty and worry, but if we’re being honest with ourselves, we’re constantly up against uncertain times.

The stock market has been charging upward since 2009, but let’s not forget all the uncertainty we experienced along the way. We had the European sovereign debt crisis through 2011, the U.S. government shutdown in October of 2013, ebola in 2014, Brexit in 2016, a trade war in 2018, another government shutdown in 2018/2019, and a global pandemic in 2020.

I’m not trying to downplay what’s happening in Ukraine and what the world is currently up against. It’s awful. And scary. And heartbreaking.

The general point (or reminder) I’m trying to make is that we’re always dealing with challenges and uncertainty. We use this term pre-covid in ways sometimes that suggest that uncertainty didn’t exist in the financial markets before then. But we forget that in late 2018, the U.S. stock market dropped 20% in less than 3 months and uncertainty was very much alive and well.

Uncertainty is constant. We get paid a very nice premium for investing our money in the financial markets and putting up with risk and uncertainty. It would be strange to believe that we deserve that premium without any risk or uncertainty.

Knowing that uncertainty and turmoil will always exist, we have to figure out how to deal with constant challenges without making costly mistakes. And, in general, there are two ways to do that: 1) stay focused on what you can control and 2) have a plan you can stick with. I know, not exciting, but let’s dissect that a bit.

Long-time listeners know that I like to highlight the worst-case scenarios for a financial plan and an investment strategy. By going through that exercise and shocking your plan, you can then ask yourself, can I commit to this plan through all the future unknowns? If my investments dropped 30% and it took 4-5 years for things to recover, can I commit to the plan? Can my plan survive that kind of shock?

If not, it’s time to adjust your plan and your investments. Which might mean you have to delay retirement, or reduce your expenses, or save more money, or adjust your travel budget, or downsize, or move to a city with a lower cost of living – all things that you have control over.

As I’ve said so many times here on the show, NOW is the time to ensure you have a plan. NOW is the time to ensure your investments are properly aligned with that plan. Yes, the U.S. stock market is down 11 or 12% this year. But over the last 12 months, it’s up close to 6 or 7%. And over the last 10 years, it’s up over 200%.

Making prudent changes to your investments now does not mean that you’re selling things at a loss. The market has been very kind to patient, long-term investors. NOW is not the time to be greedy. NOW is when you want to ensure you have a plan you can stick with – not when we go through another catastrophic meltdown. Because that meltdown might coincide with your desired retirement date or the year you were hoping to sell your business or the year your child’s first college tuition payment is due.

And to be clear, making prudent changes to your plan and your investments right NOW does not necessarily mean panicking and selling stocks, taking risks off the table, or putting everything under the mattress. For many of you, even those in retirement, your plan can withstand a high level of risk. You can withstand a high level of risk. You know that you’ve gone through the appropriate analysis, and you’re ok with it.

Another 2008/2009 like event would not change your lifestyle or force you to go back to work. Your plan might be designed around your goal of growing your money for the next 30 years so you can maximize the amount you give to your children or the amount you can donate to charity at end of life.

So, when I say that NOW is the time to have a plan, and NOW is the time to ensure you can stick to that plan, I’m not suggesting that everyone go run for cover because of a war overseas or because we might see double-digit inflation. Your plan is unique to you, your needs, and your goals.

The key is to have a plan, a plan that is regularly updated, a plan that takes into account unknowns, a plan that takes into account catastrophic scenarios. The plan equals knowledge and that knowledge gives you the power to make intentional, informed decisions about your financial life. Decisions around things you have control over.

Now that I’ve hopefully made it clear that reviewing and/or updating your plan doesn’t mean panicking and selling everything, let’s circle back to current events and where we might go from here.

With prices increasing and double-digit inflation looking more likely, a recession could very well be around the corner. By the way, this is NOT a prediction, I’m just trying to be objective and make an honest observation given the information we have in front of us. One such piece of information is that we’ve never seen an inflationary spike like this without it ending with a recession. It’s happened 9 times since 1940.

As Ben Carlson pointed out last week,

“Economies typically go into a recession from overheating and excess. An overheating economy tends to lead to inflation, which itself is a form of excess. The way those excesses get wrung out of the system is through a slowdown in growth and demand. So it’s not a surprise that we would see inflationary spikes followed by recessions.”

It’s important (and interesting) to highlight that those 9 recessions we experienced since 1940 post an inflationary spike, on average, lasted less than a year. The 2008/2009 recession lasted 18 months, the 1980 recession lasted 6 months, and every other recession fell somewhere in between. But, to be fair, 12 months can feel like an eternity when you’ve lost your job, or are forced to delay retirement, and the world feels like it’s going to end.

Speaking of job losses, one of the most interesting parts about all of this, and maybe something that can provide some optimism here, is that we’re currently in one of the strongest job markets ever, in history. There are over 11 million job openings in the U.S. right now. Pre-covid, that number was around 7 million. There are 4 million more job openings in 2022 than in 2019.

Consumers also have record low levels of debt as a percentage of income and record high cash balances in the bank.

Of course, this can all change quickly, but we’ve never seen a combination like this before. In 1982, which was the last time inflation was this high, the fed funds rate was at 13%, unemployment was close to 9%, and the stock market was nearly flat for well over a decade.

Today, the fed funds rate is at 0%, unemployment is below 4, and U.S. stocks are up 200+% over the last 10 years.

Perhaps the financial health of consumers coupled with the financial health of our job market helps to provide some much-needed protection against a long, drawn-out, catastrophic recession. I don’t know, and remember that nobody else does either.

But one interesting point that friend of the show, Morgan Housel, recently made is that recessions are less frequent these days. 100 years ago, recessions were quite normal and occurred every 2-3 years. But over the last quarter century, we’ve only had 3 recessions, one of those being COVID in 2020 which is the shortest recession ever in history.

Pushing aside reasons for why recessions aren’t as frequent, Morgan’s point is that, when recessions are rare, people aren’t good at handling them. When it rains in San Diego, all hell breaks loose. Nobody knows how to handle a little storm because it's usually 70 and sunny. Folks in say, Seattle, on the other hand, are well experienced and equipped for handling rain.

Back to recessions, because they are more rare today than 100 years ago, it presents a higher level of risk. People aren’t prepared. They get caught off guard. And their financial plans get totally derailed. Don’t be those people. Just the fact that you’re listening to this podcast right now lowers the risk that a recession derails your plan. Because, hopefully, you have a plan, a plan you can stick with, and a plan that takes into account both the ups and the downs.

On that note, before we part ways, I do want to take a minute to mention that, thanks to countless requests from listeners over the last couple of years, we’ve made some significant improvements to our service model at my firm in an effort to better meet the needs of retirement savers over age 50.

We now provide a comprehensive retirement and tax plan for a one-time fee of $7,900. Upon the completion of the plan, you can choose to implement the plan on your own (which we are fully supportive of) or hire us for ongoing services to implement the plan and do the heavy lifting for you.

To learn more, I’ve placed a link in the show notes, but you can also just head over to definefinancial.com and click on the button that says “Get your retirement plan.”

And if we don’t have the right expertise to help you, please don’t hesitate to send me an email at podcast@youstaywealthy.com and I will be happy to try and get you into the right hands and help you find a qualified financial planner or resource.

For all the links and resources mentioned today, head over to youstaywealthy.com/146.

Thank you as always for listening, and I’ll see you back here next week.

Episode Disclaimer: This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services.