How Can We Expect Our Economy to Behave?

A compass pointing southwest on top of a spreadsheet full of numbers

I don’t own a crystal ball, and those that claim to have such a treasured gem should make you nervous. In fact, you might just want to run fast in the opposite direction. But after the 2-plus tumultuous years we’ve just endured, many of us are looking for a break from the headlines, the noise, the higher cost of living, and frankly, a decent return on our money. It’s no surprise that I am getting a lot of questions from folks asking what we can expect to happen in the near future. Many folks are looking for some reassurance that things are going to get better and that things might soon return to “normal”, whatever that may look like.

I explain that I am not in the prediction business when it comes to the economy . . . that is fool’s gold. But what I can do is explain a little about how we arrived here and some of the issues we should keep our eyes on. Three that are worth following in particular are inflation, interest rates and economic growth. These three alone, but especially combined, can have a noticeable impact on our everyday lives. So this week, I’d like to dig a bit deeper into these areas so you can better understand what’s going on now – and what could happen tomorrow.

Some prominent analysts and economists believe that we’ll see inflation hanging around for the long term, with rising interest rates, and likely slower economic growth than we’d like to see. And I tend to agree. 

This sentiment was echoed by Raghuram Rajan, a professor of finance at Chicago Booth. Rajan was previously a governor of the Reserve Bank of India between September 2013 and September 2016, and also the chief economist and director of research at the International Monetary Fund in the early 2000’s. 

He recently spoke at the Morningstar Investment Conference in Chicago in May and presented his thoughts on what he believes are the near-term outlook and the bigger picture changes that will affect investing. In his opinion, the economic outlook is affected by the pandemic and the fiscal response to it, both in the U.S. and globally, as well as the war in Ukraine and concerns around Fed policy. 

For example, demand for certain goods increased significantly during the pandemic – think the huge rise in food deliveries as a result of restaurant shut-downs and fears of leaving the home and becoming sick, or needing to care for children learning remotely. And this all happened as global supply chains were also hit by lockdowns and labor supply tightened.  

Labor supply is returning, but not completely. There are still higher than usual levels of unemployment, and the jobs available are not proportional to workers that are available. This in turn drives up wages (especially as workers need to keep up with rising inflation), and these costs are passed along to consumer. 

The financial markets often look to the Feds to help them, Rajan said. The Fed is raising short-term rates, and that could cause long-term rates to rise, which is already happening – mortgage rates are already above 5%. Given the disruption we are seeing in supply chains, Rajan said, the Fed will not stop at 2.5 to 3%; it will go much higher. More likely, he said, there will be more tightening and slower growth₁.

What this suggests is that we could see slower growth, which then means lower real and nominal interest rates.  According to Rajan, the real rate for the 10-year is about zero, he said, which is consistent with his long-term forecast of slower growth. 

Hmmm, this sounds a lot like the lost decade of the early 2000’s, doesn’t it?  I have seen this before.

Look, I believe there are three areas that could be key to helping create longer term growth for investors: de-globalization, technological and climate change.

For example, de-globalization is a concern particularly with respect to China. Once COVID was under control, China tried to reform its economy. The problem is that they are too dependent on the global economy and focused on increasing domestic consumption. China has kept wages low to support industries, so reversing this could stunt creativity and competitiveness. And they need to reduce tensions with the U.S. and others to return to outsourcing manufacturing to other, friendly countries. It’s possible this won’t happen in the short term and their rivalry and poor relations could continue.

And then there’s technology. Now, technological change can be good or bad. For example, some advancements can mean job losses in some fields, as technology solutions can replace the need for skilled workers. One potential result is that communities in manufacturing cities could then see higher unemployment, social breakdowns and more crime. 

On the plus side, however, technology can be a real positive. Consider the work-from-home economy during the pandemic. Some workers may be willing to sacrifice a portion of their salary in exchange for the benefit of being able to work from home.  

Lastly, climate catastrophes are multiplying and appear to be connected to climate change. Climate change has been a topic of discussion for decades, and increasingly so in the last few years. It seems that most governments agree on the potential damage of continuing on business as is – but deciding just what the next steps should be continues to be struggle. In the investment arena, both regulators and shareholders want action. For example, ESG (environmental, social and government) investing is a good concept in theory, but it could come with a price tag because these funds have to develop screens and screen companies. 

Now, I don’t mean to paint a depressing picture for you. Heck, I haven’t even talked about the crime issues, open borders, and oil.  I will save that for another day. Yes, we have some economic challenges ahead of us.  But as I’ve always said, your success will depend largely on your system; in good times and bad. A solid system circled around downside risk mitigation using quantitative data that may help you prepare for potential short and long-term challenges with greater confidence. 

And as always – be vigilant and stay alert, because you deserve more!

Have a great week.

Jeff Cutter, CPA/PFS offers investment advisory services through Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, and Mansfield. 

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