February’s 7.5% CPI is a problem for the stock, bond, and real estate markets
The stock market is at historically high valuations and asset prices broadly are in a bubble. While it may not feel like 1929, stock valuations are as stretched today as they were in 1929 and 2000, according to Nobel Prize winner Robert Shiller’s Cyclically Adjusted Price Earnings “CAPE” ratio.
Timing markets is very difficult to do. In fact, most investment professionals will tell you not to try. Nevertheless, the probabilities of investors generating good returns when they start off by buying an overpriced stock or asset are far more difficult than if the same asset is bought at a low price. For this reason, I am writing my third consecutive cautionary article for The Daniel Island News readership. There are times when caution is advised. I am advising caution.
The great problem today is that interest rates are artificially depressed, and a 40-year period of declining interest rates is ending. With inflation data, like the Consumer Price Index (CPI), which just reported the highest rate since August 1982, interest rates should rise faster and higher than the markets believe. Rising rates will be disruptive to stock, bond, and real estate prices. January was the worst month for stocks since March 2020 when COVID-19 crashed the market and economy.
The St. Louis Federal Reserve Bank chart below shows the reversal of 40 years of declining interest rates. Since March 2020, rates have begun to rise. Inflation is driving interest rates higher.
Source: St. Louis Federal Reserve (fred.stlouisfed.org)
If this trend of rising interest rates continues, stocks and bonds will perform less well and possibly decline meaningfully over the next few years.
One reason interest rates are artificially low is that the Federal Reserve bought $9 trillion in Treasuries and mortgages which it holds on its balance sheet. These assets were bought to rescue the economy from the 2008 financial crisis, the Great Recession, and the COVID-19 collapse. The Federal Reserve’s mandate is to promote maximum employment and stable prices, not to set market prices.
Our prognosis is grim because recent decade’s deflationary forces of outsourcing manufacturing to China and technological efficiency enhancements have run their course. Today, we are experiencing inflation rates not seen since August 1982. Not since 1929 and 2000 has there been a time so important to reassess financial risks and personal investing. My cautionary advice is in concert with Warren Buffett’s “favorite indicator,” Jeremy Grantham’s market bubble research (Grantham expects a 45% decline in the S&P 500 over the next three years), and Nobel Prize winner Robert Shiller’s CAPE indicator.