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Lower stock prices will not buoy bonds nor will lower bond prices buoy stocks. Both stocks and bond prices are poised to fall together. This prediction is not based on inflation, nor is it based on any other story. It is based on the way markets behave and the way this market is behaving.

Inflation Worries?

March 4th, 2019 by Kurt L. Smith
  • In order to be worried about inflation I would presuppose you probably had to experience it rather than try to picture it from a textbook or figure out why economists keep talking about it. Ask your children or grandchildren to explain inflation, or better yet, ask them how important it is or whether they are worried about it.

    Inflation, or the control of it, is the price stability part of the Federal Reserve’s dual mandate. Maximum sustainable employment is the other piece. So it must be important since the financial press always seems to be tracking the Federal Reserve’s every move.

    Defining inflation has never been easy, so don’t be too hard on your children or grandchildren if they can’t define it easily. One formula utilizes U.S. Treasury note and bond prices to help define future inflation. If U.S. Treasury securities are viewed as riskless securities then we can say that it is future inflation that accounts for the differences between short-term U.S. Treasury interest rates and long-term U.S. Treasury interest rates. As the current two year treasury is about 2.5% and the ten year is 2.65% and the thirty year is 3%, one might presume the outlook for changes in the inflation rate over the next umpteen number of years is probably very little. With the advent of Treasury Inflation Protected Securities, or TIPS, the calculation for the outlook for future inflation was made even easier. With the ten year treasury at 2.65% and the ten year TIP at .70%, expected inflation is 1.95% (all basis Bloomberg). That’s greater than nothing but, again, it shouldn’t elicit fear and constant monitoring either.

    With employment near maximum (low unemployment) and price stability (inflation) stable as indicated by treasury security prices, we can easily posit the Federal Reserve has never done a better job than it is right now. Ask them what they are currently doing and they will tell you: waiting. Patiently.

    I am old enough to remember inflation, Jimmy Carter and Whip-Inflation-Now (WIN) buttons. I was told/shown the ravages of inflation as we attempted to determine the costs of college in the 1970’s for one (me) attending in the early 1980’s. College prices were rising and inflation, along with double digit interest rates, was the culprit. One must be diligent and save more in order to be prepared.

    Now that we are at the polar opposite of the 1970’s experience, we should perhaps turn that advice on its head to “one must be profligate and borrow more in order to be prepared (or just throw caution to the wind).” Yes, that about sums it up.

    Indeed college costs did go up from the 1970’s to the early 1980’s, but inflation or lack of price stability had little to nothing to do with why college costs became the monstrosity they are today. Government policies, the availability and use of debt as well as a changing world and myriad other reasons all contributed to exploding college costs more than the inflation rate.

    Yes the world changed. What has not changed is that markets are markets and markets will always behave like markets. This is so important today and I cannot stress it enough.

    Unemployment is historically low. Interest rates are historically low and the prospects for future inflation (per Treasury pricing) are low. There should be nothing to do except invest and wait…patiently.

    Unfortunately this is not how markets behave. And this market, the one you are invested in, will not remain stagnant as the narrative might suggest. This market is behaving in ways that suggest the bull markets for both stocks and bonds is over.

    Therefore I expect lower stock and bond prices in the months to come. Lower stock prices will not buoy bonds nor will lower bond prices buoy stocks. Both stocks and bond prices are poised to fall together. This prediction is not based on inflation, nor is it based on any other story. It is based on the way markets behave and the way this market is behaving.

    Isn’t this what I’ve been saying? Yes, my Top of Tops letter November 2017 said the same thing. Stock and bond prices did indeed swoon. Now they have bounced back and now you know my prediction for what comes next. Take your cue from the markets. That’s where I focus and where I believe you should focus. Reading pundits or watching the economic data can reinforce your beliefs; watching the market will give you insight as to what comes next.

    Take your cue from the markets. That’s where I focus and where I believe you should focus. Reading pundits or watching the economic data can reinforce your beliefs; watching the market will give you insight as to what comes next.

    Baytown, Texas Certificates of Obligation

    Moody’s: Aa2   S&P: AA  Under

    Due 2/1 Dated 3/15/19    Maturity: 2/1/2039

    Sale Amount: $28,390,000

    YEAR       MATURITY         COUPON          YTM*

    1               2020                     3.00%              1.60% 

    2               2021                     3.00%               1.65%

    3               2022                     3.00%               1.68%

    4               2023                     3.00%               1.73%

    5               2024                     3.00%               1.80%

    6               2025                     3.00%               1.90%

    7               2026                     5.00%               2.00%

    8               2027                     5.00%               2.15%

    9               2028                     5.00%               2.25%

    10             2029**                 5.00%               2.35%

    11             2030**                 4.00%               2.55%

    12             2031**                 3.00%               2.85%

    14             2033**                 3.00%               3.00%

    15             2034**                 3.00%               3.10%

    16             2035**                 3.125%             3.20%

    17             2036**                 3.125%             3.26%

    18             2037**                 3.25%               3.32%

    19             2038**                 3.25%               3.37%

    20             2039**                 3.375%             3.42%

    *Yield to Worst (Call or Maturity) **Par Call: 2/1/2028

    Source: Bloomberg

    This is an example of a new issue priced the week of 2/28/19

    Prices, yields and availability subject to change

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