R.I.P. transitory inflation

A week ahead of the Federal Reserve’s final meeting of the year, Chair Jerome Powell testified before the Senate Banking Committee and admitted what most economists had been saying for some time: The term “transitory” has overstayed its welcome when it comes to describing inflation.

For months, Fed officials have clung to the notion that the current surge in prices is transitory, or temporary. This belief allowed the central bankers to maintain two emergency measures put in place to combat the economic fallout from the COVID recession: $120 billion worth of monthly bond buying, which was intended to prevent financial markets from freezing up; and

0% short-term interest rates, which would encourage borrowing and lending among consumers and businesses.

With US growth bouncing back after the surge of the Delta variant, Fed officials used their November meeting to outline the strategy for normalizing policy in the months ahead.

The first step would be to reduce the amount of bonds that they were buying by

$15 billion a month. When that was done

(mid-2022), officials would turn their attention to raising short-term interest rates.

But during the Congressional testimony, just a few weeks after the Fed meeting, Powell said they could accelerate that timetable, which caught some by surprise. After all, what had really changed in three weeks? Perhaps the fact that inflation is running at the quickest pace in three decades. Or maybe it was dour readings of consumer sentiment. Or maybe Powell has concluded that the Fed’s dual mandate, which is to ensure the economy grows enough to get people back into the labor market while not creating inflation, is out of whack.

Regardless of the reason, Powell’s comments, coming on the heels of the WHO announcement of the new COVID variant Omicron, threw investors for a loop. Considering the uncertainty that abounds, some decided that they would rather sell their stock positions, while still sitting atop more than 20% returns for the year.

Thomas Mathews of Capital Economics notes that inflation at these levels “historically, has coincided with very poor stock market returns … in years of 6% or higher inflation since 1900, real returns from US equities have been negative, on average … But so far, the stock market is showing no signs of being at any sort of inflation ‘tipping point.’ ”

Well, that’s good news, but Mathews also warns that there is a chance that “inflation remains high enough to put the brakes on the stock market’s gains.”

Does this mean that you should abandon stocks and go to cash? Come on, you know the answer to that question. As always, the advice remains: Stick to your game plan, which hopefully incorporates a diversified portfolio of holdings that can see you through various conditions. To that point, the folks at Vanguard have crunched the numbers on the historical risk and return among income, balanced and growth portfolios from 1926-2020 (https://investor. vanguard.com/investing/how-to-invest/ model-portfolio-allocation). The results are a good reminder that you need not be a hero and select the best performing asset class — or specific security — in any given year. Rather, it’s best to understand when you will need access to your investments and how comfortable you are with the gyrations of markets from year to year.

You may be the kind of person who believes that earning an average annual return of 10.3% for a 100% stock portfolio is totally worth the high-highs and the low-lows. Conversely, you might prefer to limit those ranges and be perfectly content with an average annual return of 9.1% for a portfolio with 60% stocks and 40% bonds.

Whatever your decision, avoid allowing market movements to spook you into changing your plan.