Sticky Inflation, The U.S. Consumer, And Your Portfolio
Trying to make sense of it all.
In my most recent post, I alerted readers to a recent adjustment to my personal portfolio. I wanted to return to flesh out a little more detail as to my thinking at the moment.
I’ll spend a little time talking about the issue of “sticky” inflation, some recent information regarding the strength—or lack of it—of the U.S. consumer, and how I am thinking about my own portfolio.
So let’s get right into it.
Sticky Inflation
In a November, 2022 recap featuring recent comments from Fed Chairman Jerome Powell, I featured the 3 categories into which Powell broke out inflation.
Core goods
Housing services
Core services less housing
Of the three, the news with respect to core goods continues to be at least reasonably good. A combination of consumers starting to spend more on services (eating out, recreation, travel), together with supply chain improvements, has led to some improvement here.
However, the news on the other two fronts is not as good. Housing expenses continue to be high, although this may start to abate as a recent pullback in asking rents gradually feeds into official inflation data. Additionally, high mortgage rates may continue to restrain the price of home purchases.
It is in that 3rd area, core services less housing, that inflation continues to prove “sticky.” Why? Here’s how I summarized Powell’s thoughts in that November article I linked above.
Because wages make up the largest cost in delivering these services, the labor markets hold the key as to where inflation may fall in this category. And here, the news is not quite so good. (Italics mine, for emphasis)
Despite some high-profile layoffs in the technology sector, hiring in America remains unusually strong. And Fed officials continue to struggle with the question of how much they need to reduce it to truly wrestle inflation under control.
January’s Personal Consumption Expenditures (PCE) report didn’t help. This index climbed 5.4% in January from a year earlier, an acceleration from the 5.3% recorded in December, and a break in the recent cooling trend.
Over the past couple of weeks, stocks appear to have responded to this, as hopes for a quick “pivot” on interest rates appear to be just that; hopes.
The U.S. Consumer
Interestingly, in the midst of all of this, the U.S. consumer continues to spend. But, beneath the surface, there are at least some signs that not all may be well.
Take a look at this graphic, from the latest Quarterly Report on Household Debt and Credit, published by the New York Fed.
In particular, please note the growth in Credit Card and Auto Loan debt. A blog published to accompany this report noted the following.
[In addition to mortgage balances increasing] . . . credit card balances saw a $61 billion increase—the largest observed in the history of our data, which goes back to 1999. All told, the increase in credit card balances between December of 2021 and December of 2022 was $130 billion, also the largest annual growth in balances. Delinquency transitions in the fourth quarter ticked up as well, for credit cards, auto loans, and mortgages. These are increases in delinquency transition rates that appear relatively small, perhaps a return to pre-pandemic norms, but our closer look here reveals some worsening of delinquency rates among certain groups.
Related to this, I just saw this tweet today.
Is this having any effect on the U.S. consumer? Recently, both Home Depot and Walmart released their latest earnings, along with their outlook. I spotted this, in a CNBC article summarizing the two events.
Home Depot’s shares slid Tuesday morning, while Walmart’s were effectively flat, as they foreshadowed the emerging theme: consumers are becoming harder to win over.
At Walmart, that means shoppers are buying more necessities like groceries and lightbulbs rather than big-ticket items or discretionary items like electronics and home decor. At Home Depot, it could mean customers may delay a home project or opt for cheaper floor tiles or kitchen appliances.
. . . On an investor call, (Walmart CFO) Rainey called food inflation “the most stubborn of all the categories.” He said that Walmart expects that shift away from higher-margin general merchandise goods and toward lower-margin categories like food ” to get a little bit worse” in the coming months.
In summary, all of this appears to indicate some weakness ahead.
How I Am Positioning My Portfolio
As February closed, my portfolio is basically as follows:
Cash - 28%
Bonds - 34%
Stocks - 38% (roughly 24% U.S. stocks & REITS and 14% foreign stocks)
As can be seen, this is reasonably close to a simple 1/3 split between the 3 asset classes.
With respect to my thought process, the most recent 10-year annualized nominal return projections from Vanguard may be of interest.
The first thing to note is that, for the first time in years, cash is generating a very solid risk-free return. As an example, as I write this, Fidelity is touting that Fidelity Government Money Market Fund (SPAXX) is sporting a 7-day yield of 4.20%! So my 28% in cash is both generating solid income, as well as giving me “dry powder” to put to use as I perceive opportunities presenting themselves.
Next, bonds. You don’t have to go too far out on the maturity scale to generate a decent return. Further, for the more adventurous among you, a modest allocation to longer-term bonds (think BLV and TLT) offers both decent current returns and the potential for capital gains at some future point where rates may decline.
With respect to stocks, Vanguard’s outlook tends to support my view with respect to staying diversified, and that foreign stocks may offer even greater potential than U.S. stocks over the near- to mid-term future.
Summary And Conclusion
So there you have it. That’s my best thinking at the moment. I hope it has been of some benefit to you.
What do you think? Do you agree? Disagree? As always, feel free to share your thoughts in the comments section below.
One small addendum, that I should have featured more prominently.
It is exactly that rise in the return from cash and even short-term bonds that constitutes a headwind for stocks. After all, if one can get even a 4% return more or less risk free, the reasonable investor will demand a greater return from stocks. In turn, that means the starting point (price) for stocks needs to be lower.
It is that specific dynamic that causes me to spread my allocation between all 3 asset classes, including a meaningful portion in cash.