Economic Outlook - November 2022

Do you remember the empty oatmeal container – that cylindrical cardboard carton with the red, white and blue graphics, the image of the Quaker oat guy and the snap-on plastic lid? Among my younger siblings, this was the trophy to have when the oatmeal was gone. I don’t know why. Maybe it was the random noise generated when they banged on it with a wooden spoon, or maybe it was another tunnel to run the Hot Wheels track through. (Do you remember those, too?) My parents would be laughing if they were around to read this.

Coveting the oatmeal container and playing with Hot Wheels mark the last time inflation was elevated to this level. For 40 years, yields have been on a downward trajectory. Since the end of 2008, the Fed Fund rate has spent more time near 0% than with an actual coupon interest rate cost. When interest rates on the 10-year U.S. Treasury bond reached 0.50% in 2020, there was $18 trillion in developed foreign bonds trading at negative yields. That means investors purchasing this foreign debt were guaranteed a loss if the bond was held to maturity. You may recall my amazement and confusion as I wrote about this very topic at the time. This was not normal – and the environment of elevated consumption alongside the low interest rate environment was not normal, either.

Out of curiosity, I calculated the average yield for the 10-year U.S. Treasury bond over the last 40 years. That rate was 5.16%. Today, the yield on the 10-year Treasury is 4.0%, which is still 1+% below the 40-year average. I was able to get mortgage interest rate history for 24 years. The average mortgage rate over that period was 5.02% (by way of comparison, the average 10-year Treasury yield over the same time was 3.34%). An era of low inflation, combined with stimulative central bank interest rates, joined the forces of globalization and cheap energy costs to deliver cheap goods and services.

It looks like we are headed back to something resembling a more normal economy. Since nobody can provide a specific definition of “normal,” let me try to outline it in broad strokes. My initial reaction is that inflation may not return to the Fed’s goal of 2%. Perhaps something in the 2.5% to 3% range would be closer. Short-term interest rates are currently higher than the range I expect them to settle into. Perhaps those will be somewhere between 3% and 3.5%. The yield curve should be positively sloped, which means that longer-term interest rates will be higher than short-term interest rates. Consumers will start prioritizing purchases and cutting expenses at the margin. Savers will again see a return on checking and savings accounts, and bond investors will see interest rate yields higher than they have known for the last 13 years. Stock investors who recall a 16% annualized return (from the end of 2008 to the end of 2021) will need to settle for 7% to 9% over the next decade.

There are exceptions to these broad themes. A recession next year, on the heels of the global central banks’ aggressive inflation-fighting tactics, is at the top of the list. Russia elevating its threat to Ukraine is another. China wanting to take over Taiwan also makes the list, and there are others. The point is there will be cyclical events, both good and bad, that influence short-term economic and market performance. Don’t get caught up in these. Focus on allocations and investments aimed at your long-term goals. I realize I may sound like a broken record (to return to “dated” memory!), but I see too many investors wanting to reallocate their portfolios based on the “news du jour” – and sacrificing the original intent of realizing their long-term goals.

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