Into Thin Air
Last week marked the solemn anniversary of one of the most notorious mountain climbing tragedies in history when eight people lost their lives on Mount Everest in 1996. Books have been written chronicling the tragedy with perhaps the best-known being Jon Krakauer’s Into Thin Air. Various causes led to the deaths of those who perished, but they all had one thing in common – they were on the descent, not the ascent. This is a reminder that climbing to the peak of a mountain can be very challenging, but it can be just as difficult to get back down off mountain. Retirement can be very much the same: saving for retirement during your working years is similar to scaling a mountain but is generally only half the battle. Challenges lie in replacing your paycheck in retirement by converting that savings into income while avoiding obstacles, such as paying too much in taxes.
Equity markets were mostly lower last week with the major economic event being the release of the Consumer Price Index (CPI), which showed inflation pressures remain elevated but continue to slowly decline. Headline inflation rose 4.9% over the prior year which was in-line with expectations and a slight decrease from the prior month’s 5% annual increase. Headline CPI has dropped considerably from its peak last June when it hit 9%, however the rate of deceleration has slowed with the latest reading being nearly unchanged from the prior month. The largest contributors to this inflation reading were shelter and food costs. Price changes of other goods have moderated with energy components showing declines compared to a year ago. Core CPI, which excludes food and energy, was higher by 5.5%, changing little since December and remaining not too far off its recent peak of 6.6% last September. The Producer Price Index (PPI), a measure of goods produced, came in much lower at 2.4%. This is dramatically lower than its peak of 11.6% from March of last year. Prices of goods are stabilizing but the cost of housing and services continue to rise causing overall consumer inflation to remain elevated and “sticky.”
The implications of this inflation report are that inflation remains elevated and above the Federal Reserve’s comfort zone but since it is declining, albeit rather slowly, the Fed is now expected to pause interest rate hikes at their next meeting in June. And while they are probably not likely to lower rates in the near future, longer-term interest rates have dropped over the past two months leading to some credence we may have already experienced the peak in interest rates for this cycle.
On the Precipice
The debate over the debt ceiling is now grabbing headlines and will likely continue to over the next few weeks. We would like to think that despite being at odds with each other, neither of the major political parties would want the U.S. federal government to default on its debt which is why we think it is very probable some sort of compromise will be reached. The market seems to agree as it seemingly is not being impacted by the lack of compromise. There is always a chance for a default and if we were to see one it could be catastrophic for the markets, especially in the short-term. But our view is what is happening in Washington, D.C. is what would be considered “political theater” by both sides. There is also a good chance of a short-term agreement to give more time to negotiate. On a lighter note, as we have recently learned, many members of Congress trade stocks regularly so it would not be in their own personal interests to let a default occur which gives us further hope an agreement will be reached.
Perhaps most concerning about the ongoing negotiations is the likely outcome of lifting the debt ceiling and associated increase in government spending. Widely accepted economic thought says that increased government spending can lead to higher inflation, reducing corporate profits, and slowing job creation. Further, empirical evidence overwhelmingly supports the view that a large amount of government debt has a negative impact on economic growth potential, and in many cases that impact gets more pronounced as debt increases. A large majority of studies on the debt-growth relationship find a threshold somewhere between 75 and 100 percent of GDP. As of the end of 2022, federal debt was 120% of GDP, already above the threshold where growth is inhibited. Reduced economic growth and lower corporate profits are not good for the stock market, possibly making decent returns in the market harder to achieve in upcoming years.
Debt ceiling negotiations and the associated political gamesmanship will likely continue to make headlines, but probably will not affect markets greatly. The CBOE Volatility Index (“VIX”), popularly known as the “fear gauge” remains near historical lows, implying that volatility is limited, and markets are not expecting anything besides an agreement to raise the debt ceiling and avoid default. But of course, as we have experienced in the past, markets can be incorrect and not fully price in risks.
On the economic front, consumer spending will be in focus this week with retail sales data set to be released as well as earnings reports from retail giants Wal-Mart and Target. The most important data point may ultimately be the weekly jobless claims release given that last week’s reading was the highest since October 2021 and continuing jobless claims continue to inch higher. Softening labor market trends support the Fed’s move to the sidelines and also play into concerns about the lagged effects of the tightening cycle. This is why it seems increasingly probable the Fed will pause and take a “wait and see” approach for a few months to determine the full impact of rate hikes. Stress in the banking sector is leading to tighter lending standards and therefore has become a de-facto tightening of monetary conditions, taking some pressure off the Fed to continue on the path of higher interest rates.
Planning for retirement is a long, arduous task which involves substantial preparation, just like climbing a mountain. Reaching the peak means working around the obstacles right in front of you, i.e. short term market moves, while not losing sight of the end goal. And once you reach the summit, there can be just as much of a challenge to descend. Let us be your guide to help ensure you successfully navigate the obstacles you may face on the downhill part of your retirement expedition and make sure your savings do not vanish into thin air.
Have a wonderful week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
Please contact us if you would like to review your individual financial plan or learn how the TaxSmart™ Retirement Program can help you.
Office phone # 952-460-3260