How to Invest Like It’s 1938

Former Federal Reserve Chair Paul Volcker titled his memoir ‘Keeping At It. His successor, Jerome Powell, has adopted the phrase, Christian H. Cooper writes.

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About the author: Christian H. Cooper is the portfolio manager at Subversive Capital Advisors, a former term member and the Council on Foreign Relations.

The world has changed. Did you notice? The ironic thing about long-term investing is that it does, in fact, happen over a long term. But humans, and certainly investors, are notoriously hard-wired for the short term. That’s a dangerous trait for sapiens to have when tectonic change appears to be underway. 

The breadbaskets of the world are at war in Europe and the United States has just begun shipping the iconic Bradley Fighting Vehicle to the front lines. The United States, in a policy choice ripped from the pages of a dystopian novel, has begun limiting movement of technology and people involved in making chips. 

Taiwan has increased its required military service from 4 months to 12 months. Both Germany and Japan have begun a decade-defining remilitarization. And the surge of Covid infections in China could drive a new global wave of the pandemic. What does history tell us about the course of inflation after pandemics and wars? Nothing good.

If you listen closely to Federal Reserve Chair Jerome Powell, you will notice a curious variation on a phrase he keeps peppering into speeches: “keeping at it.” Powell is a product of Georgetown Prep, Princeton University, and the U.S. Treasury. His use of this folksy musing might strike you as odd given his background. That is, until you realize it’s a phrase Powell predecessor Paul Volcker was wont to use to the point of naming his memoir Keeping At It

This is the moral question Powell is confronting and one the market is fundamentally mispricing: What are the implications of the loss of the peace dividend for an entire generation? 

Most members of the Fed completed their graduate education generally in the 1990s, only a decade removed from the war on inflation Volcker waged in the 1980s. Just enough time to make the topic ripe for academic study and for them to personally witness the effects. 

You can’t get the lived experience of what over-10% inflation feels like from a textbook today. There is a lot at stake when interest rates begin to get out of control. Societies start asking existential questions like, “Who owns all this debt?” Inflation is more than just an economic erosion. It also represents an erosion of trust within a society as people and circumstances begin to reprice what the risk of any given currency is. If there is a significant debt-ceiling fight, and it appears there will be, you will want to be glued to the market-implied default risk on U.S. debt as your first early warning of rougher markets ahead.

If you want to understand what the Fed has to do, you have to understand that policy is a product of its members’ world view and their experience, both academically and personally, of what it feels like when inflation gets out of hand. 

If we consider a world, to borrow a phrase from Thomas Friedman, that is no longer flat, then de-globalization and the loss of the peace dividend is only going to be amplified. Inflation doesn’t get fixed when gas is structurally lower, more housing is affordably built, or food prices are lower and more stable, because those things just don’t happen anymore. 

Yes, new supply chains will be built; yes, Europe will have a different energy complex; yes, “near-shoring” will make sure our iPhone 15X+ will arrive on time. But the bruising from the dual body blow of wars and pandemics is just starting. Uncertainty has a price, and the markets appear to be missing the point. 

As the month opened, the nonfarm payrolls print was to the upside (not a surprise) and the markets rallied off technical lows (not a surprise), yet the 2-year U.S. Treasury rate dropped almost 15 basis points, even while the Fed is widely expected to raise rates one more time to the 4.5% to 4.75% range. To have a 2-year rate lower than what the Fed charges over the short term implies the market believes there will be a rate cut sometime in that rolling two-year window. 

If we believe that inflation will collapse from the current 6.5% to a point where this Fed—the same institution that lived through Volcker and is steeped in the social consequences of persistent inflation—believes we are cratering toward 2% and is willing to cut rates, that means the market has to also believe we will have one of the more historic collapses of wages and input costs in economic history. It’s far more likely inflation will be sticky around the mid-5% range and the Fed is going to keep raising rates until it strangles inflation down to 2%. 

If rates are going to be higher for longer, and the world is no longer flat, and inflation gets stuck at 5%, then active management matters, growth investing is dead, and the Nasdaq is heading to its pandemic lows…but if you’ve got to own something, chips, energy and food—is not a bad place to be. 

The U.S. is embarking on a continent-wide Manhattan Project scale development of 3 nanometer chips. The world is realizing that smaller-scale nuclear reactors should have a front seat at the energy complex question and natural gas is likely the transition fuel. Speaking of natural gas, the price fell so much that fertilizer production in Europe may be increasing this spring just in time to meet what appears to be an increase in demand, a net positive in an otherwise dark time.

If this is your first market downturn, they always seem to last a bit longer than you hope they will. Broad equities might have 20% lower to go, and rates appear set to move about 0.75 points higher. The circumstances of every challenging time change, but the cure does not. Have your emergency cash ready. Plan for a four-month layoff if you can. Invest with what you are comfortable putting away and checking in a year. Check in on your neighbors. Dollar-cost average, know your valuations, and own your values; back to basics. In other words: just keep at it. That’s what I’m going to do. Feels like this Fed is too.  

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