The U.S. economy is recovering from the Covid recession and major market indices have continued to notch upward, yet many investors seem headed for a winter of discontent.

Emotionally scarred by the pandemic that kept them homebound much of last year, many clients are now afraid that the economic aftermath—the highest inflation in 30 years—will pummel their stock portfolios. For many, this fear is morphing into outright paranoia, fueled by incessant media reports on inflation, sticker shock from much higher prices at gas pumps and grocery stores, and exposure to the national obsession with what, for most, is a new discovery—the supply chain.

Though good economic growth has been firmly established, as reflected in abundant job creation in October, an ABC/Washington Post poll released at mid-month showed that about 70% of Americans believe the economy is in bad shape. Perhaps understandably, the public can’t seem to square recovery and a brisk market with an economy where abundant jobs are going unfilled.

Of course, all these worries are permeating investors’ consciousness. A recent survey by the Fed showed that investors’ biggest concerns include persistent inflation and the possibility of a resurgent pandemic powered by new variants.

Though their account balances may be rising, many clients are now worried about the potential for decline. Of course, this is a normal sentiment. But regarding the economy, from their glum faces, you’d think we were headed into a recession instead of climbing out of one.  

Accordingly, this really isn’t a time for advisory handholding, as advisors must do in bear markets. Rather, times like these call for fact-based advisor-‘splaining to vaporize hobgoblins of irrational fear.  

Here are some talking points to use when clients say:

“I’m worried that inflation will stymie my equity portfolio’s growth, and may even send shares plummeting.”
The historical impact of inflation on equities is widely misunderstood. Extensive research shows that on the whole, negative market impacts from inflation are the stuff of myth and assumptions. But many clients just aren’t comfortable without some sort of boogeyman, so they seize on perceived risk from inflation as though this were an immutable law.

Sure, there’s a lot of hair pulling over inflation by tech-heavy investors, but that’s mainly because rising inflation and the higher interest rates it tends to bring usually lower the valuations of immature growth tech stocks, especially those with negative earnings. And increasing inflation now has some analysts saying there’s more than a 50% chance of a Fed rate increase by this summer.

But stocks have historically been the best inflation hedge 75% of the time. Since 1973, over two-year periods after CPI inflation readings of more than 5%, the best-returning investment has been gold. But, as gold is hardly a viable long-term investment, most investors should focus on number 2: equities. Over the two-year periods after CPI inflation readings of 5% and below, the S&P 500 has beaten gold, returning 32.8% after inflation readings between 2% and 3%, 25.1% after inflation of 3% to 4%, and 17.2% after inflation of 4% to 5%. Though gold beat the index after CPI readings of more than 5%, the S&P 500 still rocked, with returns of 23%.

This historical performance should come as solace for equity investors concerned about the November 12 labor report putting inflation at 6.2%. Inflation is widely projected to moderate, so this could put the rate in the sweet spot for equities as the best hedge.

“Even if that’s true, how can you know what equities are most advantageous for me to own at a time like this?”
The performance of key parts of the market during high inflation is a matter of record. Some sectors and styles have historically posted good real rates of return on average during such periods. According to a study by Dimensional Fund Advisors, these styles and sectors posted the following average gains when inflation exceeded the median in years between 1927 through 2020: small cap value 12%, energy 10%, large cap value 8%, and financials 6.3%. This time around, industrials’ infrastructure subsector should do well in the next year or two, according to trend analyses showing that impacts of the $1 trillion infrastructure bill aren’t yet fully priced into some of the companies affected.

“I hear the supply chain bottleneck will probably last for years.”
This is a groundless fear, as supply chain issues are already resolving. Qualcomm CEO Cristian Amon told CNBC recently that he expects his company’s supply issues to ease materially by the end of the year, enabling it to meet demand in second half of 2022. This projection for an industry greatly affected by supply chain disruption sharply contradicts pessimistic projections of bottlenecks lasting indefinitely.

What’s more, the FAA’s end to banning many foreign travelers in early November not only opened up a lot of airline business, but also accommodates increased throughput of specialized industrial cargo. And even now, domestic inventories aren’t as paltry as they’re often made out to be. Constricted supply is intersecting with pent-up demand, but this tension will ease as supplies continue to increase.

“I’m afraid we may have a pandemic resurgence, with nasty new variants that could turn the market bearish.” Though the pandemic is far from over, the severe pandemic of 2020 and early 2021 manifestly is. The Delta variant is now a shadow of its former self, as about 60% of Americans are fully vaccinated and the recent approval of vaccinations for children will bring the nation closer to herd immunity. Also, new pills from Merck and Pfizer could significantly reduce the number of serious outcomes from infection. This means that more people—especially the unvaccinated—will be emboldened to take jobs from among the millions currently open, and that more people will go out, travel, and spend money.

“Many seem to believe that current high inflation will lead to a weak market the rest of this year.”
Actually, historical seasonal effects suggest that the overall market will probably get a strong year-end tailwind. As of mid-November, the S&P was up 25% for 2021, and 22.5% through the end of October. There have been only nine times in the last 75 years when there have been 20% (or greater) year-to-date gains for the S&P 500 through October 31. In all these years, the S&P 500 rose in both November and December. Also boding well for returns the rest of this year is the fact that 2021 isn’t an election year. Since 1990, the fourth quarter has returned an average of 4.7% for the S&P 500. Most of the bad fourth quarters in this average were in federal election years. So much for help from politicians.

The pandemic created chaos because it took us into uncharted economic territory. It’s only natural that there would be a little chaos on the other side.

Though the Fed may be tapering stimulus and raising interest rates, the market will adjust and resume—or sustain—its long-term growth from the powertrain of innovation and economic productivity.

In the short term, there will be spending aplenty from what’s left of Americans’ forced, pent-up savings, estimated by Black Rock at nearly $650 billion. After all, consumer spending is what the U.S. economy, the biggest consumer economy on to the planet, is largely about.

Dave Sheaff Gilreath, CFP, is a founding principal and CIO of Innovative Portfolios, an institutional money management firm, and Sheaff Brock Investment Advisors LLC. Based in Indianapolis, the firms manage about $1.4 billion.