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The Fed, Markets, and Inflation - A Trifecta of Worry for Retirees

Feb 06, 2023

"I want off!"

I will never forget the first time I went on a roller coaster with my little brother. A minute into the right, they had to reverse the coaster to get us off. My brother was done. He wanted off. Mind you, it was a kiddie coaster.

This past year has brought flashbacks of the past. The market has been a roller coaster, and not the slow, gentle kind for kids. No, this wild ride, filled with bumps and bruises, is just getting started.

The issue is that we are caught in a four-way tug-of-war between the markets, the fed, politicians, and everyday Americans. Each is fighting to have their voice heard. Each is convinced that their version of reality is the truth.

Unfortunately, like the game of musical chairs, until the music stops we won't know who is right and who will be left without a seat.

As investors who are living on a fixed income, these issues will have an outsized impact on our lifestyle. See, while we are working. While we are earning money. When we have time on our side...these are all academic questions. Who is right? Who is wrong? Who will profit? Who will lose? Doesn't really matter. We can always find another job. We can always invest more. We can always work a little longer.

...But in retirement, when we have a finite sum of money, these questions can become existential. Our ability to recover from picking the wrong answer is limited...or nonexistent. As a financial advisor and educator, helping people navigate these questions and issues is my primary responsibility.

The Big Question!

So, what are the "BIG" questions that have the market so unsettled? What is it that both the Monday morning quarterbacks and the professionals cannot agree on? It all boils down to four unknowns...

  1. Are we entering a recession? If so, how bad will it be?
  2. How "real" is inflation?
  3. How high will interest rates rise?
  4. What will the stock market return over the next 3-5 years?

The answers to these questions will determine which companies get funding, where people store their cash...and if taxes will increase. Of course, The Fed is watching Wall Street, trying to control their reaction, and Wall Street is trying to predict the Fed...all while everyday investors watch their savings and lifestyle slowly slip away like a great dream gone with the night.

So, let's tackle the big question on everyone's mind. Are we entering a recession?

Are We Entering a Recession?

A recession is defined as two consecutive quarters of declining economic activity. In non-geek speak, it means that there is a sustained period where unemployment is rising, businesses are closing, and consumers aren't spending as much.

And the Federal Reserve wants a recession.

That may sound crazy, but it's true.

The Fed wants to keep inflation in cooling the economy. See, if people think that a recession is coming, they fire people, hold off on big purchases, and hoard their cash...which keeps money out of circulation. Or, in economic "tightens" the money supply.

The Fed has only two jobs, ensuring that there is a healthy amount of jobs and a healthy amount of money in the economy.

Over the last ten years and especially during COVID, politicians and the central banks have been pumping money into the system. Additionally, due to shutdowns at factories, there were fewer goods for people to buy. This lead to the inevitable increase in, too much money chasing too few goods.

It's kind of like what's been happening in real estate, but on a larger scale. Home prices have increased in part because there are fewer homes than there are buyers. This leads to people bidding up homes, paying above asking, and other inflationary practices.

The Fed has been watching this...and is trying to hit the breaks.

Unfortunately, they only have a few tools at their disposal. The Fed's main tool is raising interest rates. By making the cost of loans more expensive they reduce the number of people who can borrow and the amounts that they can borrow.

Rising interest rates change the flow of money in the economy.

One of the universal truths about money is that it's always in motion and seeks to reproduce. When interest rates are low, money flows into investments like stocks and real estate, driving up their prices. When interest rates rise, money moves out of these "risky" investment vehicles and into "safer" investments, like treasuries and bonds. After all, why would you risk all your money for just a 2-3% "potential" gain - when you can have a guaranteed 5 or 6% return in the bond market?

This puts pressure on all parts of the system.

People stop spending money on luxuries, investors start hoarding cash in "safe" investments. Risky business models that relied on "free" cash start to fail, and people turn sour on "unprofitable" businesses.

As the demand for goods and services decreases, businesses let people go. Freeing up the "labor supply," which in turn drives down wages. Wages increase because there are more jobs than people...but when there are more people than jobs, then wages decrease...when this happens long enough, it's called a recession.

If this all sounds pretty's because it is.

The real complexity comes from trying to read the tea leaves.

See, the Federal reserve's full-time job is reading the tea leaves. Literally, all they do, all day, every day, is compile reports and measure data...all in an effort to determine what people are thinking and where the economy is going.

Unfortunately for the Fed, Wall Street wants to know what's happening too. There's profit to be made by knowing which companies will go bust and which will thrive. So, Wall Street is always trying to predict the future, The Fed, and politicians.

Today, we have an interesting Mexican standoff. On the one hand, the Fed says inflation and wages have risen too fast, too quickly. Politicians are trying to win votes by handing out free money. And Wall Street wants the historic Bull market of the last 14 years to continue. They want the flow of free money to continue.

Who will win? Only time will tell. The tug of war is happening because Wall Street keeps seeing pessimistic data and saying, "see, Fed, the economy is shrinking. You can back off the interest hikes." The Fed has been sending mixed signals, leading to volatile markets.

How Long Will This Continue?

It's impossible to say. As long as the Fed keeps sending mixed signals, volatility, and uncertainty will likely remain part of the stock market environment. The key for investors is knowing how to manage risk in this type of environment.

This means diversifying your portfolio. It means ensuring that regardless of which side wins, your retirement is safe. It also means staying informed and taking advantage of opportunities as they arise.

By being mindful of these strategies, investors can weather uncertain markets and come out unscathed on the other side. With a little bit of preparation and research, it is possible to navigate the stock market even in volatile times. As the saying goes, there's always a bull market somewhere.

Tread carefully and as always be prepared.

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