James Market Clarity

Inflation Clarity

Neil Craft: Hello and welcome to the James Market Clarity Podcast. I'm your host Neil Craft, and today on episode eight, I'm joined by Portfolio Manager and First Vice President, Brian Shepardson. Brian, how are you today?

Brian Shepardson: I'm doing pretty good. How about yourself?

Neil Craft: I'm doing well. Thanks for being here. We appreciate having you, Brian.
You've been our long time Fixed Income expert, and today's topic focuses on the rather timely topic of inflation. Brian, let's start with what got us to this point in inflation and what factors may have contributed to it, as it stands today.

Brian Shepardson: Yeah, inflation is not something that just happens overnight and to be honest, it's really been a chain of events that as I look at it started back when the U.S. economy was shut down last March due to COVID. What we saw back in March, then as a follow-through, the Federal Reserve stepped in to kind of save the day. They started buying U.S. Treasuries, mortgage backed securities, and for the first time they even started buying U.S. corporate debt. So from that standpoint, they were adding a lot of money to the money supply to the tune of $3 trillion. You add that into the pockets of people going out to the United States, as well as, you know, we see the Paycheck Protection Plan, other stimulus plans, and we're continuing to hear about even more into the future.
You know, I think we can see how that money supply, or as we measure it, M2, has really increased over the past year. One thing that we continue to follow through, however, is the idea of what inflation really is, and it's simply too much money chasing too few goods. So we have the first part of the equation set up and I think we're just now starting to see a lot of that money chase those too few goods as the U.S. Economy begins to open up again, individuals are starting to, you know, go out to dinner more, maybe traveling for the first time, possibly adding more and more things back to their house in terms of fixing it up a little bit here and there. So whatever it might be that opening up of the U S economy has really gotten people in that shopping frame of mind with a little bit more money in their pockets.

Neil Craft: Sure, and correct me if I'm wrong, but it almost feels like a little bit of things have to catch back up to speed, as far as the supply side goes.

Brian Shepardson: Absolutely. You know, a lot of pent up demand is really causing those issues, and I think where it was before on the supply side, when everything got shut down, there was a lot of supply. No one really buying today. It seems almost the opposite with some of those factors where we've heard about chip shortages coming from China affecting, whether it might be automotives. We've heard stories from John Deere as well. Some of those electronics, all those products are really starting to be in higher demand at this point in time, with a little bit lower supply.

Neil Craft: Sure. Well, thank you for bringing us up to speed there. As we kind of turn our gaze towards the future, where do we see inflation going from here? Are there any, maybe specific indicators that you're looking at or, or the research team is.

Brian Shepardson: Certainly, there's quite a few things that we look at when trying to track inflation and where it's going. Number one, I would say within the bond market itself, just those overall expectations, we've seen the long end of the bond market, meaning long-term dated bonds, 30 year bonds, start to drift higher in yield. That's one signification that maybe inflation is picking up. We also look at Treasury Inflation Protected Securities (TIPS), and they have a little bit of a difference in them that they have an inflation expectation built into the price. And that's starting to tick up.
We also look at commodities that are moving higher, as well as housing. So when we see all those prices start to move a little bit higher, those are some signs that inflation is starting to pick up.
And maybe lastly, we're starting to see it in terms of wage inflation. As the unemployment rate comes down further and further, it's apparent that more and more people are getting back to work, and it's going to be a situation where possibly they could do so at a time with a little bit higher rate.

Neil Craft: Sure. Well, a lot of that makes sense. Now as many of our listeners know, James Investment has been a balanced manager for it's crazy, but almost the last 50 years, and as a balanced manager, Fixed Income is always going to be a part of that equation. In times such as these, how do you approach your portfolios? I know you mentioned TIPS. Are there any other tools that you like to employ?

Brian Shepardson: Well, certainly when it comes to the Fixed Income positions that we do have, the first thing that we can do is lower the duration of those bonds. Simply, what that means is, selling out of the longer dated 10, 20, and 30 year bonds, maturity, and get more short, meaning 1, 2, and 3 year bonds. The rationale for that is those shorter bonds have less price sensitivity to interest rate changes. So as we do that, it helps protect our principal for what we've invested.
We can also look to some other things. Like you did mention TIPS, which are Treasury Inflation Protected Securities, which give a little boost when inflation does creep up above and beyond that, it doesn't always have to be within the Fixed Income arena that we look at. We've done several studies that try and point us in the right direction as to what to buy. Those that research does show that commodities often do better than bonds, but believe it or not, the asset that holds up the best is actually small cap stocks. Those tend to do very well in high inflationary environments.

Neil Craft: Really, I would not have thought small cap stocks would have been the, the go-to in times of inflation.
Brian Shepardson: Yeah, you know, once we kind of look back, we think about it in terms of those companies that are large, and hold a lot of cash; that kind of value erodes a little bit. So maybe it's so smaller companies that are a little bit more nimble, they're investing back into themselves, they're able to weather the storm of inflation and kind of use it to their advantage.

Neil Craft: Gotcha. Adapt and overcome with small caps. There it is. Absolutely. Well, Brian, thanks for your time today, and I really appreciate you being here.

Brian Shepardson: Not a problem. Thanks for having me.

Neil Craft: If you have any questions about investments, please get in touch with us at www.jamesinvestment.com and be sure to join us next month as we dive into our discussion on active versus passive management, and how ETFs can help supplement your portfolio. James Investment: Your Future, Our Purpose.