It's more than just energy; rising inflation affects almost every product category touched by the consumer.

• October experienced a bear market rally in stocks and bonds as investors hoped for the elusive "pivot" on policy from the Federal Reserve. 

• Economic data continue to indicate that the mild recession that began in early 2022 continues to deteriorate, despite the positive 3Q2022 GDP reading. For example, housing activity is falling off a cliff due to its interest rate sensitivity.

• Inflation may have peaked in June at 9.1%; September's inflation reading was 8.2%.

• Topics in this month's note:
• Inflation is everywhere
• Why inflation will be sticky
• The Fed will not pivot quickly with inflation this high
• Recession data update: housing very weak
• IRS issues 2023 tax brackets and 401k limits
• LIWM performance report through September 2022

Table 1: Performance update (as of 10/31/2022)

Performance discussion

October performance was higher across many markets despite signs of economic weakness. There were hints from the Federal Reserve that policy was not designed to trigger a severe recession, raising hopes that a "Fed pivot" on policy was near. Earnings weakened slightly as tech earnings fell and energy earnings rose. Additionally, employment remains strong, indicating that consumers continue to spend despite higher costs for many items. Notably, corporate and municipal bonds did not rally at all in October.

If you are concerned about your portfolio, please call us if you'd like to discuss.

Widespread inflation is embedding itself into the economy. While the news reporters tend to focus on the price of gasoline, they gloss over the inflation in services, food, manufactured goods, and many other categories. 

Here are two charts that show categories significantly contributing to inflation. It is pretty easy to see how extensively inflation has penetrated the economy. This chart compares inflation equally; the CPI numbers reported by the government are weighted based on urban consumer spending.

Figure 1: Components of inflation including energy (LIWM)

Figure 2: Components of inflation ex-energy (LIWM)

Analysts are taking note of the pervasiveness of strong inflation. Here is a recent Wall Street analysis looking the percentage of CPI components above 5%.

Figure 3: Percentage of CPI components above 5% (Apollo)

Why inflation will be sticky this cycle

Many analysts are predicting a collapse in inflation sometime in 2023. There is a lot of historical evidence that inflation falls during recessions, including during the 1970s episode. Perhaps you remember this chart I have shared with you several times.

Figure 4: Inflation, US 10-year yields and Federal Funds rate 1960-1980 (LIWM)

Additionally, if you torture some of the inflation data, the peak CPI readings in June can be made to look as if headline CPI is near 2%. This requires several beneficial assumptions about inflation and math crimes when it comes to data analysis. Here is the analysis behind a recent CBSMarketWatch analysis calling for peak inflation. Incidentally, we prepared this analysis to show why it was wrong. The Fed is focused on Core CPI that is still rising, not headline CPI which is analyzed here.

Table 2: Analysis showing headline CPI was really only 2%, not 8% in 3Q2022. (LIWM)

Even though we think inflation will fall as we progress through the current recession, there are powerful inflation pressures in place that may prevent a return to the low-inflation era of the 2010s.

• Demographics 

Baby boomers are retiring and adult participation in the workforce is continuing its multi-decade decline. Companies are scrambling to find workers and unlike previous recessions, workers are being retained (for now).

• Debt

Governments have enormous levels of debt and must find a way to deal with it. There is a joke in economics that there are 3 ways to deal with debt: 1) pay it off, 2) default, and 3) inflate it away if you are a government. Only governments get the ability to debase their currency as a way to lower the real value of debt and cheat the bond holders. Among professional economists, this has been the game plan all along. Here is a 2011 paper advocating inflating away government debt: The Liquidation of Government Debt. Ironically, this paper is published by the National Bureau of Economic Research (NBER) the same group that officially marks the beginning and end of recessions for the government.

• Deglobalization

Tensions with Russia and China are disrupting very long supply chains that the world has come to depend on over the last 20 or 30 years. Whether it be Ukranian food going to African countries or Chinese goods sold all over world, interruptions in the normal trade of goods will make everything more expensive. Shortages will develop and costs will be incurred finding alternatives.

• Deficit Spending

Global governments have spent lavishly during the pandemic, just as they have over recent decades. Low-cost debt has encouraged borrowing, injecting large amounts of cash into the global economy. So far, the response of many governments to the current inflation is to find ways to provide more growth so people can pay the bills. Any first-year economics student could tell you that this is just going to make inflation worse. 

Why the Fed won't pivot quickly

Analyzing the Federal Reserve will be a key for surviving the next few years as an investor. With inflation at 8%, the central banks are riding a tiger. They KNOW what to do, they just DO NOT want to do it.

Historically, defeating inflation has required central banks to raise their policy interest rates above the headline inflation rate for significant periods of time. If you look closely at Figure 4, you can see how wildly the Fed had to move up interest rates to eventually put a stop to the inflationary spiral.

That's not the problem. The key issue is that most of the global central banks have their policy rates well below inflation. In any other environment, this type of policy would be considered inflationary. It is clear they are hoping inflation will fall as we go through this recession, helping them avoid politically damaging higher interest rates. Of course, as I mentioned before, inflation also eliminates the real value of their debt, so the central banks and their governments have an incentive to delay cracking down on inflation.

Table 3: Central banks' policy rates and corresponding CPI (Charlie Biello)

Historically, the Fed has not reduced interest rates until PCE core inflation falls below their policy interest rate. Remember, the Fed focuses on inflation measures that do not have the volatile food and energy components. They focus on Core CPI and Personal Consumption Expenditures (PCE). 

Here is one analysis that looks at adjusted PCE and Federal Funds rate to see whether a Fed pivot is imminent. Based on historical norms, inflation is too high for the Fed to stop raising rates and begin rate cuts.

Figure 5: Federal Reserve pivots v. corresponding adjusted PCE (John Hussman)

Here is a snapshot of core PCE inflation over the last few decades. It is well above target and shows no sign of easing.

Figure 6: Core Personal Consumption Expeditures (PCE) index change yty% (Wolf Street)

Recession update

Data from the Institute for Supply Management (ISM) continues to deteriorate. What this means is that the economy is sliding further into recession. Existing home sales have fallen off of a cliff and despite positive 2% GDP in the third quarter, earnings continue to gradually erode. One of the key reasons earnings are holding up is that companies are finding consumers are tolerating price hikes quite well. The Fed can't be happy about that.

Higher interest rates are rapidly slowing economic growth. In particular, the housing numbers are jarring for two reasons: 1) they indicate how over-stimulated the economy was from zero interest rates and pandemic stimulus, and 2) how rapidly things slow down now that inflation has made an appearance. Most of the interest rates changes affecting housing is driven by bond market changes and not Fed policy.

Figure 6: Housing Starts, ISM composite versus real GDP growth still point to deeper recession (LIWM)

Figure 7: Existing Home Sales fall dramatically (LIWM)

The dramatically lower inflation readings from 3Q2022 played a role in the positive GDP reported for the same quarter. GDP growth is typically reported in terms that are adjusted for inflation. High inflation subtracts from real growth; low inflation adds to real growth.

During most of the summer, the US government pulled oil from the Strategic Petroleum Reserve (SPR) to suppress the market price of gasoline that was creating so much controversy. This policy did, in fact, help push down oil and gasoline prices, directly affecting headline CPI (Table 2) and 3Q2022 GDP (Figure 6). 

The lower CPI reading and its impact on 3Q2022 GDP were not widely discussed in the media. It is possible oil prices and CPI will rise after SPR withdrawals end in the next few months.

Figure 8: 3Q2022 GDP analysis looking at nominal GDP, inflation and real GDP (LIWM)

Market strategy

Bear markets are characterized by short, sharp rallies. There are multiple reasons for this behavior: aggressive hedging by speculators, fear of missing "the bottom" or hints that the Fed might change policy. In October, we experienced a little bit of each factor.

Bear market rallies are a chance to rebalance and reposition portfolios that are out of line with an investor's goals. As the SPX approaches 4000, we will be 17% off of the all-time market high and well above the 2020 pre-pandemic highs. For those queasy over market volatility, this will a chance to re-evaluate portfolio positioning.

Figure 6: 2022 Bear market update

2023 Tax Brackets and Retirement Plan Contribution Limits

A silver lining to the 40-year high inflation for this year is that tax brackets and retirement plan contribution limits are being adjusted significantly as well. Almost every dollar limit set by the IRS is set to increase by 7 - 8 % for tax year 2023. Additionally, 401(k) and 403(b) limits are being increased by $2,500 to $22,500. For those over 50 years old, the catch-up limit will also increase by $1,000 to $7,500. That means for those over 50 and able to maximize their 401(k) contributions, the total dollar amount they can save for 2023 is $30,000.

Traditional IRA’s contribution limits will increase by $500 to $6,500, although the catch-up limit for those over 50 remains unchanged at $1,000. The phase-out ranges for deductible contributions to traditional IRA’s were all adjusted upwards by approximately 7%. Additionally, the income phase-out range to make Roth IRA contributions increased for those married and filing jointly to $218,000 - $228,000. This could be a valuable saving tool for investors who are early or mid-career and haven’t reached the peak of their earnings potential yet. 

Our performance through 9/30/2022

Many of you have heard us talk about the power of asset allocation and its influence on portfolio performance. We believe it is a very powerful technique for managing risk in bear markets. Here is a report of how our portfolios are doing through this time period. These numbers are weighted average return calculations called composites that are based on real portfolios compared to their relevant benchmarks.

During 2022, we have been underweight stocks and traditional bonds across the board, while overweight short-duration treasuries and floating rate debt. In general, we are beating the benchmarks solidly across the board. It has been a difficult year for most as both stocks and bonds fell.

Table 2: LIWM strategy performance compared to relevant benchmarks as of 9/30/2022

Final Thoughts

We are in the midst of a bear market rally, in our view. The Fed is still raising rates, inflation is high, earnings are slightly weaker, and employment is strong. We expect the Fed to continue raising rates, which will have negative effects on the markets and economy.

There are many important data points this week that have the potential to move markets:

Nov 1: ISM and PMI readings on economic growth

Nov 2: Fed meeting and press conference (watch their long-term inflation target)

Nov 4: US employment report.

As always, please call if you'd like to discuss:

Rob 281-402-8284

Chris 281-547-7542

Robert Lloyd, CFA^®

President and Chief Investment Officer

Lloyds Intrepid Wealth Management

1330 Lake Robbins Dr., Suite 560

The Woodlands, TX  77380

281-402-8284

Robert.Lloyd@lloydsintrepid.com

www.lloydsintrepid.com

Christopher Lloyd, CFP ^®

Vice President and Senior Wealth Planner

Lloyds Intrepid Wealth Management

1330 Lake Robbins Dr., Suite 560

The Woodlands, TX  77380

281-547-7542

Chris.Lloyd@lloydsintrepid.com

www.lloydsintrepid.com

Lloyds Intrepid LLC is an Investment Advisor registered with the State of Texas, where it is doing business as Lloyds Intrepid Wealth Management. All views, expressions, and opinions included in this communication are subject to change. This communication is not intended as an offer or solicitation to buy, hold or sell any financial instrument or investment advisory services. Any information provided has been obtained from sources considered reliable, but we do not guarantee the accuracy, or the completeness of, any description of securities, markets or developments mentioned. We may, from time to time, have a position in the securities mentioned and may execute transactions that may not be consistent with this communication's conclusions. Please contact us at 281.886.3039 if there is any change in your financial situation, needs, goals or objectives, or if you wish to initiate any restrictions on the management of the account or modify existing restrictions. Additionally, we recommend you compare any account reports from Lloyds Intrepid LLC with the account statements from your Custodian. Please notify us if you do not receive statements from your Custodian on at least a quarterly basis. Our current disclosure brochure, Form ADV Part 2, is available for your review upon request, and on our website, www.LloydsIntrepid.com. This disclosure brochure, or a summary of material changes made, is also provided to our clients on an annual basis.

Performance Disclosures

INVESTING INVOLVES RISK, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL. PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS.



NOT FDIC INSURED. NOT BANK GUARANTEED. MAY LOSE VALUE.

Lloyds Intrepid LLC is doing business as Lloyds Intrepid Wealth Management. Lloyds Intrepid LLC offers investment advisory ser-vices and is a registered investment adviser in the State of Texas where registered and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. Lloyds Intrepid LLC and its advisers do not provide legal, tax or ac-counting advice. Lloyds Intrepid LLC formulates retirement plans, investment strategies, portfolio construction and investment due diligence for clients with signed investment advisory agreements with us.

This presentation is offered for informational purposes only and is not a specific offer or solicitation by Lloyds Intrepid LLC to buy or sell any investment product or service. This presentation is not investment advice. All opinions and outlooks are subject to change. The information contained herein has been obtained from sources believed to be reliable, but the accuracy of the information cannot be guaranteed. Investments possess a variety of risks. Equity securities possess more risk than bonds or other debt securities and are particularly subject to fundamental change as well as changes to economic, legal, regulatory, and monetary policy, both in the U.S. and abroad. Smaller and international equities have more risk than large US stocks. Bonds are subject to credit risk, interest rate risk, inflation risk and default risk. Treasury bonds tend to have little credit and default risk but are highly sensitive to changes in interest rates and inflation. Corporate bonds tend to be more sensitive to credit risk and default risk. Municipal bonds typically pay tax exempt interest and despite being government entities are subject to credit risk, interest rate risk, inflation risk and default risk. Mortgage bonds possess credit risks and prepayment risks not found in other bond categories. In-vestments in real estate are subject to interest rate, default, and economic risk. International investments, either through direct investment, ADRs or funds, possess unique risks associated with currency translation, different accounting standards, and legal risk from operating in a foreign jurisdiction. Commodities possess unique risks that include regulatory risk, high price-volatility risk, along with interest rate risk, inflation risk and credit risk. Portfolio strategies that use asset allocation, diversification, re-balancing, indexing, or security selection do not ensure profit gains or loss avoidance. Indexes are unmanaged and not available for direct investment; index fund performance will differ from index performance due to management fees. Losses will likely occur in declining markets.

This performance report is generated from the returns of actual portfolios. Composites represent actual portfolios that are man-aged together in a single discretionary strategy. Lloyds Intrepid LLC performance has not been independently verified. All advisory fees, commissions and client paid expenses are reflected in this net-of-fees presentation. Some portfolios are portfolios that pay no fee and have less than $10,000 of value. These will be disclosed if requested. There are no material factors for comparing returns to benchmarks; each strategy is matched with an appropriate benchmark for comparison. Strategies presented reflect the performance of Lloyds Intrepid LLC discretionary portfolios. Investment objectives are consistent with the assigned benchmarks. 

These portfolios have a potential for losses as well as gains. Returns are presented net-of-fees. Risk measures, when presented, are calculated gross-of-fees. Performance is reported in U.S. Dollars. Composites exclude portfolios that have changed model during the measuring period. Internal dispersion is not presented for composites with less than five portfolios. Dividends are included in portfolio return. Investments cannot be made directly into an index.

Lloyds Intrepid LLC offers discretionary portfolios where holdings and asset allocations are actively managed. Unless noted otherwise, these strategies do not use leverage, derivatives, or short positions, are generally liquid and carry the risks associated with index, mutual fund and exchange-traded-fund investing. Occasionally, these strategies will hold individual stocks. The investment objective for each strategy is to exceed the long-term performance of the associated benchmark. Here is a list of our strategies:

Bonds

  Bond portfolios target an asset allocation of 99% bonds.

Conservative

  Conservative Portfolios target an asset allocation of 25% stocks and 75% bonds and cash.

Moderate Conservative

  Moderate Conservative portfolios target an asset allocation of 37% stocks and 63% bonds and cash. 

Moderate

  Moderate portfolios target an asset allocation of 50% stocks and 50% bonds and cash.

Moderate Aggressive

  Moderate Aggressive portfolios target an asset allocation of 63% stocks and 37% bonds and cash.

Aggressive

  Aggressive portfolios utilize an asset allocation target of 75% stocks and 25% bonds and cash.

Stocks

  Stock portfolios target an asset allocation target of 99% stocks.

Blended benchmarks are custom benchmarks that are applied to the performance of each named composite and reflect the long-term asset allocation target for each strategy. The composites presented here are those where LIWM has complete portfolio and asset allocation discretion. 

Bond composite benchmark is 100% Bloomberg Barclays Aggregate Bond. The Bloomberg Barclays Aggregate Bond benchmark is used in the blended benchmarks below. 

Stock composite benchmark is 100% S&P 500 total return. The S&P 500 benchmark is used in the blended benchmarks below.

Conservative composite blended benchmark is 25% stocks and 75% bonds.

Moderate Conservative composite blended benchmark is 37% stocks and 63% bonds.

Moderate composite blended benchmark is 50% stocks and 50% bonds.

Moderate Aggressive composite blended benchmark is 63% stocks and 37% bonds.

Aggressive composite blended benchmark is 75% stocks and 25% bonds.

While returns are presented here as net-of-fees, gross-of-fees returns are available for institutional investors on request and reflect the deduction of transaction costs and custodian fees but not the deduction of investment management fees.