Pandemic, Ukraine, Inflation and Interest Rates
David Edwards:
6:02 on the Eastern Seaboard. David Edwards of Heron Wealth in New York City, and Buff Parham of Parham Associates down there in South Carolina.
Buff, before we get into the main part of the evening, a fun question came in today from one of our listeners - "Who's that cool guy who's always asking you questions?" I thought, "I've never mentioned what Buff actually does." So I'm going to take that opportunity now. Buff is a 1971 graduate of Stanford University. He had decades of experience in sales management at all the major networks, ABC, NBC, CBS, Telemundo, and then 11 years ago started Parham Associates which is an executive coaching firm helping people like me speak better in public.
David Edwards:
This is the second anniversary of the first webinar I did at the start of the pandemic. And boy, back then we didn't know anything. We didn't know how to work Zoom, we didn't know how to work remotely. There was a real sense of foreboding that perhaps the pandemic was going to be the end of our civilization. Every month for the next 12 months, I spoke to our audience about what we knew, what we didn’t know and what we thought might happen next. In the second year of the pandemic we were able to ease back to webinars once a quarter, so our last webinar was at the end of last year.
I’m thrilled that we got through these past two years together, and successfully!
David Edwards:
The pandemic is still with us. Last year it was the third highest killer of average Americans. Number one was heart disease, number two was cancer, number three was COVID, number four was dumb accidents, car crashes and other accidents like falling off cliffs. It will probably be the number three killer again this year. 750 Americans died today, over a million have died so far, probably more if you really parse the death statistics. Yet, as of a month ago, we have simply accepted the risk of dying of COVID as a fact of life. This is the same risk assessment you make every time you get into a car or into an airplane.
David Edwards:
I am not going to spend a lot of time talking about the pandemic tonight. Instead, I'm going to ask Buff to jump right in and start asking questions that came in from our webinar viewers.
Buff Parham:
Thank you, David. A lot to cover. The repercussions of Russia's military invasion of Ukraine are numerous and critical. What do you think will happen in Ukraine over the next three months or so.
David Edwards:
There's a quote that I love to bring out on occasions like this, "War is God's way of teaching us geography!" I wasn't 100% sure where Ukraine was, where Belarus was, until about mid-February when I started looking at maps. I also reminded myself of the history of Russia. At the end of World War II Russia was the second biggest economy in the world after United States. United States was number one, and Russia at 50% of the size of the US was number two. As we got into the '90s and then the current century, Russia fell farther and farther behind. It was the 12th largest economy in 2020, which meant that it was smaller than Germany, Italy, France and even South Korea.
David Edwards:
In Russia, there's this incredible sense of grievance about the way the Soviet empire used to be, and the diminished state of Russia now. By the way, Russia’s territory spans 11 time zones. It's two and a half times wider than the United States, it's just enormous. Yet, Russia has a tiny population of 144 million people (Ukraine, the size of Texas has a population of 44 million.) The Russian economy is pretty much a Third World economy focusing on exports of grain, gas and oil, relies heavily on imports for most consumer goods.
David Edwards:
The other part of history I reminded myself was what happened in between 1979-1989. While Leonid Brezhnev was still the premier, Russia invaded Afghanistan and stayed in Afghanistan for 10 years. During that war, 15,000 Russians were killed, 35,000 were wounded, and a million or more Afghanis died. The Soviets easily took the major cities in 1979. However, for the next decade, the Afghani Mujahedeen armed with American provided Stinger missiles harassed the Soviet troops. When the Russians finally retreated, that defeat caused Brezhnev to fall out of power and caused the Soviet Union in general to fall apart in 1991. The Young Turks charging in to replace Brezhnev were led by Boris Yeltsin who ran Russia for about 10 years, and another Young Turk, Vladimir Putin, who took power in 2000.
David Edwards:
Putin was a rough-neck from Leningrad, now St. Petersburg, worked his way up through the KGB, including time spent in East Berlin during the fall of the Berlin Wall. Putin has an incredible sense of grievance about how Russia is treated today compared to the hulking behemoth nations feared in the '50s and '60s. In recent years Putin has flexed Russian might, grabbing chunks of territory in Crimea and the eastern region of Ukraine, intervening in Chechnya, Georgia and Syria. Putin finally went for the big grab to get all of Ukraine. When this invasion started up at the end of February, I wrote to our clients that, "This experience will be like swallowing a porcupine, hard to get down, even harder to get out” because all the quills get stuck in your throat.
David Edwards:
The invasion has actually gone far worse that I would have expected. I thought and most Europe observers expected that the Ukrainians would be overrun in a week or 10 days, and there'd be Russian troops in Ukraine facing across the Polish border. It turned out that Ukrainians had been training for this day since 2014 after losing Crimea. If Russia is Goliath, the great armored Philistine of Biblical times, then Ukraine is the shepherd boy David with the slingshot. Turns out you can fling a stone as fast as a musket ball. You can break someone's head open with a pebble if you do it right.
David Edwards:
For the Ukrainians, David’s slingshot is the Stinger missiles that shoot down aircraft, the Javelin missiles that blow up tanks, and the drones that hover, find targets and destroy with laser guided munitions. The Russians are helpless against these weapons, with 10-15,000 soldiers killed, hundreds if not thousands of tanks, missile launcher, troop carriers and supply trucks destroyed. The Russians can’t be pushed out of Ukraine (yet) but the Ukrainians have fought them to a draw so far.
Let’s consider four possible outcomes:
First outcome is that Russia overruns Ukraine, and that seems to be off the table at this point. Didn't happen in the first two weeks, not going to happen now. Even though the Ukrainians are massively outgunned by Russians (who see determined to vandalize every city in Ukraine), for every Russian soldier in country there are 100 Ukrainian civilian-soldiers, men and woman, determined to defined their country.
The second outcome is that the Russians are able to create a stalemate, grab enough territory of Ukraine to stay permanently in the country, with sniping operations back and forth across the line of demarcation. This may be the best result for Russia,
The third scenario is that the morale of the Russian army breaks under the attacks of the drones, soldiers basically abandon their tanks and missile launchers and walk back to Russia, which would be the best outcome for the Ukrainians.
The fourth outcome that I fear the most is that if Putin sees his army getting pushed out of Ukraine, he might be inclined to use a tactical nuke against Kyiv. We know about city busting nuclear weapons from the days of Hiroshima and Nagasaki. Now Russia and the United States have so called “tactical nukes” with much smaller explosive yield that are designed to destroy city centers, airfields or tank formations. Putin might drop a tactical nuke on downtown Kyiv to kill off Ukrainian President Zelenskyy. And then we're in World War III, because I suspect that the Americans have a ballistic submarine in the North Sea, which would launch a nuclear missile at Moscow to kill Putin. Shortly thereafter Russian nuclear missiles are flying back to the capitals of Western Europe and to the United States.
David Edwards:
That would be a terrible outcome, and the odds of it happening are not zero. People have asked me already, "What should we do? How should we prepare?" And I said, "There isn't much we can do. Cash will be useless, no ATMs would work, nowhere to spend your money anyway. Gold would be useless. You could bash someone's head in for their food, but other than that no value. Stocks would be worth zero as our whole civilization would have ended. Pretty much canned goods would be the currency of choice. Most of us would not be alive in that scenario anyway, so we've just got to hang in there and hope that nuclear war DOESN’T happen.
Buff Parham:
Terrible would be an understatement. But given the mass exodus of Western companies and the various sanctions that have been placed against Russia already, what threat does a default on its public debt pose to investors around the world?
David Edwards:
Russia has already been under sanctions since 2014 for invading Crimea. As a result, the exposure of Western investors to Russia is only about 3% of the entire emerging world. Emerging market stocks are only about 5% of the developed world's stock markets. If there's 100% default in Russia, and the entire Russian stock market went to zero, it would really have no material effects on non-Russian investors.
David Edwards:
What's very intriguing is to see is what happens when a country is suddenly completely disconnected from the modern world. Russia exports gas, oil and wheat and imports everything else. And at this point, their trading partners are China, India, a couple of others. Russian can't get American cars or European cars. They can't get iPhones. Already young technically educated Russians are running just as fast as they can to the airport, taking the only flight left out of Russia to Dubai and to the rest of the world.
David Edwards:
Russia is already in demographic decline. A huge country as we mentioned that peaked in population in 1993. Now this war may accelerate the demographic decline. I think only one person in all of Russia wanted this war, and it's Vladimir Putin, but no other Russian had the ability to prevent it from going forward.
Buff Parham:
Is this current bout of inflation a temporary or permanent threat to our economic wellbeing?
David Edwards:
Inflation occurs for two reasons. One is excess demand, and the other is a lack so supply. Back in the mid '70s you had very significant inflation in United States based on a lot of demand chasing fewer goods. The whole US economy was transitioning at that point and inflation went very high for a few years. Then Paul Volcker came in as Fed Chair, drove short-term rates to 15% for a couple of years, so then a mortgage was 18% and car loans were 22%. The entire United States was buried in a deep recession till inflation was stamped out. Since then, we’ve had low inflation in the 2% range.
David Edwards:
Over the last couple of years, we've had lack of supply inflation. We had a war on pandemic and now a war in Ukraine. Wars are inflationary. A lot of things that you might get normally just aren't there now. We’ve seen disruptions in supply chains like semiconductor chips. All the countries that make chips had their own lockdowns, and shut down chip factories. I was lucky to buy a new car last summer at list price. The last time I bought a car was in 2009. I got it at about 20% discount. What I hear now, nine months later, is that if you want to buy a new car today you're going to pay an extra $3-6,000.
David Edwards:
When I picked up my car, the sales lady said, "Good news! You’re the last customer to get two sets of keys. From here on out new customers only get one key set.” The car companies are THAT short on chips. Just when it seemed like we were going to get clear of the war of pandemic inflation, we've got this new war in Ukraine, which had an instant effect on the oil markets. Oil went from about 80 bucks a barrel to 130 bucks a barrel in a couple of days, came back down below 100, now it's like 109 or so. What's happening is that a lot of Europeans that previously got their oil from Russia are seeking alternate supplies in the Middle East. Meanwhile, the Russians are trying to sell oil to China and India at deep discount for the cash flow. This is not an efficient process because it might take 4 days to ship oil from Russia to Europe, more like 40 days to ship from Russia to India.
David Edwards:
We will also have elevated food prices for a while. Between the two of them, Russia and Ukraine account for 40% of world grain production. Now, that fact doesn't effect the United States so much because we grow our own grain here. But in most of Asia and much of Africa, they're dependent on grain from Ukraine Russia for basic survival, for bread. That price is going to be elevated because the Ukrainians can't sow seeds now because there's tanks in their fields. The Russians can't export, even if they wanted to. Ships are reluctant to go to Russia because shippers can't get insurance, number one. And then number two, shippers need to get paid in dollars or euros, and Russians can't do that at the moment because all their currency is frozen.
David Edwards:
For basic things we buy like cars and televisions, prices will be elevated because of supply constriction.
There's one other place that we see inflation right now, which is in housing. Housing prices peaked in 2007, came down sharply through 2011 , by about 35%, and then have been rising steadily ever since to an all time high. That rise accelerated in the last two years as short term interest rates went to zero and mortgage rates declined to 2.5% At low interest rates, everybody could afford to pay up for a house. Well now we're going to see rates go 0% up from the current 1.5% up to 3.5% by the end of next year. That will put some pressure on housing prices. Mortgage rates are already over 4% and could well be 5% by the end of next year.
David Edwards:
Higher inflation is going to be with us for a while. What's interesting is that inflation affects different economic cohorts differently. For example, everybody listening to this webinar is in the 1% of Americans for income and assets. You may not believe it, but you are. And you might find that it hurts to pay 100 bucks for a tank of gas that was $75 a month ago.
I'm already spending a lot of money on high quality food like ground buffalo beef, fresh fruits and vegetables. If our weekly grocery bill goes up or down, I’m not even noticing. For other stuff that I need to buy, well maybe I'll postpone buying it for a year. If you don't have to get a new car this year, wait till next year when car manufacturers have caught up with demand.
David Edwards:
The people that are feeling inflation the most are the people with the lowest economic levels in our country where if you need a tank of gas to get to work every week and it goes from $75 to $100, that really hurts.
Or if you're buying your food at Walmart and things go up 10%, that really hurts. You know what’s worse? When the economy slows, this is the group most likely to experience layoffs.
David Edwards:
Investors are way panicking about inflation. I'm like, "You know what? Inflation is going to take a couple of years to settle down, then supply and demand will come back into line and inflation goes away."
Buff Parham:
Well, you touched upon it. The Fed raised interest rates by a quarter of a percentage point last week, and we expect to see possibly six more rate increases this year and three more in 2023, which would take the Fed fund rate up to probably 2.75 or 3.5%. Do you think this plan will actually halt inflation? And perhaps more important, will there be enough near-term growth to prevent stagflation?
David Edwards:
I don't think it's going to have a significant impact. You can raise interest rates as much as you want, it's not really going to address the reasons why inflation is here. It's not excess demand, it's lack of supply. Stagflation, that was something that we all grew up with in the '70s, was when unemployment was high and yet inflation was high. Right now, unemployment extremely low – 3.8%. Several million people aged 50 to 65 retired early during the pandemic and they might come back to work. But right now the US economy is booming.
Huge numbers on GDP, average Americans have more cash on hand than they've had in decades. Real wages, which peaked in 2000, are actually on their way up for the first time in a long time. The stagnation part isn't there, the economy is booming and we just have to wait until the rest of the world catches up to us.
Buff Parham:
One more time, is the pandemic truly over?
David Edwards:
No, it's not. It's not. But it's gone from what we'll call pandemic stage to the endemic stage. The endemic stage means it's always there, it's going to be killing people at a certain rate indefinitely. The people that need to be afraid are the ones that are not vaccinated or not boosted. I think Pfizer this week came out with a fourth shot booster.
We're going to be going to get annual COVID shots for the rest of our life, just like we get annual flu shots. There will be another pandemic. They come along every five or 10 years. This one was particularly successful at taking over the planet. Remember when there was an outbreak of Ebola a couple of years ago?
Buff Parham:
Yeah.
David Edwards:
I think it was back in 2014 or 2015, and people freaked out about that. But luckily Ebola was contained and didn't impact the general population – 11 people were infected and 2 died. The other thing that's important to keep in mind is science is all about detective work. In the very beginning people said, "Don't wear masks, save those masks for frontline medical people, but wash everything you buy in bleach." And then after a few months we realized, "Oh wow, washing in bleach is irrelevant because COVID doesn't last very long on hard surfaces but you definitely need a mask." And then what kind of mask is the best mask? Is cloth good enough? Is N95 good enough?
David Edwards:
People need to understand the scientific process, you've got to understand that it's trial and error. It takes time. You need data. You need to do studies. You've got to look at a lot of statistics. Sometimes answers are just not obvious. I think that our ability to get vaccines in 18 months is the greatest unsung miracle of the 21st Century. It used to take decades to get vaccines. We still don't have a vaccine for AIDS, and we haven't got one for the common cold. But we were able to get vaccines for this new disease in 18 months, that is astonishing.
Buff Parham:
I know that people say that the most dangerous words in investing are, quote, "This time it's different." But some investors really are saying that with the Russian attack on Ukraine, this time really is different. Fortune gave five reasons why the stock market could perform badly form here. We know that you're a student of history. Do you think this time is really different and that investors should sell, or at least lighten up on equities in their portfolios
Buff Parham:
What should they do with any cash?
David Edwards:
Time and again, I've told people and clients that the stock market doesn't care about anything but revenues, earnings and interest rates. Individual investors might be freaking out about emergence of more pandemics or Ebola or assassinations or any number of bad things that happen in the last 50 years. But the stock market doesn't care about any of that. It only cares about revenues, earnings and interest rates. And so back in December, I looked at the year ahead. I said, "Well, I see a strongest economy in years and I see strong revenue growth. I see strong earnings growth, so that will push the market higher. But I also see interest rates going up and that'll push the market lower. So net we're going to come in at 6-9% at the end of the year."
David Edwards:
And you know what? My forecast is still the same. We're going to come in at 6-9% at the end of the year. "What about three weeks ago? The market was down 12% on the year, David, does that mean you're wrong?" I said, "No. Other people are focused on the war and were willing to sell me their very good stocks at 10% off." Four weeks ago, I called up Lucas our portfolio manager and said, “ Look at every portfolio we have. If anyone has extra cash, put it to work right now."
What happens if I'm right? Well, then we'll be up 10-15% from where we are right now by year end.
David Edwards:
What if I'm wrong and we have a nuclear war? Well, then our investments won't matter. Nobody's going to be around to look in their portfolios. I always used to tell clients, I said, "Your financial plan will last the rest of your life except for a few scenarios. One: meteor strike. Two: zombie apocalypse and the third one is nuclear war." For the first time in a long time, I've actually had to worry about a nuclear war being a real factor.
David Edwards:
From when we started investing threes weeks ago, the market already rallied back 7%, awesome. I suspect it will continue to rally as year moves on, as investors recognize that this situation in Ukraine is actually a humanitarian crisis, not an economic crisis.
Buff Parham:
So you're sticking by your guns. You're a good man. I like it.
David Edwards:
Yes, I'm sticking by my guns.
Buff Parham:
We've got a question from the audience. "What would be the impact of the war on the upcoming presidential election and the impact on Biden overall?"
David Edwards:
I know! Isn't it amazing that we're in continuous presidential campaign mode?
Buff Parham:
It never stops.
David Edwards:
Continuous congressional mode as well. Can we ever talk about anything besides politics? My wife commented a few weeks ago when the war started, "God dammit. I was looking forward to the summer of not worrying about anything, the pandemic was ending, and now I've got something new to worry about." I'm like, "Yeah, when was the last time you weren't worried about the world? Oh yeah, 1998. In that happy year, Bill Clinton was the president. Average American wages were heading to all time high. The stock market was booming. We had a budget surplus. Nobody ever heard of Al-Qaeda. I had no idea where Iraq was. The financial crisis was still 10 years in the future and all we worried about was stains on Monica Lewinsky's dress. I would kill to get back to that happy time."
David Edwards:
Anyway, it's way too early to start making predictions about presidential election. Probably Biden will be the nominee again. He said that he felt strong that he would run, despite being 80 years old. Probably Donald Trump will be a candidate. Six months ago I would have said he'll be the nominee for sure. But now I'm not so sure. He seems to be losing his popularity. There are other Republicans like DeSantis and Josh Hawley and Ted Cruz circling to replace him. It's just going to be unpleasant and awful. If anyone watched the nomination hearings for the Supreme Count justice, all of the Republicans were trying out their soundbites for 2024. But anyway, no predictions yet.
One more thing. We were able to reopen our office in New York City on March 14th. We were closed for a good long time starting exactly two years ago. We reopened first last November 1st for six whole weeks and then closed again mid-December. Now we're back, and I think our work-from-work plan is going to stick. The death of New York City has long been over hyped. New York is back and better than ever!
David Edwards:
On that upbeat note, I'm going to wish you all a pleasant evening. Buff, we'll talk soon.
David Edwards is president and wealth advisor with Heron Wealth, a $500 million registered investment advisor based in New York City working with 225 client families across the U.S. and around the world. Dustin Lowman contributed additional research for this column.