Our Holiday Party, in Photos

Here at Vested, we know that smart is sexy, and our team and network embody this truth. Earlier this month, nearly 200 financial services executives and industry contacts joined us for our holiday party at the Museum of Sex to celebrate the year and season. Together with our employees, they enjoyed Mowcow Muellers and Long Island Iced DLTs, and boosted their knowledge with funny money facts.

It was a great way to celebrate what’s been a wild and wonderful year: 2017 saw Vested earn the trust of high-profile, newsworthy clients in the financial space; add smart, passionate people to our team; and methodically deliver on our clients’ expectations. We turned our ideas, both silly and ambitious, into realities. And we still have two weeks to go.

We also learned a lot, collectively. From an industry standpoint, the macro environment remains very uncertain. At the same time, the media sector continues to contract, and agencies like ours must find new and exciting ways to share client stories that deliver value. These circumstances make our job challenging — but unashamedly exciting. We see opportunity where others see difficulty, and it’s extraordinarily rewarding when we deliver for a client.

There’s a lot to look forward to in 2018. For now, check out the holiday party photos below from our staff photographer to get a sense of how we unwind.

Vested’s Millennial Money Study

Vested Research Series presents:

Millennials and Money

With the Millennial Money Study, Vested has developed one of the richest studies to date on Millennial attitudes towards finance and money. Among its numerous findings, this landmark report finds Millennials don’t trust banks, love perks, don’t care about data privacy but care deeply about data security.

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Investors Still Wary of Stocks

Media, until recently, carried several stories about improved investor confidence, in particular how the index of fear has dropped to levels not seen in years. On its own, such news would actually give cause for concern. It might imply that investors have developed the kinds of enthusiasms that drive markets too far too fast and set them up for a correction, perhaps some time this coming summer. Fortunately, money flows have continued to signal the opposite. Instead of undue enthusiasms, they tell that investors, despite past price gains, remain wary of equities and imply that ample buying power remains to carry the rally further. Of course, there are always dangers. Policy disappointments could bring down stocks, as could shocks from abroad. But at least the picture on investor behavior remains reassuring.

Except for a rough patch or two, recent market action certainly tempted a dangerous enthusiasm. Right after the election, stocks took off. The S&P 500 index, a good gauge of the market as a whole, jumped 4.6 percent from November 8 to year-end 2016. It gained another 5.5 percent over the first quarter this year and rose almost another 2.0 percent during April and into late May, even incorporating the brief, politically induced selloff.

But investors seem to have resisted any temptation to chase gains. Quite the contrary, in fact, they have exhibited a continued preference for bonds. According to the firm Dealogic, both individual and institutional investors during the first quarter, the most recent period for which complete data are available, purchased more debt than ever from companies and governments, almost $180 billion dollars in fact. During this time, they bought almost $80 billion in junk bonds, double the amount they bought during this time last year. And it seems that the pace of bond buying picked up through April, though complete data are not yet available. Either these investors are desperate for income, which is possible, or unenthusiastic about equities or both. Either way, such patterns have made clear that equity investors remain far from any kind of undue exuberance.

Figures available from the Investment Company Institute (ICI) confirm this picture. To be sure, these statistics cover only mutual funds and exchange traded funds (ETFs), but they are nonetheless indicative of general patterns. At least they have done so in the past. According to the ICI, investors redeemed $28 million from domestic equity mutual funds as prices rose during the first quarter and an additional $14.6 million in April, the most recent period for which complete data are available. More recent, though tentative data show that such sales actually accelerated during the initial weeks of May. Though these net withdrawals are less than a percent of amounts outstanding, they nonetheless speak to caution not exuberance among equity investors. In contrast, mutual fund buyers increased purchases in bond funds. Inflows here amounted to some $102 million during this time. Relative ETF flows were more moderate but similar.

These patterns say two rather forceful things. First, investors seem to have little fear of losses in bonds. They have continued to buy even though many have warned of the inflationary implications from past floods of Fed-provided liquidity into capital markets and the Federal Reserve (Fed) has made clear its intention to raise short-term interest rates. Second, and more immediately significant, investors show no inclination to chase past equity price gains and in the process set the market up for a correction. Of course, other influences would cause equities to retreat, a failure by President Trump to deliver on his market-friendly promises or several potential problems in Europe. But at least market tacticians can dismiss the dangers of undue exuberance among equity investors.

The Federal Reserve’s New Normal

A few weeks ago, a Federal Reserve (Fed) release prompted a sudden market selloff. The morning of April 5 started with considerable investor enthusiasm about indicators from payroll manager ADP. These suggested that employment and hence the economy looked strong. Equity indices soared. The S&P Index, for example, gained some 25 points in no time. It held that gain until 2:00 that afternoon when the Fed released the minutes of its open market committee (FOMC) meeting of the previous month. These indicated that some on the committee wanted to begin selling off the bond holdings acquired during the quantitative earnings of previous years. Concerned that Fed-provided liquidity would dry up and further spooked by the news that some committee members saw equities as pricey, at least relative to historic norms, the market turned down immediately, quickly reversing all the morning’s gains and closing down for the day.

The brief panic seemed to dissipate almost as quickly. Markets rose the following day. But if investors and traders managed to put their initial shock at Fed attitudes behind then, they had better get used to the new policy tone. Unmitigated Fed liquidity support, so typical of past years, has clearly become a thing of the past. FOMC members now seem more eager than ever to “normalize” policy, that is raise short term rates into line with historic norms and, to the extent possible, unburden their balance sheet of the huge bond holding they had acquired over the last few years. Though policy makers have also made clear that they want to avoid shocking markets by moving too fast, they still seem determined to pursue this new direction. They have any number of reasons. The recent pickup in inflation is surely one of them.

Admittedly, the FOMC minutes avoid making too much of the inflation acceleration. Policy makers nonetheless are well aware of three critical facts: (1) An excess of liquidity in the economy tends to raise inflationary pressure. At least it has historically. (2) Once inflation gains traction, it develops a momentum of its own. (3) Policy has poured so much liquidity into markets in previous years that even the most active policy now will take a long time to erase its implicit inflationary threat. An earnest effort over coming quarters can, of course, forestall any rise in inflation. In part, that seems to be the Fed’s intent with its normalization policy. The inflationary signs had to have made policy makers wonder whether they are pursuing their new policy actively enough.

Various inflation measures compiled by the Labor Department certainly make compelling reading. Producer prices, which measure the cost of goods and services sold among businesses, have risen at almost a 3.5 percent annual rate so far this year, well above the Fed’s informal 2 percent target. Consumer prices have traveled along a more moderate path, rising at a 1.6 percent annual rate during this time. More telling from a policy point of view, however, is the longer-term pattern. Measures taken over a 12-month stretch reveal these blunting the effect of volatile sectors that can have an outsized influence over a 1-, 2- or 3-month readings. On such a basis, producer prices have accelerated from virtually no inflation recorded last summer to a rate of 2.3 percent over the 12 months ended this past March, the most recent period for which data are available. This is a considerable jump in seven short months. Consumer prices, usually more stable than producer prices, have also accelerated on a similar basis from a recorded inflation rate of less than 1.0 percent last summer to 2.4 percent over the 12-months ended this past March, also a smart acceleration in a brief time.

These inflationary signs may carry a false signal. Things of this kind have occurred in the past. The Fed’s insistence on a controlled progress presumably takes this possibility into account. But it would be foolish for the Fed or investors to ignore the unfolding picture, especially since inflation, once started, becomes very stubborn and can cause considerable harm to markets and the economy. Any further indicators along these lines will keep the Fed on its normalization course. Even if recent patters abate, policy makers can point to other reasons to stick to their stated policy.

Asset Allocation

With the Trump administration introducing a raft of new policies, investors have wisely rethought their asset allocation. Market commentary is replete with advice on the subject, telling which assets will likely gain or lose in 2017. The effort is commendable, but such advice can easily misdirect people. A prudent investment portfolio cannot simply add more likely winners and unload likely losers. It must also shape itself to meet other critical criteria, the investor’s time horizon, for example, his or her objective in investing in the first place, tolerance for risk, the currency or currencies denominating the portfolio’s future liabilities, whether there are needs for income, possible tax obligations, that sort of thing. These will constrain how far an investor can tweak his or her investment portfolio for the tactical particulars of 2017.

Such considerations would seem to make a general discussion of asset allocation impossible, but all is not lost. One way to talk about 2017 positioning in more concrete terms than just more or less is to start with a basic or neutral investment portfolio and then consider how it might change tactically to account for the special features of the coming year. By making the circumstances of the hypothetical investor explicit, a reader might well interpolate this weighing and the tactical tweaks for a different basic portfolio set up to meet other needs and preferences.

Accordingly, this discussion will start with a basic or neutral allocation for a common sort of investor. For these purposes, this portfolio assumes the need to accommodate a very long time horizon for investing, say a young person investing for retirement or a pension fund. It assumes some willingness to take on risk, though nothing excessive. It further assumes an expectation that the portfolio’s future liabilities will occur in dollars and that the portfolio has no need to protect gains and income from taxes, again a pension fund or a personal retirement account. After explaining that portfolio generally, the discussion can then turn to how that allocation might adjust for the particulars of 2017.

Reasoning on the Basic or Neutral Portfolio

  1. Stocks constitute the largest part of this portfolio because: 1) Over time stocks generally outperform other asset classes and this portfolio has a long time horizon. 2) It is dollar based.
  2. Despite the lower allocation for small capitalization stocks, this percentage is relatively high given the relative size of that market segment. This is because small-capitalization stocks outperform large capitalization stocks generally over time, though with greater volatility, which is why the allocation is not larger.
  3. European stocks get a small allocation because they correlate highly with US stocks and so offer little diversification benefit. The only reason there is any allocation at all is to give the manager latitude to buy stocks opportunistically.
  4. Stocks in developed Asian markets are less correlated to US equities than European stocks and so offer diversification advantages. The region, except for Japan, is also faster growing than Europe.

 

  1. Emerging market stocks, though risky and volatile, offer superior growth potential over time. Their risk recommends a thorough diversification among these markets.
  2. High-grade dollar-dominated bonds have little role in such a portfolio except to offer diversification and stability.
  3. Lower-grade dollar-denominated bonds (including those issued by foreign entities, including emerging economies) have a slightly larger allocation because over time they typically pay a yield premium that more than compensates for the risk.
  4. Municipal bonds have no role here because this portfolio has no tax considerations. If it did, then for a dollar-based investor municipals would take up the bulk of the bond allocation.
  5. European bonds are here mostly for diversification and stability, much like the high-grade dollar-denominated bonds.

  1. Emerging market bonds in their own currency are here mostly for diversification, though like low-grade dollar-denominated bonds they tend to pay a yield in excess of the risk.
  2. Commodities and precious metals are generally better captured by using stocks that move with their prices, e.g, mining companies.

Reasoning on Tactical Portfolio Adjustments

These allocation changes are based on the expectation that the enthusiasm over Trump de-regulation, tax reform, and infrastructure spending is justified and will not face a countercurrent from excessively protectionist measures.

  1. Both large and small-capitalization US equities would benefit, but small disproportionately because: 1) they tend to move more violently than large stocks with accelerations and decelerations in the economy, and 2) they should benefit disproportionately from de-regulation.
  2. European stocks are vulnerable to the many economic and political pressures on Europe and if they break from the usual correlation with the U.S. equivalent, they are not likely to outperform. Nor is there a strong likelihood of currency gains.
  3. The same would be said about stocks in Asian developed markets though they face less extreme pressure than Europe this year.
  4. Emerging market equities might well suffer from a protectionist Washington, but they have suffered enough in recent years to have put a lot of such pressure into the price anyway.
  5. Despite their diversification rule, dollar-denominated high-grade bonds offer low yields and a great likelihood of capital losses this year as the Federal Reserve (Fed) raises interest rates.
  6. The same could be said for lower-grade, dollar-denominated bonds except the improvement in credit quality brought from accelerating economic growth will partially protect these bonds from the full extent of the losses suffered by high-grade bonds.
  7. Municipal bonds have an outlook much like the low-grade bonds but the lack of a need for tax protection counts them out of this portfolio anyway.
  8. European bonds have even lower yields than dollar-denominated bonds and, if they have less chance of capital losses in 2017, they are unlikely to add a capital gain to those piddling yields.
  9. Emerging market bonds in their own currencies have a similar justification to emerging market equities, especially since the currency depreciation against the dollar is likely to slow or stop altogether.
  10. Industrial commodities have a role because accelerating growth in the United States and relief of China crash fears could lead to price uptick.
  11. Precious metals seem to have little potential to outperform in 2017 unless the world really does come to an end.

 

Fintech Regulation

For all the rhetoric, Trump’s regulatory agenda remains vague. In the financial realm, he has talked about disassembling Dodd-Frank, but has given few details on how, in which ways, or when. He has delayed the Labor Department’s disruptive fiduciary rule for brokers and fund managers, but given no indication of what, if anything will replace it. Despite such huge uncertainties, however, some regulatory questions yield to a measure of clarity, particularly where financial technology is concerned or, as it is increasingly called, fintech. Its rapidly expanding reach has all but ensured increased regulatory attention. But more, fintech also seems poised assume a larger role in how regulation is administered and how firms of all sorts comply.

Fintech surely has made impressive strides. In 2015 alone, according to a study by Business Insider Intelligence, venture-capital investment in the area increased 106 percent to almost $15 billion globally. There is only incomplete data as yet for 2016. During the last few years, fintech inroads into legacy financial activities have occurred so fast that, according to Goldman Sachs, startups are poised to siphon $4.7 trillion in annual revenue from legacy banks. That same research estimates that traditional financial services firms will ultimately lose 20 percent of their business to fintech, and that job losses in these firms will approach 30 percent. Meanwhile, traditional wealth mangers have already lost significant business to internet-based investment advice software, what the industry calls robo-advisors. These increasingly threaten to become a dominant intermediary between many financial firms and their customers. Yet, even as fintech has taken from traditional players, it has brought welcome financial services to thousands that previously had no access.

This growth, not unreasonably, has spurred regulatory action the world over. In the United Kingdom, the Financial Conduct Authority (FCA) has recently brought what it describes a special range of considerations for fintech and linked the effort to its counterpart in Australia. At recent meetings of the world’s leading economies, the so-called Group of 20 or G-20, the host nation, Germany, argued that global financial stability hinges in no small part on fintech regulation. Though G-20 participants also noted approvingly how fintech has the potential to bring financial services to the billions around the world presently without access, including some 40 percent of small- and medium-sized businesses, they nonetheless also agreed on the need for more regulation. Accordingly, the G-20’s Financial Stability Board (FSB), presently headed by Mark Carney, has begun the process of devising rules that can at once encourage innovation while guarding against abuse, inequity, and risky behavior.

If the efforts of the G-20 and the FSB aim at a global framework for fintech regulation, each national regulatory body, like the UK’s FCA, is grappling with its own efforts. All aim to strike a balance between encouraging welcome innovation on the one hand and protecting consumers and the financial system on the other. The United States seems to face especially difficult problems, enough for fintech managers to identify frustration as their primary response to regulatory contact, at least according to a recent survey conducted by Silicon Valley Bank.

A big part of this frustration stems from the number of agencies this country uses in financial regulation. In addition to the Federal Reserve, there is the Consumer Financial Protection Bureau (CFPB), the Financial Industry Regulatory Authority (FINRA), the Securities and Exchange Commission (SEC), the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corp (FDIC), the Federal Crimes Enforcement Network, and this is only a partial list. It confuses still more that these agencies themselves cannot agree which is responsible for the oversight of which sort of fintech firms or arrangements. And, of course, each of the 50 states has one or more regulatory agencies. Further difficulties emerge because many of the regulations were written before there was an internet or e-commerce, and regulators remain reluctant to interpret rules for new business models.

Against this background, many will no doubt welcome recent steps by the OCC. With an eye to cutting through the regulatory confusion, the agency has invited a dialog among financial firms of all stripes and regulators from all agencies to suggest ways to foster “responsible innovation” among fintech providers in a culture of compliance, an awareness of risk, and the fair treatment of consumers. The goal is a “national charter” for fintech, much as regulators did with credit card companies years ago when their activities disrupted older, established patterns.

These efforts will need to jump many hurdles to reach their goal. State regulators may present the biggest challenge. They have expressed concerns that a national charter will create what they call a “weak baseline” that encourages a competition among states to use regulatory ease in order to attract fintech clusters. Still, it is encouraging that in addition to the OCC effort the CFPB has also taken steps to make regulatory applications more predictable, in this case by offering what it calls “No-Action Letters” that would allow innovative firms to try out products without fear of regulatory reprisals. While there is room in these early efforts for skepticism, even cynicism, it is nonetheless encouraging that a clarification and simplification process has at least begun.

Foreign competition should secure and accelerate these efforts. It is certainly clear that other nations are using regulatory gestures to lure fintech. The UK certainly has positioned itself as an imposing competitor. Britain’s FCA has begun an effort to promote London as a fintech center through what it calls “Project Innovate.” Though it has insisted, as its charter demands, on risk control, compliance, and concern for consumers, the FCA has taken a step beyond anything discussed in the United States. It aims to develop cooperative procedures to road test new ideas in something of a controlled environment, what it refers to as a “regulatory sandbox.” This novel arrangement surely could enhance London’s already dominant fintech position and threaten to draw business from the United States. Since at the same time, Hong Kong has initiated similar efforts, as has Singapore, under its “Smart Nation” program, and Australia’s Securities and Investments Commission (ASIC) under its “Innovation Hub” program, the U.S. authorities must feel an intense need to secure the industry by relieving its frustrations with present regulatory ambiguities.

Fintech has potentials that can at once complicate and ease this regulatory conundrum. Not only has its success invited regulation, but its remarkable flexibility has allowed it to provide answers for compliance problems throughout the financial industry. It seems a natural outgrowth of its ability to gather, sort, manipulate, and present data in myriad of forms. This part of the business has met with so much success that Kirk Wylie, founder of early fintech startups, has asserted that “[t]he easiest way to start a [fintech] business […] is to look for regulation that is coming down the pipe and develop a solution for that thing.” Other fintech efforts have offered ways for legacy financial firms to streamline the multiple overlapping and labor intensive solutions they have long used for compliance. At the same time as this so-called reg-tech is gaining traction, regulators have begun to realize that fintech solutions may well also streamline their practices and procedures. The UK’s FCA in particular has started experimenting along these lines.

Though fintech seems well positioned to work all sides of these questions, the one thing it cannot do is tell where this revolution is going. Even if Donald Trump were not promising to upend the American regulatory climate, which he is, that would be impossible. But if specific directions remain obsure, it is nonetheless clear that fintech will at once need to deal with greater regulatory scrutiny than in the past but will also have increasing opportunities to shape the nature of its own and others’ relationships with regulators.

Fintech and the Shadow Banking Revolution

Upheaval has occurred rather suddenly. In a compressed period, innovative technologies have helped the so-called shadow banking system steal a march on traditional lenders, especially where small business and startup financing is concerned. Meanwhile, fintech innovators have found themselves caught up in their own revolution and have begun to rely increasingly on non-bank sources for financing. These are powerful trends, but investors would do well to heed the words of the world’s new literary Nobel laureate: “The wheel is still in spin.” Banks now seem poised to reassert themselves into the area, on their own and in partnership with non-bank lenders. This latest change will likely open opportunities for fintech even faster than before.

Shadow Banking in Numbers

Data are striking. Non-bank lenders of all sorts have risen from obscurity about a decade ago to originating some $200 billion in small business and startup loans at last count. Though banks still originate some $350 billion of such loans, this is a loss of market share at a prodigious pace. Smaller community banks, once overwhelmingly dominant in the area, have suffered the most. Their share of small business lending has dropped from 77 percent of the total at the turn of the last century to some 43 percent presently. Their share of lending to startups has dropped from fully 82 percent of the total to a mere 29 percent. Such a sudden rise for non-bank lenders from next to nothing to nearly a fifth of the entire market surely constitutes a revolution. It speaks to the radical nature of this change that most of today’s dominant non-bank lenders did not exist a decade ago.

Several forces have created this turn of events. One is the decision among bankers to pull back from risk, especially in real estate but also with small business lending. It is easy enough to understand why. The 2008-09 financial crisis bankrupted many small and large banks and would have done more damage were it not for support from the federal government and the Federal Reserve (Fed). If that experience were not enough to instill timidity into bankers, regulatory behavior since the crisis, especially the Dodd-Frank financial reform legislation, has made it expensive for them to take risk by insisting that they hold greater amounts of capital to back such loans. This regulatory milieu seems to have constrained smaller community banks especially. Even though larger institutions, those designated “too big to fail,” must hold greater capital reserves and meet more comprehensive reporting requirements than smaller banks. Ghe implicit government guarantee against failure has given them a comparative advantage that more than compensates. It is noteworthy in this regard that about a fifth of the nation’s community banks have closed their doors since the law passed.

Meanwhile, the low interest rate environment fostered by the Fed has further dissuaded banks from lending. By lowering short-term interest rates, policy makers have reduced financing costs at depository institutions to nearly zero. Though longer-term bond yields, on U.S. treasuries and other high-quality securities, have dropped with declining short-term interest rates, they have not fallen nearly so far. On average during this time, the rate gap between short-term deposits and 10-year treasuries, for instance, has averaged about 200 basis points. These matters have given banks, large and small, an attractive arbitrage with which to turn a profit without having to take either lending risk or incur the disapproval of regulators.

The Non-Banking Business Model

A more exiting story emerges from the non-banking side of the competitive divide. These lenders would no doubt have filled the financing gap left by the banks in one way or another. As it is, fintech has given them tremendous competitive advantages. To be sure, non-bank lenders use a bewildering array of business models. Some act as a kind of facilitator for peer-to-peer lending. Lending clubs, which started in this way, have since broadened sources of their own financing, sometimes from banks, and have begun to make comparatively large unsecured business loans. Some so-called “balance sheet lenders” raise funds through private equity and debt financing in capital markets and then actually keep the loans they originate on their balance sheets. Many of these are associated with so-called “payment processors” for internet-based transactions, such as PayPal and Google Wallet. For all this variety, all these non-bank lenders count on innovative fintech to make their lending arrangements more appealing to the ultimate borrowers, many of which are, of course, the fintech startups themselves.

Though the list of specific fintech applications might seem infinite, fundamentally they draw strength from powers in data collection, manipulation, and analysis. Because fintech allows these lenders to draw on data from non-traditional sources, they can develop a more complete picture of the borrower than was previously possible, allowing them to go ahead confidently with loans that would seem too risky in another context. This approach has benefitted especially startups that could never have passed muster under traditional credit tests. The facility with data has allowed fintech innovators to transfer funds flexibly to find sources of financing and get around state usury laws, both of which have enabled them to gratify borrowers who otherwise would have faced rejection, though they have often done so at steep rates. When working with payment processors, tech-driven non-banks can reduce risk in still another way by arranging to have repayments come through automatic deductions from incoming receipts.

The whole package makes the entire process easier for both borrower and lender and more likely to end in success. At once, it relieves much of the burden of applying for the loan, shortens the time from application to a response and, critically, allows the lender to make more flexible trade-offs between interest rates, loan covenants, and lending limits, managing in the process to control risk while fashioning a deal that has more appeal to the borrower. It is a competitive array that clearly has overwhelmed the old strength community banks, knowing the borrower, and made passé former bank practices that seemed capable of little more than a simple yes or no under standard arrangements.

What Lies in the Future?

The picture, however, appears to be changing yet again. For one, the Fed is raising rates. As its policy, as it inevitably will, narrows the gap between what it costs deposit-taking institutions to fund themselves and what they can get on high-quality bond purchases, banks surely will again begin to tolerate the risk needed to get higher-paying loans. Meanwhile, community banks, seeing the advantages of their non-bank competitors, have begun to work with them instead of against them. The developing links have appeal to both players. The community banks, of course, will get access to financial technologies they could not otherwise develop for themselves. This will enable them to qualify a prospective lender more quickly and more thoroughly than previously. Cooperation will also enable them to gratifying customers they could not in the past. Instead of the outright rejections of the past, they will gain the ability to refer a questionable borrower to an affiliated non-bank lender. At the same time, the non-bank lender gains by broadening its field for marketing and acquiring a way to offer customers loan support and other essential banking services that these notoriously staff-short firms could not in the past.

Three things are apparent in these unfolding directions. First, non-banking lenders will remain a force in the market for financing small business generally and startups in particular. Second, though the differences between non-bank and bank lenders, especially community banks, seem set to blur, the business models that non-bank interlopers have developed and their effective use of fintech will clearly have a place in tomorrow’s environment. Third, the move toward cooperative ventures seems set to give greater innovative scope to fintech, by creating demands for them to apply their skills to still more areas of banking and finance.

The Federal Reserve Move: Money and Inflation

The Federal Reserve (Fed) made another move to raise interest rates last month and promised three more such moves in this new year. In a technical sense, one could say that they have tightened monetary policy, but this most recent move and those to come would be better described as an effort to make policy less easy. Confident that the economy will continue to grow, if not particularly rapidly, the Federal Reserve is continuing with its plan to normalize policy from the extreme ease it had adopted to cope with the 2008-09 financial crisis and the lingering economic effects in the intervening years. Recent data on inflation and money growth have given the Federal Reserve added reason to pursue this normalization policy.

The investment community has almost stopped looking at the inflation figures. Inflation has remained so quiescent for so long that many investors have forgotten even how to cope with it. Recent data hardly suggest matters are urgent, but they have thrown up a few warning flags, enough surely to have captured the Fed’s notice. Some strategists, to be sure, have dismissed this picture, denying flatly that inflation could become a problem. They may be correct, but it would be unwise for investors or the Fed to dismiss the prospect out of hand.

Certainly, consumer and producer prices have called attention to themselves. Back in 2015, and even earlier this year, these inflationary measures indicated negligible pressure. In some months, general prices levels actually fell. For the last six months, however, things have changed. Consumer prices have accelerated, growing by an annual rate of 2.7 percent. If not an especially frightening pace, it is nonetheless a sharp contrast to the 0.7 percent inflation rate averaged over the course of 2015 or the 0.9 percent rate averaged during the 12 months to this past March. Producer prices tell much the same story. These have risen at a 1.7 percent annual rate during the last six months, hardly fast but far different from the small outright decline recorded for all of 2015 or for the 12 months ending this past March.

Such comparisons would be easy to dismiss had they reflected shifts in the prices of food or fuel. These have a reputation for volatility and tend to correct over time. But this recent acceleration is more general. In fact, the volatile food and fuel elements have run counter to it. Consumer energy and food prices during the past twelve months have risen at a slower pace than prices generally. It is they that have fueled the recent inflationary signs. Similar comparisons hold when making the calculations from producer price statistics.

Signaling that these inflation accelerations may deserve special attention is the recent behavior of the money supply. Fewer links in economic and financial life are better established than the one between inflation and the growth of the money supply. The relationship is not so rigid that it explains year-to-year swings, much less month-to-month movements, but over time, in any economy, excessive money growth leads to inflationary pressure — hence the old saw: too much money chasing too few goods. Money growth had remained contained during much of this recovery since 2009, remarkably slow in fact given the amount of liquidity the Federal Reserve (Fed) has poured into financial markets. During the last six months of 2015, for instance, the narrow M1 measure of money, which includes currency in circulation and checkable deposits at financial institutions, grew at less than a 4.3 percent annual rate, not much different from the nominal economy’s rate of expansion. But that picture has changed radically during those last six months, during which this M1 calculation of money has jumped at an 8.1 percent annual pace.

Most worrisome for the longer term is how the Fed’s past policies have laid the groundwork for a continuing, inflation-fostering money explosion. Policies of zero interest rates and quantitative easing over years have created an enormous amount of liquidity in the financial system. As an indicator of how far matters have gone, the Fed’s balance sheet has swollen from a touch over $900 billion before the financial crisis of 2008-09 to about $4.5 trillion at present. The flood of liquidity has expanded reserve holdings at financial institutions from a relatively narrow $3.0 billion above legal requirements to some $2.5 trillion recently. Because this liquidity is the basic stuff of money creation, the financial system today finds itself with a huge potential for money growth that could easily create considerable inflationary pressure. The Fed could disarm the threat by removing the excess liquidity but is doubtless loathe to mount what clearly would be a massive operation for fear of, among other things, an immediate negative impact on the real economy.

Matters at the moment are far from acute. Indeed, the recent growth of money may well indicate that the basic liquidity built up over the years has at last begun to flow into the economy. The pace of real economic growth might as a consequence pick up from the disappointing pace averaged so far in this recovery. But beneath this pleasant prospect lies a dangerous inflationary potential that investors and strategists dare not ignore. They may have time yet before they have to adjust their portfolios to cope with it. But it is time for them to note inflation’s adverse potential impact, especially on bond prices, and consider how they would change strategy. That need suggests strongly that the Fed will continue its recent policy course, that it may bring up such matters more frequently in its press releases and other commentary, and that discussion of money growth as well as inflation will appear increasingly on investment agendas and in media outlets.

Through The Looking Glass: A Message For Professional Communicators

Whatever your political views, last night’s stunning election outcome confirms two related facts that June’s Brexit vote raised merely as suspicions:

1) As Brexit presaged before this, the political concept of ‘Right’ vs ‘Left’ which has defined the terms of the developed world’s macroeconomic debate for the past century is dead. Done. Over. The New Debate is about Technology and its impact on Jobs, about Urban vs Rural, about Income Distribution, about Empirical vs Emotional and about Protectionism vs Globalization. In other words: our job, what we discuss, debate and think about every day has never been more relevant than it is this morning. Cold comfort for some perhaps but worth recognizing.

2) As Brexit also predicted, because this New Debate is uncharted territory, conventional wisdom is completely out the window and we are in for a ‘new normal’ of political and macroeconomic volatility. The developed world is Through The Looking Glass at this point. For professional communicators, that is both our challenge and our opportunity. The challenge is we may not be able to rely on the conventional wisdom – even as it applies to communications strategy. Already over the past 6 months, several media trainees have pointed out that some well-worn media prohibition I’m outlining “worked just fine for Trump”. Expect a lot more of that. We will have to rewrite several sections of the playbook, even as we’re prescribing it to our clients.

The opportunity is our clients and senior executives will be looking for strong, effective communications advice and support as they themselves navigate this new global uncertainty.

It’s imperative that communications pros project confidence, steadiness and calm to our clients and, in the words of Churchill, don’t “let a good crisis go to waste.”

Here’s a place to start:

Become Your Own ‘Tenth Man’

In Max Brook’s World War Z, the Israelis are eerily prepared for a seemingly unthinkable zombie apocalypse. Why? They had implemented the Tenth Man Protocol. After decades of conventional wisdom (about Munich, about the 6 day war) bringing them to the brink of annihilation, they mandated that if 9 of the country’s leaders agreed unanimously, it was the responsibility of the tenth man to disagree. To buck conventional wisdom. To think the unthinkable.

Conventional wisdom tells us that once in office, politicians tends to tack to the center and quietly abandon their most outlandish promises. Your tenth man will tell you to get ready for a very physical wall on the southern border, a trade war with China, heightened tension in the Pacific and a redrawn relationship with NATO. What will be the consequences of a Tenth Man world?

Not all of the playbook will be thrown away, not all of your experience is wasted, but get ready to have your professional instincts second guessed on numerous occasions moving forward.

A New Real Estate Bubble?

Housing prices have ticked up enough of late to rekindle interest in real estate investing. For some observers, however, these gains have raised fears of a new real estate bubble, especially in places like California, Nevada, and Florida, where the crash of 2008-09 fell hardest. Several business journalists and quite a few financial professionals have expressed similar concerns. Given what the economy and financial markets suffered 8-9 years ago, such feelings of caution are only natural. But except in very select regions, this economy, though far from impressive in many respects, runs little risk of such an event.

Home prices have indeed turned upward. According to the National Association of Realtors, the average price of an existing home nationwide has increased about 6.0 percent a year during the past three years or so. Unlike a bubble, however, the rate of increase has not accelerated. Those who fret over a bubble point out that the price increases have nonetheless outstripped the growth of household incomes. That is accurate. Incomes have grown at only a 3.2 percent during the past year. Still, this difference hardly speaks to a runaway situation. What is more, these real estate price gains fall far short of the double-digit pace they exhibited during the boom that ended so badly 8-9 years ago.

It provides additional comfort about a bubble that sales activity and has none of the frenetic character displayed in the run-up to the 2008-09 bust. New home sales have actually fallen during the two months to September, the most recent period for which data are available. They are indeed running about 30 percent over where they were 12 months before, but inventories of unsold structures are holding at a comfortable level of close to 5 months’ supply, where they have hovered for some years now. Arguing still more forcefully against the idea of a bubble, is how today’s rate of single-family home sales, at an annualized pace of about 609 thousand a year, though well up from about 510 thousand last year and 300 thousand back in 2010-11, is still almost 60 percent below the levels touched in 2006 and 50 percent lower than they averaged between 2003 and 2006.

Nor do rates of new building show any sign of the speculative froth. To be sure, starts of new residences, single- and multi-family, have risen. As of this past September, the Commerce Department has calculated that such construction has run at a yearly rate just over 1.2 million. Though well up from the deep lows of the 2009 great recession, this rate has hardly advanced from where it averaged this time last year and remains 50 percent below the rate of 2.4 million a year touched at the furthest extent of the 2005-06 bubble.

Especially powerful evidence emerges from various measures of affordability. For decades the National Association of Realtors has tracked the burden of home ownership by weighing the cost of supporting a mortgage on the average home against household income, both in particular regions of the country and for the country as a whole. Though real estate prices have outstripped household incomes, mortgage rates have come down during this time enough to more than offset the effect. Indeed, mortgage payments on a home in this country has fallen in the past 12 months on average from 15.6 percent of median family incomes to 15.3 percent. Affordability overall, which implicitly includes taxes and insurance, has actually improved, albeit by a relatively modest 2.2 percent. Though such affordability measure are nowhere near as strong as in 2012 and 2013, when real estate prices were still deeply depressed, this critical measure today remains far better than when the past real estate bubble was blowing up and, tellingly, also far better than any time in the 1990s. Except for those few years right after the housing collapse, one would have to go back to the early 1970s to find affordability figures as good as today.

Of course, these are national averages. Some regions of the country have had very different experiences. Prices have risen especially fast in Florida. Fort Myers, for instance, has seem affordability erode by some 16 percent during the last couple of years. Daytona Beach has seen a 14.5 percent drop, Port St. Lucie a 19.5 percent drop, and Jacksonville a 21 percent drop. Spots in Nevada, too, have seen such erosions, most notably Reno’s 19 percent decline in affordability. But even in these places, housing remains far more affordable than in 2008, while other regions of the country, including remarkably the New York and Washington, DC metropolitan areas, have continued to see modest improvements. To be sure, mortgage rates will not fall much further and may rise. That will certainly detract from affordability, as will likely hikes in real estate taxes and insurance rates. But such adjustments at this stage in the business cycle are hardly surprising and hardly point to the bubble that some seem to fear.