JAMES RIVER ASSET MANAGEMENT, LLC.

Newsletter 2nd Quarter

August 2020

While Al is still recovering from his shoulder replacement, I am filling in on writing the quarterly newsletter. I hope you are doing well and staying out of the heat. It seems easier to do these days since the economy has not opened back up. Today I will be talking to you about inflation – is it here, is it coming in the future, and what to do about it.

Inflation, in its simplest definition, is an overall increase in prices and a decrease in the purchasing power of money. If any of you have gone to the grocery store lately and bought a box of cereal, I’m sure you’ve noticed there seems to be a lot less cereal in there for the $5 you spend. That’s inflation at work.

Over time, some inflation is wanted and necessary. But generally, inflation over 3% is not good for the overall growth of the economy, for seniors living on fixed incomes, retirees, and others reliant on income that does not increase with inflation.

The data shows that inflation is not here today, but it will arrive when we have a vaccine available. I will tell you why I have come to that conclusion, and what investments work well in an inflationary environment.

From June 2019 through June 2020, the Consumer Price Index increased by 0.6%. This puts inflation well below the average of 2% that the Federal Reserve targets for steady growth. Most economists estimate that inflation will stay steady at 0.6% through the rest of 2020, especially as states around the country ricochet between opening and closing their economies in response to COVID-19.

Inflation, money supply, and taxes are tied very closely together. Taxes directly affect prices– lower taxes generally cause price levels to fall (meaning the cost of goods and services) while higher taxes cause price levels to rise.

The money supply is generally measured by two factors: the amount of money that is in the system, and the amount of times that money changes hands. We are hearing on the news right now that the Federal Reserve and Congress are printing money – when we hear about that, we are hearing about the amount of total money that is in the system. They are increasing that amount of money. If inflation was only caused by the amount of money in the system, then we would be seeing high inflation right now.

But, the second factor (the number of times the money in the system changes hands, which in fancy economic speak is called the velocity of money), has gone down significantly during COVID-19. Most restaurants remain closed – if they have opened, they are at limited capacity. Gyms are shut down. Movie theatres, arenas, sporting events, concerts, bars, airline travel, vacation/tourism. It is expected that the velocity of money will remain low until a vaccine is found.

All expectations show that the velocity of money will remain low until a vaccine is found. And a vaccine is expected in 2021. While it is unknown whether a vaccine will immediately be available to the entire population, this would lead 2021 to a perfect inflation storm, led by 3 factors:

1. The overall amount of money that is in the system is up by 20%. Checking and savings accounts are higher. This is the first time in history that Congress has put large amounts of money directly into people’s hands – and coinciding with that, they have limited ways to spend that money today. But once a vaccine is available, people will take their cancelled vacations, eat at restaurants, go to bars – looking to spend the extra money they have accumulated.

2. Velocity of money – again, once a vaccine is available, the increased money will start to change hands much more rapidly, which is a surefire indication of inflation.

3. Taxes – if the Democrats sweep through both houses of Congress and the Presidency, higher taxes will certainly be on their way. Higher taxation of corporations mean higher prices passed onto consumers.

It is our job as your financial advisors to make sure that you are prepared for a possible inflation storm. Professor Jeremy Siegel at the Wharton School of Business thinks we may see inflation as high as 4-5%. Typically inflation above 3% has negative effects on overall wealth, economic growth, the banking industry, and mortgages.

I am going to highlight actions that we are taking as a firm, and then discuss actions that you can take with your personal finances outside of investing as part of your overall financial plan.

As a firm, we are looking at the following:
1. Equities are typically a better way to fight inflation than bonds. Equities tend to go up with or more than inflation, reflecting increased price levels. Bonds do not.

a. Within the James River Asset Management proprietary models, we will continue to look at increasing equity positions in an overall portfolio – both as a way to      counteract lower interest rates, but also to counteract inflation.

b. ETFs that have a buffer (meaning that they protect from a certain amount of loss on the downside – example would be if a 15% buffer is provided, and the market is down 20%, the portfolio would be expected to be down 5%), are a great way to give equity exposure with downside protection. This lends to the possibility of the stability of a bond portfolio and more inflation protection.

2. Treasury Inflation Protected Securities have built-in inflation protection. In these securities, the interest that you are paid increases as inflation increases. Additionally, because no one is talking about future inflation, these securities are priced low.

a. The proprietary models have a current TIPS position. Our investment committee will increase this position over time in response to inflation.

b. If you do not own the proprietary model, TIPS could be a great addition to your overall wealth management strategy.

3. Real estate

a. We currently have a global real estate position in the proprietary models. We may look to increase this position, or add an additional real estate investment trust position.

b. Real estate investment trusts may return to favor when quarantining and social distancing is over.

As I work with you individually on your financial plans, I will also be talking to you about ways to fight inflation outside of your investment portfolios:

1. Look at locking-in any variable interest rates to a fixed rate.

2. Consider purchasing an investment property. Increases in mortgage rates make renting more attractive, pushing rents higher. Inflationary environments make it a good time to be a real estate investor.

3. Negotiate CDs at your local bank.

4. Consider “alternative” assets – such as investment grade art, wine, etc.

The long and short of it is that while I do not see current inflation, I see it coming with a bang in 2021. I am prepared and it is my job to make sure you are, too. As always, call me if you have any questions or concerns.

Sincerely,

Kristin Carleton, AAMS

Vice President of Financial Planning and Investments

(804) 323-0517

The information provided has been derived from sources believed to be reliable, but is not guaranteed as to accuracy and does not purport to be a complete analysis of the material discussed nor does it constitute an offer or a solicitation of an offer to buy any securities, products or services mentioned. The examples given are hypothetical and are for illustrative purposes. Actual results may vary. Consult your financial professional before making any investment decision.