After the Chaos: Economic Growth May Be Inevitable

One powerful example of economic recovery in the face of chaos is the reconstruction period following the American Civil War. Just weeks after the war’s end, our deeply divided nation still devastated by mass destruction and death, was shocked by the assassination of a President. But our country found a way to move forward.

An important component of the tremendous economic growth following the Civil War was technological innovation. The number of patents issued increased dramatically on breakthrough new products, like the typewriter, cash register, calculating and adding machines, and the Kodak camera. Other patents were issued for improvements in steel manufacturing and the application of electricity to industrial production. Iconic names like Thomas Edison, Alexander Graham Bell and Nikola Tesla emerged.

Investment bankers played an increasingly important role in the economy, supplying the capital that fueled growth. J. P. Morgan was among the more visible of these new players. The resources banks dispersed reflected the high savings and investment rates among U.S. citizens after the Civil War. High saving rates are also said be the case in today’s post-COVID world.

In addition to Morgan, other Titans of industry emerged, including Andrew Carnegie in steel and John D. Rockefeller in oil.

Edison, Bell, Tesla, Rockefeller, Morgan, and Carnegie all revolutionized old working-orders and improved how millions of people lived. Today, visible figures such as Elon Musk, Jeff Bezos and a host of other emerging titans pioneered companies that ushered new improvements into our lives.

In the years between the Civil War and the end of the 19th century, the United States became the preeminent economy in the world. Its growth rate, vast reserves of natural resources, and stable political system positioned it well for continued expansion. The economy, and particularly the rise of advanced industry, produced great prosperity.

As is often said, history doesn’t repeat itself, but it does rhyme. In the 20th century, following the conclusion of the Cold War with the Soviet Union, we again experienced an extraordinary time of economic progress. The Cold War, however, was a turbulent time: uprisings against the establishment, a divisive proxy-war in Vietnam, the resigning of a U.S. President, the Iran hostage crisis, high fuel prices and double-digit inflation. But these crises gave way to leadership with a plan and an economic resurgence. Fed Chair Paul Volker took on inflation, President Reagan took on a stumbling Soviet Union, and the beginnings of the Internet Age began to take shape.

Today, we are facing another, broader Cold War, with two antagonists: China and Russia. We continue to confront the health wounds of the pandemic, the economic destruction it has wrought on worldwide supply chains, and the accompanying fallout of trade deglobalization. The horrors of the war in Ukraine and the recent inflationary environment further increase uncertainty and dampen the outlook.

To address today’s chaos, it’s important to pay attention to what markets are telling us. In our investment process, we continuously map and measure the direction of inflation and growth. Currently, inflation and the Federal Reserve’s response has preoccupied the stock and bond markets, rightly so. We’ve seen inflation go up for 18 months while growth has begun moderating back towards its pre-pandemic pace.

Bond yields have seemed to be out in front of the Fed with 2-year treasuries reaching a high of 2.73% - far above the 0.16% (that’s right, less than two tenths of one percent!) of a year ago. 10-year treasury notes, of which mortgages and corporate bonds are priced, moved above 3% this month. For the first time in a long time, bonds are again providing yields above long-term expected inflation.

Yet recently bond yields have begun ticking lower. Perhaps the bond market is signaling a recession. So far, the Fed has only raised 0.75%, but is signaling another 200 basis points (2.0%) of additional rate increases by the end of 2022, putting short-term rates as high as 2.75%.

So, the biggest question the market has is how will the sharp rise in interest rates impact a slowing economy? We can’t know for certain, but like the dot-com bubble of the 1990s there will be winners and losers, and the excesses enabled by easy access to capital will be revealed. If you’ve been invested in quality stocks with dividends and paying regular cash flow, you have fared better than most.

We can’t say for sure whether inflation has peaked, however, the CPI inflation rate ticked down recently from 8.5% to 8.3% and the comparisons continue to get steeper and steeper, showing signs of lower inflation by the end of 2022. Perhaps easing inflation would mean the bottom is close at hand. Managing the increased volatility, managing the risk of stickier inflation, and managing the risk of emotional decision-making becomes increasingly important.

Still, we need to be careful not to assume a recovery happens overnight as it did in 2020. During COVID, the Fed and Congress came to the rescue and the bear market lasted less than a month. Neither are now. Make no mistake, the current market conditions are as difficult as any we have faced in the last 50 years. That’s the bad news.

The good news? Bear markets sow the seeds of future investment success…100 percent of the time. Financial assets become cheap, economic natural selection occurs, companies emerge on stronger foundations, and the benefits accrue through the creation of new jobs, increased productivity, and improved standards of living. Global competition has expedited the world economy’s push to the next innovation frontier. None of history’s chaotic events could prevent continued long-term global growth - they accelerated it. And when we inevitably overcome today’s challenges, the long trend of global growth driven by innovation will assuredly continue.

Thanks for reading,

Dave