Navigating Inflation
Christian Argyros: On today's segment of Navigating Inflation, our team is pleased to introduce Leo Dierckman, Managing Director of Oppenheimer Investment Management. Oppenheimer Investment Management is a disciplined advisor that manages fixed income portfolios for individuals and institutional clients, teams of experienced professionals share a common philosophy that emphasizes discipline investment process combined with a long term perspective, focused on managing risk. Please enjoy our brief discussion with Leo as he discusses inflation and how it affects their portfolio as a whole,
Leo Dierckman: You know, consumer prices are, are continue to accelerate in October. Rising is at the fast pace for any month and more than a decade in pushing the 12 month increase to 6.2%. I mean, think about that 6.2%. That's the largest increase. The largest since 1990 inflation is clearly a problem. And the Federal Reserve's claim that it is transitory looks more and more ridiculous each month. Wow. I completely disagree with that and I don't think it looks more ridiculous and I don't think inflation's going to be a long term problem. We firmly believe that it is transitory nature, that same 6.2% on a 12 a month basis on a 24 month basis. It's 3.1%, 3.1% on a 24 month basis. Think about what we've gone through in the past 24 months and think about how we measure inflation and the periods of time that we start talking about.
Leo Dierckman: If I'm in the newspaper business, I'm going to definitely print that 6.2%. I'm definitely not going to print this, the real change in the 24 at, at the 24 month CPI, which is 3.1% because that doesn't get to sell as many newspapers and it doesn't catch my reader's eyes like that, you know, but that's the harsh reality. It's not all forget that during 20, 20, 20 20, we had, you know, a lot of different situ a lot of things, developing a lot of changes in our marketplaces and COVID continues to remain a driving force behind the rise in inflation that we've seen. And one of the simple reasons is that it was so damn low. The prior we're looking at a 24 month period, a 3.1%. Now some of that will not we'll stay stick around. Some of it is honestly transitory, but let's remember that that has been trying to get a 2% or higher inflation rate for let's see, 10 years, 10 years maybe longer than that.
Leo Dierckman: And they haven't been successful in doing it. And, and why do they want that? Why do they want some kind of above 2% inflation rate? Because if they have a, an inflation rate that is not at least 2%, it gets awfully close to disinflation and a bank, a federal reserve, the fed to trade up can bat disinflation is extremely difficult. This is an opportune time to finally get our economy at, or at least above a 2% for possibly a three to five year period of time for inflation to get to of that average. We're trying to get to that average. Now, why does the fed want to get to that average, over that average again, number one, because it prevents just the opposite in something they cannot control in something they do have not don't necessarily have the tools to control is when price to start going down below.
Leo Dierckman: And it's really hard to reinflate. The second reason is their mandate and their mandate is full employment, and they kind of broaden their mandate. If we remember what our, our good friend Mr. Powell talked about early this year in 2020, they're really focused on try to get those lower echelon. You don't see wage inflation in the lower brackets of the economy and the wage lowest wages until you get a squeeze unemployment, you going to have an employment squeeze, you going to have some competition. You going to be able to give those people some, the power to negotiate higher wages at those lower levels. And we're talking service jobs. We're talking people that make, we're making 10 bucks an hour. Now are making, you know, you hear about the $15 per hour. You hear about an hour. Well, most of those jobs that ourselves require transportation to get to..
Leo Dierckman: And most of the people in the lowest tiers of our economy and in our society have no mode of transportation. They're relying upon public services and public buses and so forth. And so on, those jobs are still not paying, you know, the, those kind of people are still not are earning the Amazon wages. You know, they're earning $12, they're earning $10. And yeah, you're going to hear about in New York city where they can't get enough people, or even in St. Louis, or even in, in Indianapolis and Carmel, Indiana, where they can't get enough people, but it's predominantly because they have no, the people have not made enough money to be able to afford a vehicle or motives of train expectation. It can't get to the job. So it's not a new problem. It's a problem that we've had for many, many years. And, but now we're getting a little bit more press about it.
Leo Dierckman: So the fed wants to get these lower up runs of our, of our employment of our employees, the opportunity to make some money. And the only way they can do that is to continue to support the economy, continue to have, you know, this transit, transitory inflation, nobody has any control over the current inflation transitory inflation that we have first and foremost. That's another important thing to fed. Nobody has any control. We can't do anything about the fact that there's a bunch of ships out there in the Atlantic or in the Pacific ocean or the Atlantic for that matter, I suppose that are full of goods and me and merchandise. And I can't get unloaded because, you know, COVID D was the most recent thing that's kind of gone away. Now we'll start to see these bottlenecks go away as well. We're already starting to see some of the bottlenecks go away in the chips.
Leo Dierckman: You're not going to hear about that, but it certainly is anecdotal. We have these analysts that would call them analysts here. We have four full-time analysts and they do a wonderful job for us. And they're very intellectual far smarter than what I am. Thank God. And they have done a tremendous job of finding in listening to calls and trying to understand what's going on with the various bottlenecks. And I can tell you in our morning meeting, which we have every day at eight 30, we hear from them. And, you know, the companies they're reporting to companies are starting to see some, you know, loosening up and some better flow of things. And the bottlenecks are, are slowly, you know, dissipating. So yeah, we do believe it's transitory nature. We think it's a healthy right now because we think ultimately as we move out of COVID, which we will never fully move out of COVID, our economy is going to start going back to what it used to be, which is more of a service driven economy, unless goods driven.
Leo Dierckman: And by the end of 2022, we'll probably be talking about disinflation and people have too much physical inventory. They ordered too much. They ordered, they were worried that they weren't going to have any be able to get access. There was going to be so much product and stuff because people will have less money to spend on the consumption of goods. And they'll be spending more money on services, going out to dinner and movies and all that stuff that they like to spend their money on. So those are our thoughts, initial thoughts on the topic of, of inflation. We do think that we're headed towards a long, longer term, probably starting, I don't know, maybe in 23 you know, in 2% world, we're hoping that to 10 year treasury and get the 2%, we're hoping that the GDP is at least 2% and we're hoping inflation's around 2%.
Leo Dierckman: That's what we're look, that's what, you know, the 2% world. And it sounds awfully familiar if you remember the past 10 years where we had the long expansion and everybody was scratching their heads like, wow, this is expansion it's awfully boring, but, you know, we were, we're used to 10, 4% type of, of GDP growth and to be able to get a 4% GDP growth and this environment that we now live in and with our changing demographics and so forth you know, let's keep it, we're going to start target for a 2%, 2% and 2%. And the Fed's going to have to work really hard to keep the inflation rate above 2%. So near term, yes, we have inflation longer term likely not very likely not. And if anything, if they'll be working hard to prevent just the opposite of that, we're, we're paid to keep our money in the bank because the next day we can buy more goods or services with it as a result of deflation. So that's my parting line and happy to answer any questions that you guys have.
Cary Stalnecker: So that's helpful. Go ahead. I was going to ask David, why don't you take, why don't you take the immediate follow?
David Kaslow: Yeah. So, you know, what's so interesting about this discussion is how divergent of views are. And so it's, it's really interesting, like a lot of, of challenging economic questions. It's amazing how people look at the same, what seems to be relatively you know, the exact same data and come to different conclusions, which is fine, because we don't really think it's our job to try to answer this, to try to divine what inflation is at the two, 12 months from now or 24 months from now. So I think it's more, you know, what are the possible outcomes? Number one and two is, and the question I have for you is what do, how do you frame what you're doing in the context of you or anyone else missing the mark? Like, is there anything that you, that concerns you that if your view, which is obviously strongly held is off by little bit or a lot, what do you worry about? Or what, what should we worry about?
Leo Dierckman: Well, first of all if we were worry about something, we make a change because we got to sleep with the right we're long term, investors have been doing this for 25 years and still it's gray here, but we still have it. You know what I mean? Yep. So the reason why we still have it is sorry, nothing, nothing personal, but I'm just saying the reason is because we, we make changes if we're worried about something. So the manage the way we manage this risk of potential inflation, rampant inflation is management of duration and the duration of, you know, we're, we're somewhere between four and 5%, four and five years, excuse me, of duration. And in the longer, more credit sensitive, we concern ourselves less about duration and we concern ourselves more about credit risk. So in high yield, we really do not focus that much on duration because the story there is credit risk.
Leo Dierckman: We want to be able to manage credit risk. And then on the opposite side of that is cash management, which is, has a duration of 1.2 to 1.5 years. Obviously that's very short and has no very limited. I would never say no none, but I would say very limited credit risk. It's all triple D or better to credit in that portfolio, all investment grade obviously. And we are very confident that all those companies will have the ability to pay off their maturities as they occur. So that's the one scale. So in between, you know, is that core plus product, that core plus product and yes, I am talking my book cause you you're, we're asking how we manage money and it's we manage money based upon the, what we feel is the best way to address these kinds of concerns at any one given time.
Leo Dierckman: And the, the best long term based on the efficient frontier is core plus or corporate core plus, but let's focus on core plus core plus has 80% investment grade, 20% high yield and during a rising rate environment. And that's how we're positioned. We're positioned for a rising interest rate because the downside, if we are not positioned that way as far exceeds the upside, the, if it doesn't work out, does that make sense? Yes. We're not getting co adequately compensated to go long here. 30 year treasures at one 90 month. The five year treasure is at 1 21, 25 years, 70 basis points. Really not for us. We just bought three year treasury this morning, you know, of 83 bits, something like that, just because, you know, in three years we're going to have a clearer visibility. We are so how do we manage?
Leo Dierckman: We're being defensive in nature. We're not going along in duration. We're suggesting to people to have that nice combination of both investment grade and high yield because that in the long term is a very defensive type of portfolio because if interest rates go up and look at the yield curve, the reality of it is the long, 30 year has declined since the fed started talking about potentially raising interest rates in 2022, the long has gone down about, I don't know, 30, 40 basis points. I think it was at where was 64? I'm sorry. Yep. The, the 30 years at 1 64 started the year at 1 64 and now it's at one 90, but in the last month the yield curve has started to flatten. So I'm looking at the one year versus the, the one month Christian that I sent to you.
Leo Dierckman: You know, you'll start to see that yield curve, you know, start to go down and level out. That's why we like our three year pivot point right now. Cause that's where it's the sprint has popped the most. The yield has popped the most rather in that three year range over the past month. So we'll manage if we're wrong or what concerns us. We manage that concern by managing duration and then focusing on that combination of both high yield and investment grade combination portfolios core plus because rates start to rise it's because that economy is improving, that pushes corporate spreads down that helps invest high yield credits also spreads to compress. That means we're making money for our clients as a result of that, it offset us, offsets some of the rise in interest rates. The other thing is with corporates, we have a high enough coupon so we can offset a lot, some of the rise, but just out-earning our competitor indexes and the treasury curve because of spreads.
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