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Brett Arends’s ROI: Inflation on the shelves means deflation in confidence, a study finds

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If President Joe Biden and his team want to understand why his approval ratings are currently in the tank — he is down to 41% in the latest polls — they should take a quick look at the latest client survey by Charles Schwab, one of America’s most popular investment platforms.

Political analysts can talk all they want about Afghanistan, Ukraine, mask mandates, pandemic fatigue and the like. But there’s a key answer lying in plain sight for anyone who’s been shopping anywhere: Inflation.

Less than half of investors over age 55 feel “confident” that they are going to reach their financial goals. That includes 48% of those over age 55 who are still working, and 49% of those who are retired.

It’s one thing to worry about your financial goals when you are in your 20s. But when even half of retired people think they won’t reach them, it’s a major problem.

Confidence among the retired are down from a year ago. And they’re down among those in those between 40 and 55 — they’re now at 46%, down from 50%.

This all comes as a majority of Schwab’s clients — 58% —say they feel better off financially than they were a year ago. And that’s the case, even though a stunning 7 million more people have jobs than this time last year, while hourly earnings are up nearly 6%. Let’s not forget that, during that time, the S&P 500 has earned a hefty 13% return, way ahead of historical averages.

So what gives?

One fifth of Schwab’s clients cited inflation as their top worry. The percentage citing either inflation or rising interest rates — largely a consequence of inflation – is 26%.

Meanwhile, the 5.6% rise in hourly earnings is eclipsed over the past year by the 7.5% rise in prices, leaving the average worker going backwards.

Financial concerns in the Schwab survey are also higher at older ages, where investors typically own a smaller percentage of their portfolio in stocks and a larger percentage in bonds.

And in the past year, in contrast to the S&P 500, the bond market has been pounded by inflation and likely rises in interest rates. The iShares Core U.S. Aggregate Bond Index ETF (AGG), a proxy for the broader bond market, is down 4% over 12 months.

The survey was conducted at the start of January, so it hasn’t even factored in the most recent official inflation data.

There is good news and bad news ahead.

The good news is that the current inflation panic is almost certainly overdone. That’s not me talking, that’s the financial markets. As I’ve pointed out repeatedly, you don’t have to listen to partisan hacks on either side of the aisle telling you what is going to happen next to inflation. The money markets have already placed massive, multi-trillion-dollar bets, and if anyone knew they were wrong they could make a fortune betting the other way.

Right now, the comparison between inflation-protected and non-inflation-protected U.S. Treasury bonds points to a 5-year inflation forecast of 2.87%. That is less than half the current rate of inflation. And that forecast has come down since mid-November, when it peaked at 3.14%. So far, in other words, the market is still betting that today’s high inflation will be “transitory.” The markets believe it is mostly the result of massive supply-chain disruptions, caused by the unprecedented 2-year global experiment of trying to switch off the world economy and then switch it back on again, like it’s a TV.

The bad news is that even if inflation fears abate, that may only provide limited benefit to bond holders, including retirees. That’s because the bond market is already massively overvalued by the standards of history. (And again, this isn’t me talking, it’s the numbers.)

Historically, going back to the 1920s, 10-year U.S. Treasury bonds have on average provided holders with an annual return of inflation plus around 1.7%. In other words retirees, older investors and cautious investors who sought the safety of bonds for their money still earned a reasonable return on their savings.

Today the 10-year U.S. Treasury bond sports a yield of 1.92% a year before inflation. So unless inflation comes in at around 0.2% a year for the next decade, bondholders are going to be right out of luck. And they won’t just be earning subpar returns. They’ll probably be earning negative real returns. That’s because the same bond market offering to pay you 1.9% a year for 10 years is also predicting prices will rise by around 2.5% over the same period.

So even if inflation fears abate, bond holders may be in for a miserable time of it anyway. As that’s mostly savers over the age of 55, it doesn’t bode well for retirement security — or the political mood, for that matter.

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