Where to begin? Let us address the questions one by one and see if that can help us connect the dots for investors. When looking at the historical evidence, the strongest relationship between inflation and other economic variables lies with unemployment. Data shows that higher levels of unemployment lead to lower levels of inflation. On the flip side, lower levels of unemployment lead to higher levels of inflation.
History also suggests that government debt and inflation tend to move in opposite directions. As government debt rises, inflation moves lower. Conversely, as government debt decreases, inflation is more likely to rise. Since 1970, inflation has been moving structurally lower, while government debt has been moving structurally higher.
At a high level, this data helps us address the question. We certainly do not want to dismiss inflation concerns altogether. However, if one is to worry about the possibility of inflation, when does it make the most sense to do so? During an economic recession and in the early stages of an economic expansion, which is where we find ourselves today; government spending is on the rise and increasing year over year. During these periods, the economy is also suffering from the highest levels of unemployment. Coincidentally, these are the periods when investors are the most concerned about inflation. Thinking back to 2009 and 2010, investors were equally as worried about the possibility of inflation as they are today, due to government deficits. However, as the data shows, unemployment rates and government spending were at high levels during those years and are currently elevated today. As we progress through the economic expansion over the next 3 to 5 years, government spending is more likely to be on the decline along with rates of unemployment. So, what does it all mean?
Although it can be counterintuitive for investors, inflation concerns are more logically sound near the end of an economic expansion, which is more likely to be the case in the mid to late 2020s. Conversely, the early stages of the economic expansion is a period when investors should be focused on calibrating their portfolios to take advantage of the more cyclical sectors of the economy, which are likely to lead the way in the early stages of the recovery.
Within our Matco portfolios, that remains our focus. More specifically, throughout 2020 we have been reducing our exposure to the fixed income or bond market while increasing our exposure to the equity markets, from an asset mix perspective. Within our equity strategies, we have been increasing our exposure to the more cyclical sectors of the economy. Our process in selecting companies to invest in relies on our key investment factors, which have helped us identify these areas of growth. Lastly, within our Matco Fixed Income Fund, we continue to adjust our holdings to optimize the overall yield. We will continue to assess the prospects of increasing inflation, but any protection measures will likely be better suited once we are more fully entrenched in economic expansion.
We understand that these economic and investment considerations can be complex to consider. Our goal is to help simplify the investment world for investors and our clients. If you have any questions regarding our investment strategies or inflation, please do not hesitate to contact us.
Trevor Galon, CFA
Chief Investment Officer
Founded in 2006 to manage and service seven family offices, today Matco offers the benefits of our extensive investment management experience to individual investors, foundations, endowments, condominium corporations, trusts, corporations and not-for-profit organizations.
Our mission is to simplify the investment world for our clients by understanding their needs and providing exceptional investment solutions that preserve and grow capital.