Keep it simple. That’s it.

There’s a lot going on in the world right now – domestic and overseas. It’s difficult to follow sometimes and for someone who is passionate about understanding the links between financial markets, geopolitical events, and whatever else there is – it can take some time for a clearer picture to develop.

There is no need to do mental backflips and go on emotional rollercoasters. Otherwise, you increase your risk of ruin. The “Risk of Ruin” is the chance someone has to lose a substantial amount of money through investing, trading, gambling, etc., to the point where it is no longer possible to recover the losses. Investing – unlike gambling – is not a zero-sum game. Every investment has a different risk profile and reward probability. You can control (mitigate) this risk through a multitude of methods, but the most common as we know it today is diversification.

Like all methods to reduce risk, not all are created equal. In 200 years of asset class returns (adjusted for inflation), cash continues to be the worst asset to hold as seen from the graphic above (Source: Alfonso Peccatiello, Twitter: @MacroAlf). Stocks look pretty good and give you cash flow. Real rates (rates adjusted for inflation) go down over time which is beneficial for all assets. And gold – can – work as an inflation hedge against changing monetary policy. Alfonso made a good point that while this is helpful to keep in mind, in another 200 years, if we haven’t stopped to smell the roses, you should while you can. Last week’s CPI print of 7.9% was a friendly reminder that we can expect it to continue climbing in the coming months. Why? Well, thanks to the Minneapolis Fed database, we can see the probability distribution for US inflation over the next five years priced in by the markets today versus one year ago, as seen below.

Before you begin to worry, let me remind you how the Federal Reserve has behaved leading up to today’s environment. After the global financial crisis we had very low growth and very low inflation, so the Federal Reserve wanted to help the economy out – so they tried to foster an asset bubble. Bernanke’s wealth effect, A.K.A the wealth illusion. But how does the Federal Reserve do this if they can’t spend? They influence asset prices. The more assets one has and the higher asset prices go, the more ‘wealthier’ they will feel. They will go out to spend, borrow, buy, lend, etc., therefore, helping growth and stimulating inflation. If you are up 5x or 10x on your investments maybe you go out and purchase a home or a car, and that stimulates the economy, which is okay because growth and inflation both were slow.

In 2022 we have levels of inflation unseen in decades, asset prices at historic highs, and consumers wealthier than they’ve ever been. But just like how the Federal Reserve can use its tools to generate wealth, they can use it to also slow wealth. So, less wealth means less money in the economy which means less demand for goods and assets which helps out inflation – which is clearly the Federal Reserve’s biggest issue in 2022. Even though this unintentional outcome is unpleasant, having lower asset prices is not unfavorable. You can think of it as more affordable housing, reducing demand, opportunity in stocks, or shrinking the amount of wealth inequality. Whichever way you cut it; we cannot avoid it but there is a silver lining for us investors.

Like I mentioned earlier: keep it simple. There are an infinite number of possible outcomes for the market and the economy. The probability that an assumption is wrong increases the more variables you add: a pandemic, war, inflation, supply chain disruptions. They all have their own ripple effects influencing the market and economy. There is no need to complicate an issue beyond necessity. Stocks continue to outperform in the long run, and cash is as good as gravity. Do not increase your “Risk of Ruin”.

– Kenneth Wolin

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All charts and data from Bloomberg unless otherwise indicated.

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