by Bryan Perry

February 23, 2021

Recent data shows that real GDP growth and core inflation are rising at a faster pace than previously forecast. How both of these “nice problems to have” are addressed by the Fed is one thing, but more importantly, how should income-oriented investors position their portfolios in such a scenario?

Signs of inflation have been building for weeks, if not months. Just going to the grocery store and the gas station tells you that, but there are several more signs. Just this past week, we received a slew of core data points that build a solid case for further rises in inflation, as well as bond yields rising across the curve:

  • Retail Sales for January were up 5.3% versus 0.8% consensus.
  • Retail Sales Ex-Auto were up 5.9% versus 0.7% consensus.
  • The Producer Price Index (PPI) for January was up 1.3% versus 0.5% consensus.
  • Industrial Production for January was up 0.9% versus 0.6% consensus.
  • Empire State Manufacturing for February was at 12.1 versus 7.5 consensus.
  • Capacity Utilization for January was 75.6% versus 74.9% consensus.
  • Building Permits for January were at 1,881k versus 1,670k consensus.

In addition, the Five-Year, Five-Year Forward Inflation Breakeven Index has risen steadily over the last year. This index measures the expected average inflation rate over the five-year period that begins five years from today. The current 5-Year, 5-Year Forward Inflation Breakeven expectation rate as of February 19, 2021 is 1.99%.

Five Year Forward Inflation Breakeven Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The Fed’s goal of getting the rate of inflation back up to 2% looks to have been achieved, if not, nearly so.

The Fed’s other mandate – full employment, meaning a sustained Unemployment Rate below 5% – is and will be elusive, it seems, for the foreseeable future. Despite the stimulus packages rendered in various forms these past 12 months, the job market for tens of millions of Americans is not improving. Initial Jobless Claims for the week ending February 13 increased by 13,000 to 861k versus 775k expected.

Initial Unemployment Claims Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Although the Unemployment Rate fell to 6.3% from 6.7% in January, that was due to the fact that the Labor Participation Rate fell to 61.4%, down from 63.4% a year ago. Translated – about three million Americans who are eligible to work in the everyday U.S. economy have stopped looking for a job.

Labor Participation Rate Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The Labor Participation Rate is the percent of the working population age 16-64 currently employed or seeking employment; students excluded. (Data source: U.S. Labor Department; chart source: Statista)

Adding to this dilemma is the current push by the Democrat-controlled Congress to mandate a federal $15 per hour minimum wage. Wages should be regionally implemented, since scores of small businesses, already dealing with high rents and growing state and city regulations, could be crushed by higher wages.

One-third of small businesses anticipate laying off workers if Congress increases the federal minimum wage to $15 an hour, according to the latest CNBC|SurveyMonkey Small Business Survey. A recent Congressional Budget Office analysis forecasts that a $15 minimum wage would lift 900,000 Americans out of poverty, but also result in 1.4 million fewer jobs. It’s a real conundrum that needs to be addressed.

Regardless of the lagging labor market, the corporate economy is picking up speed, led by strong growth within the S&P 500 and the largest privately held companies in the U.S. The latest read from the Atlanta Federal Reserve GDPNow estimates first-quarter GDP growth at 9.5%, double the prior estimate.

GDPNow Gross Domestic Product Estimate Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Companies are producing more goods and services with fewer employees, a natural byproduct of most economic crises. Hiring typically comes during the recovery. On the surface, this looks hugely promising for job prospects, and hopefully it will work out that way. But as so many companies reported in their Q4 earnings calls, advances in technology and reduced remote workforces are helping to pad the bottom line.

This Tale of Two Economies will continue to exist until the airline, cruise, restaurant, lodging, custodial, amusement park, corporate cafeterias and a host of other pandemic-plagued businesses come back to life.

Against this backdrop of rising GDP and inflation, money is flowing out of the long end of bonds. The yield on 10-year Treasury Notes is up to 1.34%, and in my view, is headed to 1.5%, and possibly higher.

Ten-Year United States Treasury Yield Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

For investors seeking income that benefits from rising bond yields and equities, I’ve noted previously that one of my favorite asset classes in this environment is convertible debt – bonds and preferred stocks that can be converted into the underlying equities, thereby benefiting from stock appreciation.

Investors can buy closed-end funds using 20%-30% leverage utilizing cheap short-term rates to generate yields of 5%-7% that pay monthly dividends. This is a simple way to buy into this favored asset class.

High-quality Business Development Companies (BDCs) are another security class to own in an expanding economy. Most loans made by BDCs to small-to-medium-sized businesses are structured at a floating rate. When rates rise, those loans are adjusted to receive more interest and those higher income streams are passed on in the form of higher dividends because BDCs are structured like REITs and must pay 90% of income as regulated investment companies. The highest-rated BDCs pay yields of 6%-9%.

Covered-call closed-end funds that invest in blue-chip, market-leading stocks are also a fine way to own the best stocks while deriving a 5%-8% annual income stream. Some of these funds pay monthly.

And don’t forget select subset classes of REITs that invest in e-commerce logistics and other hot growth sectors of the economy. Here, too, one can find 3%-6% dividend yields.

Energy assets tied to oil and gas is one sector where current yields are juicy, but their future holds more risk than I’m willing to endorse at this time.

It takes some due diligence to find the best-of-breed stocks and funds in each of these assets that trade outside the conventional TIPS market and other commercial floating rate instruments that pay under 2%. But after adjusting for rising inflation and taxes, making 2% generates a negative return going forward.

The latest inflation and GDP readings are a wake-up call to bond investors and income investors alike. It’s a good time to shorten up duration in bond portfolios and consider adding exposure to assets that benefit from borrowing at or near the Fed funds rate and owning assets tied to stock market performance.

All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.

Please see important disclosures below.

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An Update on our Rapidly Growing Big Money Index

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About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry

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