Retracing Our Steps

Everything has a story.  Regardless of who you meet or what you encounter, that person or thing has a story to it.  Stories have proven to be one of the most effective ways of learning something because they’re relatable.  The narrator typically has a deep understanding of that story, usually experiencing it firsthand.  As it relates to this blog and what the “normal” topics will be, well that’s going to be investing and the economy.  Investing and the economy have elaborate stories stretching back to the beginning of humanity.  Tracing these stories back to their origins can help create some understanding of the complicated and confusing markets.

A great example of a complicated topic is inflation.  Inflation can be thought of as the increase in cost to buy the same basket of products and services at different points in time.  Compensation increases are typically tied to inflation, meaning the effects are felt less harshly while working.  In retirement however, inflation becomes an important factor.  The most common financial instrument to protect against inflation is the inflation-linked bond which has its origins in the earliest days of the United States; the Revolutionary War to be exact. [1] 

These bonds were issued to men fighting in the Revolutionary War as deferred compensation to be paid once the war was over.  The bonds were linked to a basket of commodities that were commonly used at that time, such as beef, sheep’s wool, or leather.  The concept is simple, prices for commodities are much more volatile during and after periods of war.  Therefore, linking payments to account for that volatility was a good idea.

Clearly beef, sheep’s wool, and leather are much less relevant to a retiree today than they were in the late 1700s, however, inflation itself remains important.  Inflation helps determine purchasing power, purchasing power helps determine day-to-day expenses, day-to-day expenses determine cash flow needs, and cash flow needs determine a withdrawal rate from a portfolio.  So that portfolio must be designed to account for those fluctuations.

Today’s markets and the economy are different than they were at any point in time.  If you follow the markets to some extent, you’ve no doubt heard the phrase “this time is different.”  The speaker of that phrase falling on either side of believing fully in it, or not at all.  The circumstances we are currently in are different, however, people’s behaviors are much more consistent and can be predicted with some degree of accuracy.  This is why having some historical backdrop allows for a better understanding of how people have reacted in previous years.

Take the current epidemic as an example.  Most everyone you know has become an epidemiologist and has an opinion about what is going to happen.  The simple truth is that nobody knows what is going to happen, but people’s reactions to it are likely to rhyme with their historical iteration.  For example, the City of Philadelphia, despite the ongoing Spanish Flu epidemic, decided to hold their St. Patrick’s day parade [2], resulting in many getting the flu and ultimately dying.  While this year’s parade was cancelled, people’s behavior as states re-open have some eerie similarities. 

While there are many historical topics that are worth exploring, there are a few broad topics that can create a good baseline for understanding how the economy and the markets got here today.  The market can be, very simply, thought of as a place where buyers and sellers meet.  In this context markets have existed almost since the beginning of humanity.  The rest of the month we’ll trace some of these topics to their beginnings. 

[1] http://www.econ.yale.edu/~shiller/pubs/invention.pdf

[2] https://www.smithsonianmag.com/history/philadelphia-threw-wwi-parade-gave-thousands-onlookers-flu-180970372/