Paradigm Shifts by Jack Moller, CFP®

I’ve been thinking about the concept of paradigm shifts and also trend changes. It seems important to consider these topics in the world today when so much disruption seems to be occurring at quite an accelerated pace.

The definition of “paradigm shift” according to the Oxford English Dictionary:

a fundamental change in approach or underlying assumptions

So, to my way of thinking, a paradigm shift is basically a perspective-changing time when the world looks different in some way.  Trend changes, such as we often see in markets, can flow out of a paradigm shift.  Those who can quickly recognize these significant shifts taking place, and can take the appropriate courses of action, can benefit greatly.

In this article, I want to mention a paradigm shift that occurred in the area of financial planning at about the time that Moller Financial came into business three-plus decades ago.  This shift was critical to “get right”, i.e. incorporate into our financial plans.  Then, I’d like to consider a paradigm shift that may be happening in the economy and how it would likely affect market trends.

Retirement Planning Paradigm Shift

As I hit Medicare eligibility this year, the focus on planning financially for this “last quarter of life” has taken on new meaning.  I am now not just planning for our clients but also for me personally.  When Moller Financial was founded 31 years ago, a big shift was taking place in terms of how we plan for retirement.  Previously, the paradigm was to basically:

• Work until retirement at age 65
• Live off of Social Security and perhaps a pension for 5-10 years
• Investments kept in safe bonds and CDs
• Live until the mid-to-late 70s

Yet, this strategy was becoming outdated and significantly inadequate as:

• Many people had either sought to retire before age 65 or some had continued working for many years longer.
• Life expectancy continued to expand with people sometimes living into their 90s and beyond.
• Defined benefit pensions were being phased out.
• Social Security was found to be inadequate in itself for generating the income necessary for a comfortable retirement.
• Yields on “safe” investments were in a multi-decade, secular decline.

These significant demographic, financial, and lifestyle changes dictated a new approach.  In a nutshell, we had to plan for the possibility of multiple decades in retirement with steadily rising prices and the need to pay for it with our own savings.  Furthermore, investing primarily in the old “safe havens” such as CDs, Treasury bonds, or municipal bonds with their measly yields just didn’t cut it.  So, unlike their parents and grandparents, seniors needed to have meaningful exposure to the stock market as the only investment class that was able to historically provide the growth necessary to maintain their standard of living over decades of ever-rising prices.

Of course, the stock market only provides these necessary returns if we have the patience to ride out the always temporary, but often scary, down markets.  Keeping our focus on the inevitable recoveries to follow these declines keeps us from panicking and selling.  The good news is that as we are planning for multiple decades of retirement we have, even in our senior years, a long investing time frame that favors stocks.  The challenging news is that staying the course can be emotionally challenging.  For example, just in the past 25 years or so we’ve experienced two roughly 50% stock declines (Dot Com bear of 2000-2002 and the Great Financial Crisis of 2008) along with the pandemic-induced brief, but sharp, March 2020 bear market.  Note, however, riding these temporary bumps has still ended up with decent returns over this period even if a bit below long-term averages (depending on your starting point).

Possible Economic Paradigm Shift with Investing Implications

I’m not quite as confident in “calling” the recent economic changes as being indicative of a truly sustainable shift in perspective that may last for years or decades.  Nonetheless, it does seem like significant grounds are shifting.  We don’t want to “predict” but we also want to make sure that we are not stuck in an outdated approach based on an old paradigm that we are not really even aware that we were locked into.

From Deflation to Inflation.

As I’ve written many times, I graduated from college in the late 70s during the worst inflation in modern times with double-digit price increases, interest rates, and mortgage rates.  Since the early 80s, after then-Fed Chairman Paul Volker slammed the markets and the economy with huge interest rate hikes, inflation (and interest rates) have been in this multi-decade downtrend.  During the financial crisis, we even flirted with deflation.

Since the pandemic-induced shutdown, with the impact on supply chains as well as the government financial payments to keep the economy from collapsing, we’ve seen prices soar with inflation readings not seen in the last 40 years.  Clearly, this is a huge shift and one that can impact so many other market trends.  It certainly seems like inflation is out of genie’s bottle in a big way.  Yet, I’m still not so sure.  For one thing, I am sort of sympathetic with the argument that huge amounts of debt (as we are seeing as never before in history) are more deflationary than inflationary.  Also, how will inflation react to supply chain recovery when we eventually move past the pandemic and if the war in Ukraine is resolved or at least possibly cooled off?  Finally, and perhaps most importantly, what happens to inflation when we have our next recession?

Nonetheless, as noted above, I think we need to give it some more time to see if it is sustainable.  Yet, if it we are truly entering a period of high/rising inflation, then we might look for some trend changes in markets (many of which seem to have already begun):

1. End of Long Bond Bull Market.  The Federal Reserve has started to tighten financial conditions and indicated plans to raise interest rates at the most aggressive pace since the days of Paul Volker.  They are also planning to sell billions of dollars of bonds to shrink their balance sheet.  Interest rates have already soared, albeit from some of the lowest levels in history.  We need to be prepared for the possibility that we are entering a period of rising interest rates that we really haven’t seen since the 1970s.
2. From Financial Assets to Real Assets.  Commodities seem to have awoken from a deep slumber while the mega-cap stocks have finally started to succumb to their eye-popping valuations. Commodities did do quite well during the deflationary 70s.
3. From Growth Stocks to Value Stocks.  Growth stocks (especially the mega-caps mentioned above) have been the stars for over a decade with their outperformance accelerating during the first year of the pandemic.  They benefited from their ability to generate steadily growing income streams.  This attractive characteristic led their prices to be bid up to nosebleed valuations.  While growing income will always be valuable, inflation dents the value of future earnings which can bring valuations down to earth.  At the same time, many companies in the value camp have operating leverage that allows them to significantly benefit from their ability to raise prices to keep up with inflation.
4. From U.S. Stocks to International Stocks.   Ah, no, this paradigm shift has not happened yet.  Though … it is long overdue.  It might depend on whether the possible inflationary period is a worldwide phenomenon or more of a U.S. issue.  Currently, it seems to be worldwide.

It is hard to know if some of these trend changes will continue for long.  However, I do believe that if and when we move back to an economy dealing with inflation instead of disinflation/deflation, it will be critical to avoid the old mindset of expecting forever down-trending interest rates.

Stay Diversified and Nimble

So far, 2022 has been extraordinarily volatile with both stocks and bonds struggling mightily.  In fact, it’s been the worst start of the year for many segments of the bond market in history.  We may be on the verge of significant, disruptive changes in many of the financial trends that have been in place for decades.  As always, the key is to patiently stay diversified in a broad variety of asset classes.  Most importantly, if you are in retirement or planning for a future retirement (most of us are one or the other), be sure to maintain your long-term investing perspective with necessary allocations to a wide variety of stocks and be prepared to ride out any inevitable volatility.