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The Growing Impact of Inflation and Rising Interest Rates on the Affluent

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Inflation and rising interest rates have, until recently, been only a minor inconvenience for wealthy Americans. Although prices for everyday commodities like groceries, cars, and airplane tickets have occasionally deviated from their perceived value, the affluent have not felt compelled to make significant changes to their lifestyles. Instead, their grievances centered on financial institutions and the difficulties in earning higher interest rates on their unused funds.

However, the tides may be turning for the rich. American Express (AXP), known for its popularity among the well-off, recently announced an increase in its allowance for bad debts. The reserve amount rose from $1.1 billion to $1.2 billion in the previous quarter. This development should not be taken lightly, as it could potentially signify increased pressure on consumer spending, which is a crucial driver of the U.S. economy. If wealthy consumers struggle with bill payments, one can only imagine the challenges faced by those with lower credit scores and less income.

While this point is speculative in nature, it is not without merit. The Federal Reserve has consistently emphasized that there is a time lag between higher interest rates and a slowdown in economic activity. Consequently, American Express’ decision to allocate more funds for potential bad debts might serve as an indicator of an impending economic downturn.

Of course, gaining an accurate understanding of the economy requires considering multiple data points rather than relying on one isolated event. The challenge lies in sifting through the noise of the market and economy to identify facts or themes that could act as early warning signs for future market developments.

One useful approach—something you can try discussing with friends and family—is what I refer to as the “PA Indicator.” Recently, during a gathering at a luxurious home on Eastern Long Island, I engaged in a conversation with individuals who manage wealth across generations. The topic naturally shifted towards everyone’s personal accounts, or PAs. This informal exchange allowed me to gain unique insights into the financial decisions and strategies adopted by the affluent.

The Hamptons: Frenzied Amidst a Disconnect in the Market?

Among the few select couples present at a recent gathering, the individuals from the finance industry showed a conservative approach. Meanwhile, a real estate developer continued to construct yet another luxury property, with prices soaring to several thousand dollars per square foot.

The evening offered impeccable wine, Champagne, and cuisine; however, it failed to overshadow the prevailing sentiment that prices had escalated too quickly and too far. Those present at the gathering who were actively involved in the market, and especially those whose stock investments had low cost bases, sought to mitigate their risks. Their strategies ranged from engaging in put-spread collars to selling covered calls on their stock positions.

These strategies aimed to safeguard against market risks while also indicating a prevailing belief that securities were more likely to decline rather than rise. To illustrate, a put-spread collar involves selling a call option on a security, using the proceeds to purchase a put option, and selling yet another put option as a hedge against potential stock declines.

Despite the atmosphere at the dinner party and any concerns about increased bad debts faced by American Express, there appears to be a palpable frenzy across the towns, stores, and restaurants that constitute the Hamptons.

Within New York’s summer sanctuary, there seems to be little worry about anything. This carefree mindset extends to the stock market, which continues to trend upwards, as well as to the airlines, witnessing a surge in passengers heading for vacations. It appears that individuals are fully committed to maximum enjoyment now that it seems the Covid pandemic has come to an end.

Nevertheless, it is crucial to remain vigilant and observant of the signs. The coming days will shed light on whether the emerging disconnect between escalating bad debts and the mood in the Hamptons is merely coincidental or if it serves as an ominous warning for investors.

Steven M. Sears is the President and Chief Operating Officer of Options Solutions, a specialized asset-management firm. Neither he nor the firm holds any positions in the options or underlying securities mentioned in this column.

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