Another Look at Inflation

By Russell W. Hall, CFP®

A Hot Topic

Recently, we wrote an article about inflation – how it’s calculated, what the rate has been recently, and why we think it’s important to stay concerned about inflation when considering investment allocations and returns.  Since then, inflation has jumped into the headlines and seems to be on everyone’s mind. 

How It Feels

We recognize that although the media tends to grab onto issues and blow them out of proportion (“Inflation Surge!” “Soaring Prices!”), many people are truly feeling the hit in their wallet.  It’s certain that the cost of many items has gone up, especially food and gas.  Hotels, airlines, and other travel-related industries are charging higher prices. 

At the same time, it seems like help wanted signs are everywhere.  Some employers have had to significantly raise pay rates and even offer up-front bonuses to attract new employees.  Those higher prices and higher wages must translate into high inflation…right?

The Numbers

Last month, Consumer Price Index (CPI) growth clocked in at 5.4% (annualized), which was actually down a little from previous readings.  Compare that to an average of 1.7% over the last ten years, and it looks like a return to Seventies-style inflation is right around the corner. 

Or is it?  Yes, growth and stimulus are up significantly - but it’s worth remembering that the economy is still recovering from the lows of the pandemic.  Supply-and-demand problems, like the shipping backup at ports or the chip shortage that’s increasing car prices, are more likely to be temporary.  Add to that the possibility of a slowdown due to the Delta variant, and we largely agree with the Federal Reserve and other experts who think that the elevated rate of inflation we’re seeing now is transitory and not sustainable.  Put simply, there’s not enough “gas” in the economy to drive 8-10% inflation over an extended period.

That said, we also think that inflation will be higher going forward than in recent memory.  It’s worth remembering that inflation has averaged 3% per year over the long-term, so several years of 3-4% inflation would not be far out of the ordinary.

What to Do

We touched on this previously, but the most effective way of keeping up with inflation has proven to be stocks.  Why would this be when there are Treasury Inflation Protected Bonds (TIPS), Series I Savings Bonds (I-Bonds), gold funds, and now cryptocurrency?

When you purchase a stock, you are buying a piece of ownership in a real company that sells products or services (well, usually…but that’s a topic for another article).  As a shareholder, you are entitled to share in the profits of that company.  If inflation goes up, that company can raise prices to keep up.  Obviously that is a very simplistic description of a complicated process, but at the core it’s why maintaining an allocation to stocks is the best way to keep up with inflation.

TIPS and I-Bonds have their place, but that’s usually when an investor cannot tolerate stock investing and needs their fixed income allocation to match inflation if possible.  From time to time we review those options and recommend them, but our main concern is keeping the correct balance between bonds and stocks to allow growth and keep up with inflation increases.

Gold and other precious metals are often cited as inflation hedges, but unfortunately that relationship has not held up over time.  Those investments don’t pay income (and in fact sometimes have a cost to hold), so they are worth whatever the next person will pay for them.  In inflationary environments, gold has sometimes increased in price as worried investors are willing to pay more for it, but that’s not a direct correlation.  There have been times that gold has failed to keep up or has even dropped.

To summarize - we think that investors should always keep inflation in mind and be prepared for higher rates over the next several years, but we don’t see a return to double-digit inflation on the horizon.

Want to have a further discussion about inflation? Schedule a 15-minute discovery call with a fee-only financial advisor.