Inflation: Our thoughts

Blog post #485

The headlines are everywhere….inflation is rising.

The US Labor Department reported on Thursday that consumer inflation climbed “strongly in May, surging 5% from a year ago, to reach the highest annual inflation rate in 13 years.”*

We want to address a few of the issues surrounding inflation and the impact this issue may have on your financial future:

  • What is happening with inflation and how does it compare to the past?
  • What should we (as your advisor) and you do about this, as it relates to your investment portfolio?
    • What is the impact on your stock portfolio?
    • What is the impact on fixed income investments?

What is happening with inflation and should you be concerned?

Clearly, prices of most or all categories of consumer goods are increasing, but perspective is needed. It is not surprising that prices are increasing over last year, as prices were depressed a year ago, as the US and world were in the midst of pandemic shutdowns. Most of the consumer price increases have been in the energy, used vehicles and transportation services sectors.

The automobile sector is having a very significant impact on the inflation. Prices for used cars and trucks increased 7.3% in May, from April, 2021, which accounted for 1/3 of the overall May inflation index increase. Much of this is likely temporary, as car makers are not able to ship certain vehicles due to computer chip shortages, which is putting price pressure on used cars.

It is not surprising that inflation has increased from a year ago, given the pandemic impact. It is not surprising that gas prices at the pump were down last spring and summer from 2019 levels, as most people were driving much less than normal a year ago.

Let’s look at the price per barrel of oil (which correlates with the price of gas at the pump) over the past two years, which I think is a key perspective.  The price per barrel of oil, as reported by WSJ.com, shows over the past two years a huge increase from 2020, but a much more reasonable increase from pre-pandemic level of June 2019, as follows:

Oil per barrel:

June, 2019                    $57-60

June, 2020                    $37-40

June, 2021                    $68-70

In an excellent WSJ article** on Monday, economics reporter Jon Hilsenrath wrote about the importance of a two-year time perspective for viewing inflation and other economic data (including corporate profits), versus making conclusions based on only 2020 data.  He feels that using pandemic-related data (the 2020 base) will distort many economic statistics, including inflation.

While the May inflation increase of 5% in certainly large, as the accompanying chart reflects, “the consumer price index rose 3.5% every two years during the decade before the Covid-19 crisis. That was within a range between 5.8% in 2012 and .8% in 2016. In April this year, the index was up 4.5% from two years earlier.”**

 

Hilsenrath wrote Monday, prior to the release of the May inflation data, “the message from this perspective (taking a two-year view) is that inflation is trending a bit higher than usual but not exceptionally so as of April.” **

We think that future inflation is something that should be monitored, but it does not seem like we are headed towards a period of hyper-inflation, where prices are increasing anywhere near the inflation levels of the 1970s. During that time, inflation increased many years above 6% annually and there were 3 years above 12%, including 1980.

 

 

 

What is impact on your portfolio of these inflation concerns?

One of the best long-term inflation hedges that you can have is investing in stocks and maintaining your long-term stock allocation. That is what we recommend you continue to do. As the data below shows, concerns about inflation is more of a reason to be invested in stocks, not a reason to sell stocks, as the long-term performance of stocks has far outpaced the cumulative rate of inflation.

S & P 500 annual return, 1926-2020 :                                                  around 10%

Many other asset stock classes, such as small and value:                 greater than 10%

Long term Consumer Price Index (CPI):                                              little less than 3%

 

While we believe in broadly diversifying among many stock asset classes, both in the US and Internationally, the S&P 500 provides a good illustration of the benefits of long-term stock ownership, as a solid hedge against inflation.  Since 1960, the S & P has increased by more than 71 times, while inflation has increased by only 9X. Over a very long term period, and certainly with many ups and downs, owning stocks has provided an excellent way for your money to grow at a rate that far surpasses the rate of inflation, so you are not losing spending power due to inflation.

S & P 500,    1960:                   58

S & P 500, June, 2021:                        4,200+   That is an increase of 71X

Inflation,   1960:                      30

Inflation, June, 2021:                          268        That is an increase of 9X

 

Stocks may be impacted by higher inflation, as pricing pressures throughout the economy impact companies and their earnings. There is no way to predict this, especially in the short-term. We cannot predict the future rate of inflation, nor how long inflationary pressures will exist above the Federal Reserve’s 2% long-term inflation target.

We focus on your long-term goals. We don’t make major changes in client portfolios based on things that we cannot predict, as well as things we cannot quantify or know their duration.

Inflation can have an impact on your fixed income portfolio, if inflation causes interest rates to rise. However, due to Federal Reserve actions over many years, even before the pandemic, interest rates remain very low on a historical basis. For example, the US 10-year Treasury Note remains around 1.50% today, while it was at 1.745% on 3/31/21. It has increased from under 1% at the beginning of 2021 but is still far below the 2.8% – 3.2% range in the second half of 2018.

It is particularly interesting that the 10-year rate has declined from 3/31, from 1.745%, to around 1.50% today, as inflation concerns have increased recently. If bond traders thought inflation was going to continue to increase significantly over the long-term, one would think a 10-year Note interest rate would be increasing, not decreasing. This is why we don’t make interest rate bets, but would rather build diversified fixed income portfolios for our clients, with varying high quality investments and maturities.

 

We have structured your fixed income portfolios to be defensive, by holding short term bonds and bond funds/ETFs. Generally, most fixed income investments that we recommend will have maturities that range from a few years to a duration of 6 years (the shorter end of intermediate maturities). We do not recommend holding longer term fixed investments, say 10 years or longer, due to inflation and interest rate risk. We have also added, and will be continuing to evaluate, adding other inflation protected fixed income investments to certain portfolios, as considered appropriate.

 

We hope that this information is beneficial to you, as you read and hear about increased inflationary pressures on various segments of the economy. We remain optimistic about the future of corporate earnings, as successful companies are always innovating and dealing with change.

 

Talk to us. We want to listen to you. we want to assist you, your family members and friends.

 

If you would like to read our previous blog posts, click here.

 

Let us know what you think. If you would like to contact us, please email or call Brad Wasserman (bwasserman@wassermanwealth.com) or Keith Rybak (krybak@wassermanwealth.com); or 248-626-3900 (or visit the Contact Us section of our website).

 

~ Developing Relationships by Doing the Right Thing ~

 

 Wasserman Wealth Management, 31700 Middlebelt Road, Suite 130, Farmington Hills, MI 48334

 

Sources:

*“U.S. Consumer Prices Rose Strongly Again in May,” Gwynn Guilford, June 10, 2021, 8:54 am, WSJ.com.

** “For Inflation, Looks Can Be Deceiving,” Jon Hilsenrath, June 7, 2021, Wall Street Journal print edition, page A2.