The last time inflation was this high was 2008—thirteen years ago. And, then, it was not lasting. However, in the 1970’s it reached 12% or more and it persisted for years. Why does inflation matter?
There are two aspects of inflation: how it affects consumers and how it affects investors.
I don’t have to tell most of you that prices on many consumer items have gone up over the last 12 months—gasoline, airline tickets, groceries (my favorite raspberries and blueberries have jumped during COVID), house prices, wages and many other items. When consumer prices increase, some consumers will switch to alternative, lower cost products. But, that’s not always possible.
For example, what is the alternative to buying gasoline? If your vehicle only accepts gas, you can’t start filling it with kerosene. So, consumers will either pay more or decide to drive less, if possible. The bottom line is that rising prices can shift buying patterns and also cause consumers to cut back spending so that they can pay for the things that they cannot substitute. Already there have been reports of first-time homebuyers dropping out of the market because they are being priced out of certain homes. These can be serious issues if they persist for a long time.
For stock investors
If the cost of goods and services are rising, businesses will first try to pass on those price increases to the buyer whenever possible. However, in highly competitive areas this may be impossible. That could mean that the business has to “eat” the price increase. When a company has to absorb a price increase, typically it will reduce earnings and profits. If we are talking about publicly-traded companies, that can be bad news. Investors want to invest in companies that are growing and have improving profit pictures. If profits and earnings start to decline, it can lead to stock price declines.
For bond investors
For bonds and fixed income investments, rising consumer prices are also usually bad news. Higher inflation is often associated with rising interest rates. The concept is if you own a 30-year bond with a yield of say 2% and inflation is running at 5.4%1, your “take home pay” from
owning that bond is actually -3.4%. In other words, you are not earning enough on that bond to make up for the decreased value of your investment.
Is it time to panic?—No.
It goes without saying that the past 12-18 months have been highly unusual on many levels. While much of the recent spike in inflation is attributed to the bounce back of the economy and the huge cash infusions into the economy by the US government, we believe that these are temporary conditions that will recede, especially in 2023 and beyond.
Another consideration is that no one should panic just because inflation has started to increase. Keep in mind that the long running rate of inflation has been in the 2-3% range. Over the past ten years we’ve been experiencing below-average inflation. That’s been a sweet ride. But even with some above-average inflation, we don’t think it will be a disaster for stock and bond investors as long as it does not get out of control.
Investors should remember that wealth accumulation occurs over long periods of time and during very different economic and market environments. Be patient. We’ll be watching, too.
If you have questions about inflation and whether your portfolio is positioned appropriately, give us a call. We’re here to help.
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Lyman H. Jackson Lyman@PlanWithFPS.com
Photo – This is a pic from our June 2021 vacation on Lake Winnisquam, NH with my kids and their cousins. When they all get on the tube they like to call this “megatube.” The article topic on inflation made me think of blowing up this inner tube.
Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. FPS provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client after entering into an advisory relationship. Information herein includes opinions and forward-looking statements that may not come to pass. Information is derived from sources believed to be reliable. Information is at a point in time and subject to change without notice. Such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.