Written by Andrew Roth
Everywhere you look, talking heads are sounding the alarm on inflation. What should be done and who is impacted most?
Inflation is an increase in the cost of supplies or labor, culminating in higher prices for consumers. It’s also an erosion of purchasing power. Inflation is not new, and gradual inflation is considered normal for a growing economy. It’s the reason why a McDonald's Big Mac cost about $2.45 in 1990 versus just shy of $5 today.
The COVID-19 saga created a unique economic situation in historical terms. Global production was halted by lockdowns. At the same time, the government provided relief through unprecedented cash payments and other incentives. First Trust, one of our money management partners, recently highlighted that the COVID recession was unique since it is the only recession on record where the savings of the average American increased based on their measurements.
While the relief programs were well intended, they inflated the volume of money in the system and have fueled a massive surge in demand as the economy re-opens. Consumers are flush with cash while suppliers are scrambling to catch up. This has led to a surge in real estate, building supplies, meat and gasoline prices as demand outstrips supply. Other goods like appliances are difficult to find in-stock. A well-publicized global shortage of semi-conductors is likely to affect manufacturers in all industries.
Clients are asking us our thoughts on inflation and what they should do during a period like this.
Our hope is that inflationary pressure is short-lived. Hopefully, we have a year or two of elevated inflation before things normalize again as supply catches up with demand. Inflation, however, is hard to avoid. Inflation is systemic, meaning it affects the entire economic system. Inflation is a headwind that will affect all consumers, investors, and producers. Even skittish investors, succumbing to the urge to move all their assets to the bank, would be hurting themselves as the purchasing power of cash is eroded by inflation.
Staying invested is the best course of action if you have a long-term outlook.
In the meantime, we trust the investment managers we work with to make the right decisions. When it comes to picking stocks, certain companies can adjust to inflation better than others. Some companies have an easier time passing inflated input costs to customers and can profit accordingly. Certain industries are also less input intensive (like professional or financial services) or may see increased revenues tied to financial assets. Companies related to commodities might see a bump in volume because of demand. There will be companies who continue to succeed and innovate despite inflation. We trust the active managers we work closely with to make these evaluations. Through these managers, we are also leaning into commodities as a portion of some portfolios to hedge inflation more directly. When it comes to bonds, we believe active management can focus on areas of the market less sensitive to inflation and possible interest rate hikes.
Inflation is alarming because it’s obvious to everyday consumers. There may be a period of increased prices on the horizon, but we are also bullish on the economy in the near term due to the global economic re-opening. Fortunately, our clients with assets in the market can take advantage of any corresponding increase in the economic activity and future innovation. On the flip side, this surge in prices will impact the youngest or poorest in our communities most. Families living paycheck to paycheck, or young people trying to establish themselves, will have the most difficult time countering inflationary pressure since a larger portion of their income is spent on necessities.
Philosophically, it is also easy to be critical of what contributed to this situation and speculate on the unintended consequences of our current policies. While we share some of our clients’ concerns and certainly understand their questions, we must also act based on what we can see and measure today. Periods of inflation come and go and occur in all economies. Using history as a guide, even the malaise of the 1970s and early 1980s presented opportunities for innovators and investors despite higher-than-average inflation.
Stepping back for perspective, I’m also comforted by the fact that projections of future doom and gloom are often overstated. The nature of our 24-hour news cycle incentivizes the creation of new panics and manias, many of which don’t come to fruition.
Regardless of the magnitude of inflation, we believe that deviating from financial plans, or abandoning the markets altogether, would be a great disservice to our clients’ long-term success.
For more information on the topic of inflation, visit Matt Benson’s recent article “What is Inflation?”