News & Insights
Should Investors Worry about Inflation?
The bounce back from the COVID economic depression has been swift, driven by consumers flush with cash as the result of monetary stimulus and increased savings from staying at home. The increased demand for goods and services, along with huge disruptions in supply chains globally, has led to higher prices of goods and services leaving investors to wonder if they should worry about inflation. The number of Google searches for “inflation” has spiked to the highest level since Google began tracking the data 13 years ago. A deeper analysis of economic data points leads us to believe that the current inflation spike will be temporary.
In simple terms, inflation is a sustained rise in the overall price levels for goods and services. While some level of inflation is associated with economic growth, a high level of inflation can signal an overheated economy. Though there are several different factors that contribute to inflation, the most common example is when money is in excess of goods and services. This is a supply demand imbalance. During periods of economic growth, strong demand outpaces the supply of goods, which allows producers to raise prices. Occasionally, demand can accelerate too quickly resulting in an upward price spiral, also known as hyperinflation.
How does Inflation affect my portfolio?
It is important to understand that inflation is negative because it acts like a hidden tax against earnings and chips away at returns and earnings growth over time. The goal of most investors is to grow their portfolio for future consumption or use. Inflation puts that goal at risk by increasing the hurdle rate or return that one must achieve to sustain the same purchasing power they have today.
To illustrate, an investment that returns 3% when inflation is 4% has a real return of negative 1%. This dynamic occurs most frequently within fixed income because of the fixed nature of bond coupons. As inflation rises, the real value of the income payment decreases.
Our thoughts on current inflation
Anyone who has recently completed a home renovation, taken an UBER ride, or purchased a used car, understands that prices have increased. In April and May, the Core US Inflation rate, as measured by the Consumer Price Index, or CPI, was 2.96% and 3.80% respectively; above the Federal Reserve’s target inflation rate of 2%. While many investors are trying to extrapolate the recent data points to predict the future, we believe it is important to understand what’s happening beneath the surface and the reasons that the current inflationary dynamic is transitory or temporary.
The COVID induced recession was unique in that it was a self-imposed shut down of our economy. Corporate supply chains, factories and warehouses scaled back production and, in some cases, temporarily closed. As product demand returns, kinks and bottlenecks have appeared as companies rush to restock inventory. Companies are now addressing these supply/demand challenges. For example, as illustrated in the chart below, lumber prices, which saw a significant price increase, have begun to retreat as sawmills ramp up production and consumers delay projects to avoid higher costs.
A second contributing factor to the spike in headline inflation is the lack of availability of labor. Even though approximately nine million Americans remain unemployed, reported job openings are at a post crisis high. Several small business surveys along with public comments from CEOs, point to a lack of qualified applicants. An unusual dynamic exists due to the extension of supplemental unemployment benefits signed into law as part of the American Rescue Plan in March. These benefits are set to expire in September with a number of states electing to terminate the additional benefits this summer. Once unemployment benefits roll off, the labor shortage should correct itself and eliminate the need for continued increase in wages, which are adding to labor force pressures.
We believe that inflation is likely to rise modestly in the coming months as other countries reopen and their economies pickup with growth. The inflation story will hold headlines for the summer and possibly through the end of the year, likely leading to short-term market volatility. Longer-term, we expect inflation to revert to historic averages driven down by globalization, technological advances, and a normalization of supply chains. We will of course continue to carefully monitor the information and adjust if necessary.
As always, we welcome any questions and look forward to speaking soon.
The Information contained in this document is based on data received from third parties which we believe to be reliable and accurate. YorkBridge Wealth Partners, LLC has not independently verified the information and does not otherwise give any warranty as to the truth, accuracy, or completeness of such third party data, and it should not be relied upon as such. Any opinions expressed herein are our current opinions only. YorkBridge Wealth Partners, LLC is an SEC Registered Investment Adviser under the Investment Advisers Act of 1940 (“Advisers Act”). Registration of an investment advisor does not imply any specific level of skill or training. The information contained in this document is to assist with general planning. Please consult with your own tax advisor and attorney for more specific information.