Our outlook on current U.S. inflation

May 21, 2021

When I graduated from college, Jimmy Carter was president, and inflation hit 10%! Hyper-inflation such as this can be painful.

When inflation is high, retiree incomes may have a hard time keeping up. It can cause companies to slow down, which can reduce employment.

Graduating in a time of high inflation, I struggled to find professional employment, despite a degree in economics. I was grateful to land a job at Abbott Northwestern Hospital as a department coordinator, where I had the opportunity to work my way up to a management engineer. (It was after that role that I moved into financial advice in my mid-20s.)

Inflation trends

A client recently asked me if we are moving toward hyperinflation over the coming years, given that the year-over-year April 2021 inflation rate was a substantial 4.2%. I answered “yes” to the inflation, but “unlikely” to the hyper. Here’s why.

During the past 11 years, inflation has been stubbornly low. The FED (Federal Reserve Board) targets a 2% inflation rate, but inflation has run approximately 1.8% annually since 2010. In fact, inflation has been relatively modest since 1990.

Factors for low inflation

Several factors have helped keep inflation lower:

  • More women in the U.S. and Europe have entered the work force over the past 30 years. An increase in the labor pool tends to reduce salaries and prices.
  • Countries such as China, South Korea, Vietnam, India, Brazil, and many more have moved from very low incomes to the middle class (as defined by the IMF). For example, in China, disposable income per capita increased 700% from 2000 to 2020. Another example: in 2019, I spent time with financial advisors from Brazil at the national Financial Planning Association’s conference. They worked in the suburbs, and their role was much like mine. The many lower wage earners who joined the world economy over 30 years have helped decrease prices, keeping inflation modest.
  • Enormous technology enhancements have allowed companies to work more efficiently. Some of those savings are passed along to consumers in the form of lower prices. Think of the technology efficiencies gained in daily life over the past 30 years. We went from landline telephones to cell phones, from faxes to email/text, and recently from office work to remote work.

The trends above are likely to continue. Women are continuing to enter the work force in developing parts of the world; lower wage workers abroad continue to want to join the higher-wage economy; and technological enhancements continue, including the movement toward self-driving vehicles  and folks taking virtual cooking lessons from a top chef in Italy.

Factors for high inflation

However, the U.S. and other developed countries are tending to pull back on globalization. The competition from lower-wage workers abroad has caused some wage stagnation, and a move is afoot to “buy American.” This can create inflation.

In addition, the U.S. national debt continues to grow, sitting now at $225,000 per taxpayer. Too much government debt can be inflationary. It can drive interest rate increases because the government must pay a higher interest to entice folks to buy their debt. In fact, my belief is that allowing inflation to run is a time-honored strategy that countries often use to help deal with high debt.

As the pandemic has eased in the U.S., we are seeing pent-up demand cause price increases. As mentioned earlier, prices in April were up 4.2% as compared to April of last year, the fastest pace since 2008.

Long-term or temporary inflation?

A key question for many investors is “are these price increases temporary or the start of something longer-term?”.

This is an especially good question as we saw the reporting of the April inflation numbers drive some stock market volatility, with the S&P 500 decreasing 4% as of May 12 from its all-time high of 4,200 — though as of May 20 (12:30 CST) it had rebounded 2% to 4,161.

Many analysts believe that price increases due to pent-up demand are temporary. For example, Larry Adams, Chief Investment Officer of Raymond James Financial, believes we will see this inflationary spike peak as early as this fall.  Raymond James economist Scott Brown believes core inflation will trend to 2.9% by the end of the year. Get the details on their perspectives.

Our outlook at Laurel Wealth Planning is that price increases from pent-up demand are likely temporary but that a modestly higher inflation rate (as compared to our past very low rates) is likely beyond that.

Inflation’s effect on investments

Fortunately, investments exist than can help fight inflation including TIPS (treasury inflation protected bonds), metals, commodities, etc. Over the long-term, stocks are also inflation protectors.

As suitable, we have already started adding inflation protectors to clients’ portfolios, and we may add more if we see increasing inflation unfold. We also continue to overweight equities 5%, as suitable, because despite recent volatility, our outlook for the stock market is still modestly bullish over the next 12-24 months as pent-up demand puts more people to work and enhances the economy.

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