Volume 92 No. 7 - July 2021
Inflation returns. Post-COVID exploding demand meets stifled supply. This truth may come to define these times—in real estate, the labor market, commodities, and in a rolling list of consumer goods that have come up against scarce raw materials. Our February and April newsletters covered the “sugar-high” effects that the Federal Government’s stimulus packages created to stave off the worst of the pandemic’s economic impacts on the US economy.
In May, core inflation (excluding food and energy prices) surged 3.8%, its sharpest jump since 1992. Meanwhile, headline inflation (price levels including food and energy) rose 5% year-over-year for the first time since August 2008.
Inflation erodes the purchasing power of our dollars, discourages saving and investing, and, in extreme cases, can bring on hoarding of precious metals and other goods with intrinsic value. Naturally, inflation gives us pause.
Why Do We Have Inflation?
Several factors contribute to the specter of inflation:
Demand, stalled during the pandemic, has exploded causing companies to scramble to pay rising prices for inputs like raw materials and labor. These costs get passed onto consumers in the form of inflated prices.
During the lockdowns, spending and consumption paused. Now, with over 60% of the country having at least one vaccination shot against COVID-19 and pandemic-era restrictions easing or disappearing, demand has returned. Demand that became pent-up over the year-plus of the pandemic has bolstered spending and consumption, driving up prices and fueling inflation.
The US government has created dollars at rates never before seen. During the pandemic, the Fed purchased some $3.5 trillion in government securities with money they “printed.” They are also continuing to purchase $120 billion per month in government securities, keeping the printing press running. Printing money may have played a role in bolstering the US economy in its recent dark days, but this also creates inflationary pressures.
Which Face of Inflation Will We See?
The media wants us to watch endless cycles of coverage that speculates on how long this “transitory” inflation will form part of our economic reality. They ask, will this post-pandemic inflation be short-term or long-term?
Inflation has three primary elements – wage inflation, food inflation and commodity/raw materials inflation. We believe two of these may not be so temporary and one probably is short term. With wage inflation, once wages go up they generally don’t go back down very quickly. The same is true of food inflation. The commodity/raw materials part of inflation is likely short-term as supply/demand dynamics come back in balance. We’ve already seen lumber and copper prices down 25-50% from their peaks.
During the Great Inflation of the 1970s brought on by easy-money policies and oil prices:
“Should the favorable course of economic events be altered, one likely source of disruption would be uncontrolled Federal spending; this would lead to a higher rate of inflation.”
The Investment Letter, November 30, 1972
During the post-WWII-years as the US government looked back at New Deal and war spending:
“There has been witnessed, in the United States, a progressive expansion in the supply of credit based largely on government operations. … The gravest single economic question that the nation faces, in the post-war period, is whether this credit expansion is going to lead to a considerable and permanent depreciation of the purchasing power or intrinsic value of the dollar.”
The Investment Letter, December 20, 1947
As in 1947 and 1972, we face inflation now, but the world will not end. We just need to recall certain fundamentals.
First, whether we have transitory, short-term inflation or lingering, long-term inflation doesn’t matter. What matters is what we do with our portfolios.
Inflation Best Practices
Some traditional inflation hedges have been: gold, commodities, and real estate. More recently, some investors are turning to Bitcoin. Gold and commodities have been good short-term hedges, however have not served well long-term. Real estate has served well as a long-term inflation hedge, however, the illiquidity and carrying costs make this out of reach for many. Bitcoin is being tested, and so far failing, as inflation has increased Bitcoin has fallen in value.
So how do you invest a portfolio during these inflationary times? We are investing in high-quality stocks with pricing flexibility, that pass their increasing costs to consumers, thus preserving and growing earnings. We will also continue to study and evaluate other possible ways to profit in an inflationary environment, such as Treasury Inflation-Protected Securities (TIPS).
As we’ve always said, slow and steady wins the race. We’ve been here before, in 1947 and 1972. We’ll likely be here again someday. Buy, hold, stay aware. Stick with tried-and-true investment strategies. We’ll all emerge stronger and more resilient on the other side.
Investment Counsel Inc. is a registered investment adviser. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.