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When Transitory Inflation Becomes Persistent

Volume 92 No. 11 - November 2021

11-2021 Newsletter
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If you have been to the gas station, grocery store, local fast-food restaurant, or Home Depot in recent months, you have seen the effects of inflation. Prices of goods and services have increased, and the effects can be seen throughout the economy.

“Inflation is elevated and will likely remain so in coming months,” said Fed Reserve Chair Jerome Powell before the Committee on Banking, Housing, and Urban Affairs in late September. Prices rose 0.4% in September and have risen 5.4% since this time last year, according to data from the Bureau of Labor Statistics. 5.4% is the highest inflation rate since the depths of the Great Recession in July 2008, when annual, not seasonally adjusted, inflation reached 5.6%.

Our nation’s inflation rate has been on the rise throughout the pandemic, almost continuously, since May 2020 when it measured 0.1%. Many factors can cause inflation, but one thing is for certain: inflation has been prevalent for a while. It may be more persistent, meaning it may last longer than six months. Fed Chairman Powell, for his part, still suggests that we will see inflation abate as the post-pandemic economy normalizes. He admitted, late in September, “These effects have been larger and longer-lasting than anticipated.” Then, he added, “… but they will abate, and as they do, inflation is expected to drop back toward our longer-run 2 percent goal.”

When will inflation drop back to pre-pandemic levels? Treasury Secretary Janet Yellen told CNN that we may see inflation drop to the 2% range by the middle to the second half of next year.

Why We Are Seeing Inflation

The reasons for this sustained inflation are three-fold: the printing of money, strong demand, and higher costs. Each are related to one another.

A key driver of the economic rebound has been the trillions of dollars of government stimulus money that have been injected into the economy, both from the Federal Reserve and the US government. When that stimulus money met the pent-up pandemic-era demand of US consumers and the logistics of pandemic-hobbled supply chains, a perfect storm of inflation began brewing. This met the classic inflation definition of too much money chasing too few goods.

The American consumer remains strong and demand for goods and services remains robust. Retail sales have remained consistently strong since March of 2021. Household balance sheets remain in good shape. Holiday spending is a near-term catalyst for continued demand. Shortages have led to deferred demand, and although some of this demand will be lost entirely, a portion of it will be fulfilled in the future, further extending inflation.

It has been well documented in media coverage that supply chains have been strained. Input costs have continued to increase, extending inflation. Commodity inflation remains elevated, most notably energy prices, partially due to change in policy earlier in the year. Increases in the prices of food and rent are also driving inflationary pressures. In his testimony, Powell pointed to the unprecedented reopening of the economy and the bottlenecks and hiring difficulties that have come with it. The price of energy drives nearly all other prices, as do the costs of our supply chains. The pandemic has tightened labor markets. Many older workers have used the pandemic as a reason to retire. Some workers in the service, transportation, and even manufacturing sectors have reassessed their careers and moved on to new jobs and careers. The cost to produce and transport goods has risen, and these costs too are reflected in inflation. Some companies have said they expect to experience supply chain challenges until the end of next year.

Earlier in the pandemic, debate surfaced over whether pandemic-era conditions would lead to rising inflation. Last summer, the conversation turned to whether the inflation we experienced was transitory or persistent. Newer data seems to suggest that some areas of inflation may be more persistent than transitory.

Inflation Is Nothing New

As we noted in our July 2021 newsletter, we have seen inflation before – during the years following World War II when the US came to terms with the effects of the spending that fueled war and New Deal programs, and during the Great Inflation of the 1970s.

For over 90 years, Investment Counsel has navigated the inflation that has come and gone over time. We have constructed investment portfolios for bull markets and bear markets. Just as we have in the past, we will face this new specter of inflation.

In times of uncertainty, we return to the fundamentals of the companies we own, a strategy that has guided us through previous inflationary cycles.

Investing in an Inflationary Environment

Inflation spooks investors. A common reaction is to buy into commodities – precious metals like gold, tangible assets like real estate, and even Bitcoin and other cryptocurrencies. Our strategy is to invest in companies with tested management, strong balance sheets, and the ability to pass along price increases to their customers. These companies are able to improve productivity and navigate through periods of higher inflation.

The chart below displays the price of gold compared to the total return of the S&P 500 on a percentage basis, from May 2020 to October 2021. The S&P 500, a representation of the largest companies in the US, has significantly outperformed gold, a common hedge against inflation.

Fear does not always drive wise decisions and long-term success. It is possible to invest in equities even when inflation rises. As we have since 1929, we invest in high-quality companies that pass price increases on to customers and earnings to their investors.

Higher prices at the gas pump, a pricier cheeseburger, and higher home improvement costs may persist for longer than originally anticipated. However, we will emerge stronger if we stick with the investment strategies that have served us well in the past. That advice has served us since our founding in the days following the Great Depression, as it will guide us now in helping today’s generations and the generations to come.


Investment Counsel Inc., a Division of LaFleur & Godfrey, 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.

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