• Daniel Satz

Inflation Is Back. Will It Last?

Key Takeaways

  • Today’s inflation is not a repeat of the 1970s.

  • Now is not the time to let the headlines or emotion distract you from your plan.

  • We need a little bit of inflation to maintain a healthy economy.

  • Short-term bonds and global diversification can help you through a spell of rising inflation.

Recently, some of our clients have reached out to us because they’ve seen alarming headlines about the return of higher inflation. With a consumer price index at a 13-year high and short-term inflation running at 5% on an annualized basis, I’m not going to trivialize the wealth eroding power of inflation. Just know we’re not likely to see the longer term runaway inflation that some of you remember from the 1970s.

The Federal Reserve is much savvier about monetary policy than it was half a century ago. Today’s inflation is NOT going to have a major impact on you as long as you follow the structured investment plan we’ve set up and you don’t make emotional decisions based on what you see and hear on the news. If anything, now might be a time to start reevaluating your risk tolerance relative to your risk capacity to see if you can provide yourself with an even bigger hedge against inflation long-term. This is something I will actually be discussing in a future post.

Impact of the Deficit and Stimulus Programs

Many pundits and media outlets are sounding alarm bells about the country’s $25 trillion deficit and ever-increasing spending bills. As the government prints massive amounts of money to pay for all the stimulus and infrastructure spending bills, it’s natural to think inflation will resurface. The relationship, however, between debt and inflation is a little more complex. As long as the Federal Reserve uses their powers to keep a tight grip and doesn’t allow inflation to go unchecked, the federal government will be able to continue servicing their debts at reasonable rates. As the economy recovers and begins to grow again, our GDP will increase and normalize the ratio to our debt, leaving the proportion of tax revenue allocated toward debt interest in line with historical percentages.


Over the past decade or two, inflation has been running about 2% annually. Historically, this is very low and an ideal target that the Fed tries to maintain. Sure, inflation erodes the real returns of your investments and purchasing power, but we’re a long way from the 4% historical average of the past century and light years away from 7% inflation that we saw in the 1970s with some years reaching over 10%. Again, the Federal Reserve didn’t have as good of a grasp of monetary policy then, that it does today. As a result, it let inflation run rampant without intervening.

In the 1970s, consumer demand was extremely high. On top of the Arab oil embargo which caused a massive spike in gas prices, Boomers were in their prime earning years. They were spending a lot of money on homes, cars, travel and consumer durables, which caused the price of everything to go up. Unions were also bigger and had more bargaining power than they do today, and they continued to push wages higher.

Today the inflation landscape is different. First, those in their prime earning years (Millennials) don’t have anywhere near the same spending power as Boomers did in the 1970s. Plus, the Fed today is keeping a really close eye on inflation, and union power and presence has significantly diminished. As this decade started on the heels of a long-running economic boom, the Fed realized it had to raise interest rates, since the near-zero rates were punishing retirees and other savers. Then COVID happened, and the Fed decided it would err on the side of caution and lowered short term interest rates again. COVID and these monetary policy changes may have contributed to the inflationary environment we are in today.

COVID Impact on Inflation

Let’s go back to what triggered the resurgence of inflation—COVID. The economy was in pretty good shape before COVID hit us out of nowhere. When companies started shutting down, millions of people lost their jobs or were furloughed. In order to keep the economy from collapsing the government was forced to pour money back into the economy in the form of stimulus payments, extended unemployment benefits and millions of small business loans--some of which do not have to be repaid. Then there were tax changes that allowed people to skip taking distributions (RMDs) from their retirement accounts temporarily. It all contributed to a massive and rapid increase in the money supply (about 30%) which caused a devalued dollar. The more dollars you have floating around, the less valuable each dollar is.

A devalued dollar caused the cost of imported goods to rise. But the final straw was the disruption in the supply chain. With millions of workers unemployed and staying home, companies struggled to manufacture and distribute their goods. Too many dollars floating around and not enough goods caused prices to increase since demand for those limited goods is artificially high.

We’re seeing it in the car industry with the semi-conductor shortage. That not only impacted the new and used car market, but the rental car market as well. We’re also seeing housing prices go way up due to an increased demand caused by historically low mortgage rates, a spike in the cost of lumber and building materials, and a relatively small supply of homes on the market. The other factor is the new work landscape COVID has paved the way towards. Now many people realize they can work from home and can live anywhere they want. That’s why there are many people moving around and causing upward pressure on housing in areas far from city centers.

As severe and inconvenient as this seems, these price spikes are driven by the COVID transition in our lives. Supply chain disruptions and labor shortages are even affecting the food industry, so everything is just naturally more expensive.

What’s next?

Clients ask us all the time when we think the economy and prices will get back to normal. There’s no way of knowing exactly, but many economists think by 2023 we’ll see a return to the low 2% inflation that we’ve become accustomed to since this century began. But between now and then, we’re going to see periods of higher inflation on a monthly basis. That’s simply a result of everything catching up to the huge disruption that we had in March 2020 when the entire globe shut down.

If you’re a Novi client, you don’t have to change your financial plan much. Since you already have a globally diversified portfolio consisting of real estate, stocks, and bonds, when parts of your portfolio are impacted by volatility, there are other parts that will perform well or at least remain stable. If you feel the need to do something during times like these, spend a little time understanding the risk capacity of your plan. You’ll see that the best way to outpace inflation is to hold a globally diversified stock portfolio. Of course, not everyone can be titled heavily toward equities.

For our retirees, near-retirees and others wanting a more conservative portfolio, you want to have short, intermediate, and inflation protected bonds in your portfolio. Long-term bonds have too much interest-rate risk right now, so they don’t make sense for the income they provide. As interest rates rise, your existing bond holdings will drop. Right now, since there is nowhere else for rates to go unless they turn negative, we can assume in the future rates will go up. That’s why you want bond positions that are maturing relatively soon. They allow you to take your money and redeploy it into new bonds paying higher rates. You don’t want to be locked into longer-term bonds that will become less valuable when rates go up.

Bottom line: Be as aggressive as you feel comfortable doing on the stock side of your portfolio. On the bond side, make sure to hold high quality short-term positions to prepare for a potential increase in interest rates. That way you’re well-positioned if inflation starts to run hot. Stay the course and don’t let emotion derail you from your long-term plan.

Conclusion

Since the 1970s, I’d say we’ve had 20 to 30 significant events—recessions, terrorism, inflation spikes, financial crises---that had people convinced the economy was on the brink of collapse. As we’ve seen time and time again, if you stay the course and stay invested, the stomach-churning volatility you experience from time to time becomes irrelevant. It’s only a problem if you start to make changes based on emotion and you start chasing returns.

If you or someone close to you has concerns about your portfolio or retirement readiness in the face of rising inflation, please don’t hesitate to reach out. We’re happy to help.

DAN SATZ MS, CFP® is a Wealth Manager at Novi Wealth