INFLATION! The financial news media has latched onto a recent rise in inflation creating concern among some investors. The question is: should you worry? The answer depends on long term trends, your financial situation, and your overall financial plan. Let’s look at what inflation is, how it affects you, and what actions you can take to mitigate the impact on your portfolio.
Inflation, Hyperinflation, and Deflation
Inflation is the decline of purchasing power of a currency over time. Outside the circles of the Federal Reserve and academia, inflation means that the cost of items that we purchase have increased. Unilever, the company behind everyday names such as Hellman’s Mayonnaise, Dove, and Vaseline just completed their Q2 earnings conference call where the company announced their current and projected earnings. The three most used terms during the earnings call were pricing, price, and inflation. If Unilever, a global company that sells products we use daily, sees inflation, we will all see inflation.
The next question: Is inflation good or bad? To explain it further, let’s go back in time to the late 1970s and early 1980s. Those who remember that period know that high inflation is bad. In 1981 the 30-year mortgage rate peaked at a soaring 18.63%1. As of the end of this month, the average mortgage rate is 3.26%2. If you purchased a house today and borrowed $200,000 your monthly mortgage payment would be $872 per month. The same mortgage in 1981 at 18.63% would cost you $3,117 per month (a difference of $2,245 per month or $26,940 per year). Back in the late 1970s and early 1980s the cost of most goods and services continued to increase at an uncomfortable amount each year, which led to a recession (shown by the grey shaded area in this chart).
Hyperinflation is even more extreme than high inflation. Hyperinflation is an increase of 100% or higher in the Consumer Price Index (CPI) over a three-year period, or an average of 25.99% per year for three years (the CPI is a measure of prices made up of a basket of goods and services). A dramatic example of hyperinflation is post-World War I Germany, when people burned paper money in the stove since it was cheaper than buying wood.
While high inflation and hyperinflation are bad, moderate inflation is good. In general inflation is a commonly used indicator of economic growth. Economic growth generally leads to higher corporate earnings, which leads to a combination of increased wages for workers and increased costs. As long as there is a demand for goods and services, companies can charge more without a decrease in demand. When companies make more money, stocks typically increase in value. When inflation runs at about 2% (the Federal Reserve’s Target Inflation Rate), the US economy exists in a “Goldilocks” state in which stocks rise, wages rise, and the overall standard of living increases.
At the opposite end of the inflation spectrum is deflation. With deflation, less consumption and consumer demand leads to falling prices, falling wages, and layoffs. Deflation can lead to a downward economic spiral and a crisis of confidence that is difficult to overcome. As a result, the stock markets are unlikely to react well in this kind of environment. The last time we saw deflation in the United States was from 1938-1939 when the CPI was negative two years in a row.
Today the CPI is 5.4%. This begs the question, is the current increase in prices the beginning of a period of moderate inflation or a trend towards high inflation? It is too soon to tell. One thing to consider is that the prices of certain goods (for example, gasoline during the summer travel season) tend to increase at certain times of the year. Some analysts prefer to look at the seasonally adjusted CPI for this reason. The year-over-year seasonally adjusted CPI is only 0.9%3. And while the CPI has increased significantly over the past 12 months, there were dramatic disparities between the components that make up the CPI.
A probable cause for the dramatic increase in the CPI is last year’s global economic shutdown due to the COVID-19 pandemic. Have you ever had to turn off the water main to a house for a plumbing repair? When you turn the water main back on and turn on a faucet, the water coming out of the faucet sputters for a short period of time before it flows normally. In response to the COVID-19 pandemic, economies around the world shut down abruptly and then reopened. Perhaps the dramatic increase in inflation is the sputtering of the reopened economy that will return to a normal flow over the next year. Although the 12-month increase in the CPI is the highest we have seen since 2008 (and prior to that, 1990), the inflation rate is not cause for alarm just yet.
Your Financial Situation
If you are currently employed, your salary and bonuses typically rise with inflation (of course this is not true for all employees). Additionally, if you are retired, Social Security has increases based upon a modified CPI and if you rely on income investments, moderate inflation typically leads to higher income from savings accounts and higher interest from investment-grade bonds.
GreenUp believes that having a properly diversified portfolio during periods of moderate inflation is important. As companies charge more and have higher revenues, stock prices tend to increase making stock-based investments a good protection against inflation. As a result, we believe every investor should have a portion of their portfolio in the equity markets.
Your Financial Plan
Your GreenUp Wealth Advisor already factors moderate inflation into every financial plan. If you have a financial plan, review it with your Advisor and discuss how inflation affects your retirement. If you do not have a financial plan, now is the time to start planning to make sure you are saving enough, so that no matter what inflation does in the future, you are not going to outlive your money.
- High inflation is bad while moderate inflation is good.
- We are not worried about Hyperinflation.
- The recent increase in inflation may be a symptom of shutting down the economy as a response to the COVID-19 pandemic.
- Moderate inflation is not typically problematic for workers, retirees, or investors, and may be beneficial.
- Review or create your financial plan to determine how inflation will affect your retirement.
1“Mortgage Rates: Are Your Stars Aligned?” Freddie Mac, August 29, 2019. https://myhome.freddiemac.com/blog/homeownership/20190820_mortgage_rates.page
2 Cook, Leslie. “Today’s Mortgage RATES: July 29, 2021.” Today’s Mortgage Rates | July 29, 2021. MSN Money, July 29, 2021. https://www.msn.com/en-us/money/realestate/todays-mortgage-rates-july-29-2021/ar-AAMHyu9
3 US Department of Labor, Bureau of Labor Statistics July 13, 2021
GreenUp Wealth Management is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discus