KF Update – Inflation Thoughts

6 Minute Read

Good afternoon, I hope this emails finds you well and you are getting ready for some wonderful weather headed our way in upstate New York.

I wanted to touch on a few of this week’s events in the markets, particularly the inflation data that came out.  If you have any questions at all, please do not hesitate to contact the office.

What was the inflation data that came out this week?
The Consumer Price Index (CPI) rose by 4.2% year over year.  The CPI measures the price of a basket of goods including food, energy, housing, transportation, medical care, recreation, education, and apparel.  The CPI is the predominant index we use to measure inflation in the U.S. economy.

The basket is designed to be weighted as an approximation of how it would be weighted for a household.  As an example, housing is the largest component of the CPI accounting for around 42% of the index.

What does a 4.2% year over year increase mean, and what is the context?
The price of the basket of goods in the CPI rose by 4.2% in aggregate from April 2020 to April 2021.  Price increases in this basket over the past decade have been very low, around 2% and even lower some years. 

Is the higher than expected inflation the reason for the market decline this week?
It looks to be part of the reason.  Inflation affects stocks differently; for example growth oriented stocks (The Nasdaq) suffer more from inflation.  Higher inflation means higher interest rates, and their future earnings, of which their valuations are based upon, tend to decline.  Value oriented companies (Dow Jones) are less affected because their cash flows are more current.

Take Airbnb (ABNB) as an example.  They currently do not make a profit, so they have no earnings to share with investors.  If you invest in Airbnb today, you are not doing it to lose money, you are buying the company because you believe in the future they will have strong earnings.  Higher interest rates mean those future earnings are not as valuable.

If you buy Apple (AAPL) today, they are already a wildly profitable company so you as an investor would immediately be sharing in those profits.  A company like Apple could be less affected by higher interest rates, and higher prices could even start to flow into their bottom line, increasing their margins.

What is causing this higher than expected inflation?
It depends on the economist you ask.  My opinion is that it’s a combination of supply chain disruptions due to COVID that we are still dealing with world wide, accommodative monetary policies by the federal reserve, an increase in the supply of dollars from the many stimulus measures, and pent up demand from an economy that was essentially shut down for an entire year. 

For context, there is still widespread disagreement on the cause of the Great Depression and Great Financial Crisis; it’s difficult to pinpoint a single culprit to any event in such a complex world economy.

What does this mean for my portfolio?
For those of you that always read my emails you already know what I’m going to say!  The short-term is impossible to predict, but longer term stocks provide an excellent opportunity for growth.  As an investor, it’s truly important to periodically revisit goals, time horizon, and risk tolerance; and if any of those have changed in between our regularly scheduled review meetings, please contact the office so we can discuss.

What are my thoughts on inflation, the markets, and managing client portfolios?
To start with inflation, we need to take a more granular view of its components (see below).  All of us have different inflation rates because we spend our money differently.  If you are doing a home improvement project this year (gulp), the price increases you will experience will be much higher than most.  Did you buy a used car/truck?  Those prices are up 21% from a year ago!  If someone spends most of their money on cereal, dairy products, baked goods, soda, and alcohol they are probably in great shape (inflation wise that is).  You get the picture, while the 4.2% number was shocking and inflation is discussed in generalizations, it truly is important to take a more granular view of the measure of price changes in an economy. 

I would keep an eye on June, July, and August readings.  If they continue to come in at these elevated levels, it will be difficult for the Federal Reserve to ignore these increases and dismiss them as “Transitory.”

Market wise, we’ve had a very encouraging recovery from one of the swiftest, most violent downturns we have ever had, and hopefully will ever again experience.  I’m very optimistic for the future, and bullish on stocks in general. 

In terms of portfolio management, I am avoiding longer dated bonds in client portfolios as they are also negatively affected by inflation and higher interest rates.  Ongoing rebalancing continues to be an important part of our portfolio management process.  If we do continue to see a downturn in the markets, I’ll be looking to buy into lower valuations as these opportunities arise.

I hope you found this information helpful.  If you have any questions at all, please do not hesitate to contact the office.  If you would like to schedule a meeting, you can use the blue button below which is directly linked to my calendar.  Have a great Summer!

Best,
Clint

Here are the components of the Consumer Price Index, and their percent rise from April 2020 to April 2021 taken from the U.S. Bureau of Labor Statistics.

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