Austin Coley, CFP®
CERTIFIED FINANCIAL PLANNER™
4 Things You Need To Know About Inflation
My dad used to tell me stories about going to The Varsity in Atlanta, GA during college, when he would pay less than a dollar for a cheeseburger, fries, and a Varsity Orange. The average cost of a hamburger at McDonald's was around 50 cents the year I was born. I’m sure some of you remember eating for around a quarter.
So, what happened? Why is it hard to get a cheap meal for under $5 these days? How is the average cost of a home in Williamson County up over $800,000? My colleague, Steve Alverson, paid $1.99 for a 20 oz Coca Cola this week. $1.99!
What is inflation?
Inflation is the decline in the value of currency over time. When this occurs, prices of goods and services go up. For example, let’s say the price of one gallon of milk is $3.50 today. Then, over six months, the value of one dollar decreases and is only worth $0.90. That would push the cost of one gallon of milk to $3.89.
Now, we would all agree that we would like for our $1 to hold its value. So why does inflation occur and how do we measure it?
There are three main causes for inflation:
1. Cost-Based
Cost-based inflation is an increase in the price of production or service. An increase in the price of steel would push the cost of a new car higher. Similarly, an increase in wages at a hotel would raise the cost of a room.
2. Demand-Based
Demand-based inflation occurs when the desire for a product outpaces the supply, and it pushes the prices higher. Do you remember when there was no toilet paper, soap, or paper towels on the shelf during the early part of 2020? Consumers would have paid double for the product if they were in need.
3. Fiscal Policy
Changes to fiscal policy, such as the tax law, can increase, or decrease, the amount of money is in the economy. During the past year, the Federal Government has released trillions of dollars into the economy in the form of stimulus checks. With the increased supply of dollars, the costs of goods and services (inflation!) have gone up.
Now, how do we track inflation? According to the Cleveland Federal Reserve, we start by collecting the price of a basket of goods and services. Then, we compare current prices to a base year and measure the difference. We track the price of the basket of goods and services over time and, ta-da, we can track inflation.
This short video walks through the concepts above:
What does transitory inflation mean?
A lot of the discussion from the talking heads in the media centers around not *if* inflation is amongst us, but if it is transitory or not. Transitory is a fancy, jargon-related way of saying temporary. This type of thinking says that inflation is here, but it’s not here to stay. The extraordinary circumstances of the last 18 months have put a strain on the economy and forced it into an inflationary period. Transitory thinkers believe once our economy regulates, inflation should return to its normal growth rate of 2%.
Believers of transitory inflation will point to factors such as hiccups in the supply chain that push prices higher. For example, Ford manufactures its flagship F-150 in Michigan. Due to supply chain constraints, some of the materials are on backorder due to the following:
· Backlog of orders overseas
· Lack of ships to bring products to the States
· Scarcity of port space to accept the incoming vessels
· Limited amount of trucks, airplanes, and rail cars to transport the materials to Detroit.
Thus, the supply will be lower and prices will rise. Transitory inflation would say this is an issue, but won’t have a lasting impact once the kinks in the supply chain get worked out.
Federal Reserve Chair Jerome Powell is in the transitory camp. While he acknowledged the recent inflation readings are “a cause for concern” at the Kansas City Fed’s annual Jackson Hole economic symposium, the Federal Reserve did not take any action on the basis that this inflation is temporary. According to Reuters, here are Powell’s five thoughts on why:
1. It’s not broad-based
While some goods and services are being affected by the lack of demand, others have thrived.
2. Biggest surges already receding
The prices of cars and lumber have pulled back from their summer highs.
3. No threat from wages
Wages are rising, but not outpacing the economy.
4. Inflation expectations anchored
While actual inflation has risen, data-driven measures remain at a normal level.
5. Globally, the pressure is downward
Aging populations, globalization, and advancements in technology are pushing down prices globally.
“Since January 2020, when the stock market was at an all-time high, we’ve had a major stock market pullback, a government-imposed economic shutdown, double-digit unemployment rate, stimulus packages released that were equal to 757s flying across the country throwing trillions of dollars out of the back, and a rebound in the economy that has contributed to new stock market highs.”
Our current outlook
The last 18 months have been truly unprecedented. Since January 2020, when the stock market was at an all-time high, we’ve had a major stock market pullback, a government-imposed economic shutdown, double-digit unemployment rate, stimulus packages released that were equal to 757s flying across the country throwing trillions of dollars out of the back, and a rebound in the economy that has contributed to new stock market highs. The amount of money in the U.S. economy is now up over 30% since before the pandemic.
Here at McCall & Associates, we believe there are consequences for our actions. While some of the inflation will be transitory, a portion will be permanent.
Brian Wesbury, an economist we like to follow from First Trust, explains this concept in a simple way. If we have an economy where there are 10 apples and 10 dollars, then each apple costs $1.00. If the money supply increases to 13 dollars, but the supply of apples remains at 10, each apple will cost $1.30.
Currently, we are experiencing major supply chain issues. Going back to the above example, what if we were only able to produce 5 apples, but we still had 13 dollars in the economy? Each apple would then be worth $2.60.
While the supply chain issues will work themselves out over time, the increase in the supply of money will remain the same. Even when we can produce 10 apples again, we will still have 13 dollars in the economy. That is the consequence of the actions we have taken over the last 18 months.
Supply chain issues may work themselves out, but what will we do with the excess money supply?
Getty Images
How do we combat inflation?
If inflation is here to stay, how do we combat the invisible tax? The best hedge against inflation is to invest in assets that have historically strong returns. Owning companies with strong fundamentals, that have a path to future growth, can outpace inflation over a long-time horizon.
Since adopting 500 stocks in 1957, the S&P 500 index has returned roughly 8% annually, easily outpacing inflation over that timeframe. Another possible investment is real estate, although there is a risk in utilizing debt if you do not purchase the property outright.
While owning stock and real estate has historically been a strong hedge against inflation, there is volatility risk that comes along with owning the assets. While both assets are strong options over the long term, you want to be sure not to risk any short-term cash (>3 years). Although holding cash in a savings account will expose it to inflationary risk, it will be safe from volatility and there when you need it.
At McCall & Associates, we help our clients navigate the waters of unclarity and help them use their money for the tool that it is. If you would like to schedule a free, no-commitment financial planning meeting with a member of our team, click here.
Any opinions are those of Austin Coley, CFP® and not necessarily those of RJFS or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation.
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Inclusion of these indexes is for illustrative purposes only. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns.
Real estate investments can be subject to different and greater risks than more diversified investments. Declines in the value of real estate, economic conditions, property taxes, tax laws and interest rates all present potential risks to real estate investments.