Your Life With Inflation

June 28, 2021  | By Kevin Smith

Two of my favorite topics of conversation – aliens and inflation – happened to both make it to mainstream discussion this month. I see some interesting similarities in these two mysterious subjects. There are trillions of stars. So it stands to reason there might be a planet out there with alien life. There are also trillions of dollars being printed. So could we be visited by the forces of inflation?

Like aliens, there is some evidence that suggests inflation is out there, and concern for what it could mean for our future. Will the aliens be friendly? Will we experience modest or runaway inflation? As scary as both may be, neither is happening in a way we notice or experience. At least not yet.

State of inflation today

Inflation has become a hot topic in recent days. But from a broader view, we may be noticing these inflationary effects more because, in recent history, inflation has actually been surprisingly stable. 

Income is the only area of inflation we’d usually consider positive. In the last 10 years, wages have gone up about 2.5 to 3% per year. So how do other areas of inflation – the ones that cost us money – compare to this pace of wage growth?

One fun way to put inflation into a personal perspective is to examine what it costs to start our day and go to work. This graph shows how many costs have remained largely stable over the last decade, and even decreased in some areas.

The Cost to of Starting Your Day

Avg 2011 price Avg 2021 price
Gallon of milk $3.30 $3.35
Bacon $4.25 $5.85
Coffee $4.42 $4.67
Gas $3.17 $2.79

Other areas of our spending have also been less affected by inflation than you might think. Household bills, rent, taxes, energy costs, childcare, and healthcare have all stayed relatively flat or inflated close to the rate of average income. College and healthcare costs have gone up, but not by as much as you might have thought – only about 5-7%. Meanwhile with interest rates as close to 0% as they have ever been, the cost of debt has actually experienced a deflationary effect.

What to expect going forward

How much longer will this period of relatively low inflation last? What effects will the pandemic and recovery have? How much should you shift your investment strategy?

Why we’re talking about inflation now

The past 15 months have been anything but normal. A global pandemic has sent shockwaves through every aspect of life. Some results were predictable, others have played out in ways we probably didn’t expect. 

  • Locked down industries
    Lockdowns have had a deflationary effect on the cost of things like travel and hospitality. Because demand is so low, prices on plane tickets went down accordingly. 
  • Increased money supply
    Lower discretionary spending combined with stimulus payments created a 25% average boost to people’s bank accounts. This influx of $4 trillion dollars just looking to be spent has resulted in a shortage of items like bikes and used cars. Prices on those items have gone up according to this increased demand. 
  • Higher federal spending
    The U.S. Government is currently spending 15% more than it is bringing in. In an instance like this, inflation can be a political choice, since it can reduce the value of that debt. 
  • Labor shortage
    There is currently a lack of candidates for some jobs, in part because unemployment benefits exceed the wages for those positions. This has resulted in disappointing employment numbers.
  • Supply chain chaos
    With many companies going out of business, and other countries still struggling with covid, many usual supply chains have been restricted, resulting in decreased availability for many products and materials. 
  • Non-covid factors
    In addition to the pandemic, the economy has been impacted by events like the Suez Canal being blocked, terrible weather events – including our own here in Texas, and forest fires affecting the lumber industry. 

Looking to the future

Are these unique factors likely to be quickly corrected as the world returns to normal, post-pandemic? Or could they trigger the long-lasting, looming, terrifying, devastating threat of serious inflation? 

There are accomplished economists on either side of this discussion. On one side, perma-bears, as we like to call them, think of inflation as an inevitable disaster. They believe there is no way out other than the collapse of the dollar, and tend to encourage alternate forms of storing value, such as gold. 

On the other side, inflation optimists believe in ‘modern monetary theory’. This philosophy contends that money-printing works indefinitely. It’s an approach that has been adopted by both major political parties. It says that we shouldn’t be concerned about inflationary effects and collapses in currency; that as long as we maintain high demand in the economy, everything will continue working. 

As usual, I try to find something more rational between these two extremes. The perma-bears could end up being right. However, it could take decades for their predicted correction to take place. Betting on this kind of inflation disaster could prove to be expensive, as inflation-targeted assets could woefully trail current markets. 

Conversely, taking no action could also be risky if inflation does pick up and you have a lack of defensive assets. 

What Covid taught us about dealing with inflation

The unique situation brought on by the global pandemic has given us some insights that could be useful in dealing with inflation.

Lesson 1 – We have flexibility to opt out of spending.

Our changes in lifestyle during lockdown has taught us that we can live off of less than we might have thought. We’ve found substitutes for things like entertainment expenses that we used to think of as critical. 

Lesson 2 – We know how to deal with higher prices.

The current turbulence has taught us that it’s okay to put off purchasing things that are currently too expensive. We have learned we might need to delay putting in that new shed in the backyard due to high lumber prices, making us more adaptable as consumers.

Lesson 3 – Technology enables efficiency
We are now more familiar with things like delivery apps and other tech services than we were pre-pandemic. These services give us more options and can allow us to spend more efficiently, which has a deflationary effect. 

Investment perspective

Inflation is personal. It doesn’t affect everyone in the same way. For instance, it can be an especially serious problem for retirees living on a fixed income. Likewise, some investments tend to be harder hit by inflation than others. Investments that are normally considered very safe (like cash and long term bonds) are the most hard hit during periods of high inflation. But there are some good inflation-fighting assets that could help you weather 

My top choices for the most inflation-safe investment assets

  • Inflation-protected securities
    As the name suggests, these treasury bonds are designed to protect against inflation. Their price adjusts with the consumer price index, meaning your interest return is higher as inflation increases.
  • Commodities
    Commodities are literally the price of things. When the price of these assets goes up due to inflation, your investment increases in value. However if inflation doesn’t happen, the return can be dismal, due to the lack of cash flow or dividends. 
  • Real Estate
    Rent, as they say, is the last thing people quit paying. The reliability of this investment means it tends to do well during inflation.
  • Stocks
    During inflation, companies can raise their prices. If consumers are willing to pay, value will be reflected. The danger here is that people could begin avoiding using some goods or services altogether when prices increase, making the stock of some companies more resilient than others. 
  • High yield bonds
    These are normally risky investments because they involve loans to companies with a lot of debt. However, during inflation, debt becomes worth less, making these assets more valuable.
  • Bank loans
    Banks tend to offer loans that include floating interest rates. This allows them to raise their rates, which can be a tool to fight inflation.
  • Emerging market stocks and bonds
    As the U.S. Dollar devalues, other local currencies can benefit, making holdings in these markets gain relative value.
  • Alternative sources of value
    Gold is the most common alternative value asset, and can maintain its value relative to the dollar in a period of inflation. However if inflation does not occur, return on these investments is not high, especially if interest rates increase. 

Other assets you might hear about include bitcoin and currencies from other countries. Some of these could do well during inflation, but which ones are tough to guess.

What to do
Now that you have a few ideas for inflation-proofing your portfolio, you might wonder how much of a shift is appropriate. This is a hard question.  My advice would be that a modest tilt of your current portfolio toward these inflation-safe categories would be the most appropriate path.

Only time will tell how much inflation we’ll have to contend with. It could be that both inflation and aliens have been here with us for a while, and simply aren’t bothering us. But of course that can change. While I can’t offer advice on close encounters, I hope this discussion of inflation can help you have a more prepared investment strategy. 

Posted in: Inflation
Kevin X. Smith, CFA
  |  [email protected]

Kevin is responsible for advising clients for whom he is the lead financial advisor. He also manages the operations and development of the firm, and oversees all of the investments of Austin Wealth Management clients. Kevin is on a mission…Read More

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