Why are so many people talking about inflation?

https://www.youtube.com/watch?v=ZHId-r8Gb-8

The song “Inflation Blues” has origins dating back to the 1940s. And as one can expect, different covers and arrangements of the song always seem to surface when inflation is looming.  The most recent version of the song (and our favorite) was recorded by the great B.B. King during the inflationary period of the 1980s.  Then, the tune retreated from the mainstream and remained largely unplayed over the past decade as inflation remained tame.  But, we believe it is time to revisit this same ol’ song, as threats of higher prices are capturing our nation’s attention.

The song’s lyrics paint a picture, especially if you put yourself in the shoes of a first-time homebuyer or European looking to heat their home:

Hey Mr. President

All your congressmen too

You got me frustrated

And I don't know what to do

I got the blues

Got those inflation blues

Inflation is surely on people’s minds. The chart below shows the Google search trend for the word “inflation,” and you’ll notice a swift pick up this year.

One would be hard-pressed to read an economic commentary over the past week or even month without a mention of inflation.  Further, we field multiple questions every week from investors asking about inflation’s effects on their portfolios. So, let’s answer this question: Why do investors and politicians worry about inflation?

Many fret over it, but do not actually know why.

Before we explain why inflation matters, let’s go back to school and define what really happens when inflation, or price inflation, occurs:

“Inflation is a general rise in the price level of an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy … The common measure of inflation is the inflation rate, the annualized percentage change in a general price index, usually the consumer price index, over time.”  — Wikipedia

In short, when the same amount of money buys less or fewer things over time, then you’re seeing inflation at work.  Not only is there a rise in consumer prices, but inflation’s effects can also result in workers demanding higher wages to maintain their basic standards of living. In this case, companies dependent on large labor forces will make less money – driving down their profits and stock prices. 

Interestingly enough, the government’s measure of inflation is higher today than it was before the Great Recession in 2007.  The following shows Consumer Price Index (CPI) percentage changes over the last 12 months:

So, if inflation is occurring and people are aware of this, then why is there not more concern in the capital markets? 

Perhaps it is because Federal Reserve Chairman Jerome Powell has labeled higher prices as “transitory .”  https://www.federalreserve.gov/newsevents/speech/powell20210827a.htm

We are not alone in trying to understand what this term truly means because many pundits, investors, and portfolio managers have, and continue to, interpret its significance in different ways.  Maybe this was Powell’s intent.

We believe that Chairman Powell’s use of the word “transitory” means that the current large spikes of inflation will not persist, and prices will return to more normal levels in a relatively short period of time.   At Lear IM, we do not think inflation will fall from current level, but will take longer to normalize.  

The implication of the spike in prices was related to limited supply resulting from COVID-related issues. And, once factories begin to produce the amounts needed to meet demand again, only then will economic conditions return to normal – hopefully, in a short time frame.

So, we beg to differ from fearmongering about inflation’s impact in the short-term and believe these temporary price concerns will taper over the next twelve months.  Prepared investors should rest easier than those ill prepared for inflation in their lives and their portfolios.

So, back to why investors and politicians worry about inflation.

We talked about different effects of inflation, such as increases in consumer prices and the possibilities of workers demanding higher wages.

Then, there is the government’s measure of inflation – which is pretty worthless if you ask us.  

What we do not want to do in times of inflation is to own a large percentage of bonds. We recommend owning select stocks instead.  We also recommend owning commodities, which will do better with rising prices.

Finally, consider stocks that are not labor-intensive.  By this, we mean software and cloud stocks because they do not require large labor forces, factories or higher input costs like large industrial companies.

Perhaps the biggest concern for investors is that inflation will force The Federal Reserve to raise interest rates faster than expected.  Thus far, we have no reason to believe the Fed will make an emergency rate hike. 

We believe inflation will persist, and the consumer demand will last through 2022. Transitory? Perhaps, but more like a house guest that overstays their welcome.

We don’t want investors singing the blues. Inflation does not have to be bad for your portfolio if you’re prepared. In fact, a little inflation, if played well, can be good for you.

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