Category Archives: Inflation

Inflation and Investments

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Inflation is an economy-wide, sustained trend of increasing prices of goods and services, and loss of dollar purchasing power from one year to the next. It affects investments in several ways:

Real Value Erosion:

The rate of inflation represents how quickly investments lose their real value and how quickly prices increase over time.

As prices rise, the purchasing power of money decreases. For example, if you can buy a burger for $2 this year and the yearly inflation rate is 10%, next year the same burger will cost $2.20.

To maintain your standard of living, your investments need to generate returns equal to or greater than inflation.

Investment Returns and Inflation:

If your investment returns do not outpace inflation, your real returns (adjusted for inflation) may be negative.

Suppose ABC stock returned 4% and inflation was 5%. The real return on investment would be minus 1% (5% – 4%).

Asset Classes and Inflation:

Liquid assets (e.g., cash, short-term deposits) tend to appreciate more slowly than other assets. They are more vulnerable to the negative impact of inflation.

Illiquid assets (e.g., real estate, long-term investments) are also affected by inflation but may appreciate in value or generate interest, providing a natural defense.

In summary, understanding inflation is crucial for making informed investment decisions. Consider investments that can keep pace with or exceed inflation to protect your purchasing power over time.

Persistent Inflation and Loss of Purchasing Power

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U.S. Consumer Price Index (CPI) data was hotter than expected.

March 2024 U.S.CPI annual inflation rose 3.5%, above expectations of 3.4%.

Core CPI inflation increased 3.8% year-over-year (Y/Y), compared to forecasts for a gain of 3.7%.

The March 2024 Consumer Price Index for All Urban Consumers (CPI-U) report marked a third consecutive 0.4% month-over-month (MoM) increase. On a year-over-year (YoY) basis, inflation rose by a stronger-than-expected 3.5% in March

  • The slightly stronger March Consumer Price Index (CPI) report was driven by rises in shelter and energy prices.
  • March’s stronger year-over-year (YoY) rise in the headline CPI suggests the path to the Fed’s 2% target could take longer than expected.

Persistent Inflation occurs when the U.S. money supply grows more rapidly (to pay for huge fiscal deficits) than the country’s economic output.

Money Supply and Inflation:

When the Federal Reserve (the Fed) increases the money supply, it leads to inflation.

Imagine an economy with $100 and 100 bananas. If the government increases the money supply by 10% to $110, but the banana output only grows by 5% to 105 bananas, we have more money chasing fewer goods. As a result, the average price per banana increases from $1 to roughly $1.05. Thus, the purchasing power of the currency is reduced.

The quantity theory of money (QTM) suggests that the value of money is determined by supply and demand. When the money supply grows faster than economic output, inflation occurs.

Monetarist View:

Monetarists believe that inflation results from too many dollars chasing too few goods. As the money supply grows, the value of money decreases due to supply and demand dynamics.

In summary, managing the money supply is imperative for the Fed. Too much growth can lead to persistent inflation, affecting the purchasing power of the dollar.

2024 Personal Consumption Expenditures for February

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The personal consumption expenditures (PCE) price index, the Federal Reserve’s preferred way to measure inflation, rose 0.3 percent in February, while the annual inflation rate rose to 2.4 percent in February, up 0.1 percentage points from January. The number excluding volatile food and energy prices rose 0.3% on a month-to-month basis, slightly faster than anticipated.

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Federal Reserve Chair Jerome Powell indicated the latest PCE report did not undermine the central bank’s baseline outlook, but said with the economy on a “strong” footing, “that means we don’t need to be in a hurry to cut.”

Some details of the PCE data for February, economists noted, showed improvement in aspects of inflation that the Fed considers important, even as the headline numbers have shown little progress in the first two months of the year.

The central bank last week held its benchmark overnight interest rate steady in the 5.25%-5.50% range and also reaffirmed – narrowly – a baseline projection that the rate will fall by three-quarters of a percentage point by the end of 2024.

Source: Howard Schneider and Ann Saphir, New US inflation data ‘along the lines’ of what Fed wants, Powell says, Reuters, March 29, 2024. https://stocks.apple.com/A8OnyemvKT4ue7DzP7DFCdg

Stocks Beat Bonds as Inflation Hedge

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“Stocks are great long-term inflation hedges if you are still worried about inflationary risks.” ~ Jeremy Siegel, Wharton School Economist

“If you are worried about the inflationary impacts, stocks are far better hedges than bonds — as companies can pass along their own input cost spikes to consumers,”Jeremy Siegel, Wharton School Economist, wrote in his weekly commentary published Monday for WisdomTree, where he is senior economist.

“If you bought the inflation-hedged bonds at 2% yields, it would take 36 years to double your purchasing power,” wrote Siegel, an emeritus professor at The Wharton School. “The S&P 500, however, is priced around 18 times next year’s earnings, giving a 5.5% earnings yield. This takes just 13 years to double purchasing power.”

“Stocks at the present time—with earnings of just under $250 for the S&P 500,” are preferred states Siegel. “This giving just under an 18x earnings per share valued market. I think that is a favorable multiple for the market. I believe stocks are great long-term inflation hedges if you are still worried about inflationary risks. I think stocks can handle another quarter point rise by the Fed if they deem it necessary.”

References:

  1. https://www.thinkadvisor.com/2023/09/28/jeremy-siegel-stocks-beating-bonds-as-inflation-hedge/
  2. https://www.wisdomtree.eu/-/media/us-media-files/documents/resource-library/weekly-commentary/siegel-weekly-commentary.pdf

April’s Consumer Price Index and Inflation

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CPI year-over-year inflation 4.9% as the economy showed signs of cooling 

Consumer prices in the U.S. rose 0.4% from March to April, up from 0.1% from February to March. Compared with a year earlier, prices climbed 4.9%, down just slightly from March’s year-over-year increase.

The nation’s inflation rate has steadily cooled since peaking at 9.1% last June but remains far above the Federal Reserve’s 2% target rate.

The Fed is paying particular attention to core prices, which exclude volatile food and energy costs and are regarded as a better gauge of longer-term inflation trends.

The Federal Reserve aggressively raised rates for more than a year to try to tame inflation by slowing economic activity, and indicated last week it might be done lifting them for now.

Core prices rose 0.4% from March to April, the same as from February to March. It was the fifth straight month that core prices have risen by 0.4% or more. Increases at that pace are far above the Fed’s 2% target.

Compared with a year ago, core prices rose 5.5%, just below a yearly increase of 5.6% in March.

Unlike the prices for products, the costs of services — from restaurant meals to auto insurance, dental care to education — are still surging. A major reason is that companies have had to raise pay in those industries to find and retain workers.

Federal Reserve officials say that fast-rising wages, while good for workers take home income, have contributed to higher costs in services industries because labor makes up a significant portion of there costs.

Bank Bailouts

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“Bailouts incentivize and encourage the financial behavior that makes bailouts necessary.” ~ Holman W. Jenkins, Jr.

The fundamental business model of banking is that the bank accepts money from bank depositors and invest almost all of it. A certain amount of depositors’ money, called reserve requirement, must be kept for redeeming customer accounts and customer withdraws. The remaining deposits gets loaned out, often in long-term illiquid loans  and assets.

If customers want to withdraw amounts greater then the reserves, typically refer to as “ run on a bank”, a bank has two options:

  • Raise money by selling investments at a profit or loss
  • Raise enough money to bridge its cash needs by selling equity in the bank itself hurting shareholders.

Going forward, your bank deposits are implicitly safe from bank failures, but your bank deposits aren’t safe from inflation due to lost of purchasing power, writes Holman W.Jenkins in  WSJ Opinion piece. In essence, the investment risks that large sophisticated uninsured depositors take were shifted to bank shareholders and U.S. taxpayers by the federal government.

Effectively, the FDIC $250K bank deposit insurance limit guarantee is now uncapped. By implicitly guaranteeing all bank deposits, the government’s policy will actually incentivized banks to take even more riskier investment bets with depositers’ cash to garner outsize returns. In short, uninsured deposits were a source of market deposits discipline.

Moral hazard refers to the situation that arises when an individual or bank have the chance to take advantage of a financial deal or situation, knowing that all the risks and fallout will land on another party. It means that one party is open to the option – and therefore the temptation – of taking advantage of another party.

Moral Hazard

In this case, the secondary party, the tax payers, are the ones that suffers all the consequences of any financial risks taken in a moral hazard situation, leaving the first party free to do as they please, without fear of responsibility. They are able to ignore all moral implications and act in a way that is most beneficial to them.

The government’s actions to implicitly guarantee bank deposits does not actually eliminate the risks of additional bank runs or failures, it only transfers the risk and subsequent obligations to the FDIC and ultimately the U.S. taxpayers. It also encourages financial moral hazard, the taking of extraordinary investment risk with bank assets, by bank chief executives.

Source: Holman W. Jenkins, Jr., “Joe Biden’s $19 Trillion Monday”, The Wall Street Journal, March 15, 2023

Hot PPI in January 2023

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Inflation at the wholesale level, measured by the Producer Price Index (PPI), rose more than expected in January 2023. 

The U.S. Labor Department reported that its producer price index, which measures inflation at the wholesale level before it reaches consumers, came in hotter than expected and rose 0.7% in January from the previous month. On an annual basis, prices are up 6%. In short, PPI is reflects intrinsically the prices consumers will be paying for goods and services in the near future.

Those figures were both higher than the 5.4% headline figure and 0.4% monthly increase in forecast by Refinitiv economists, a worrisome sign for the hawkish Federal Reserve as it seeks to cool inflationary price gains and tame consumer demand with the most aggressive interest rate hike campaign since the 1980s.

Excluding food and energy, core inflation increased 0.1% for the month – matching the estimate from economists.

Stubborn inflation has caused more Americans to live paycheck to paycheck despite 5.1% increase in wages, reports Fox Business. Increased wages are not keeping pace with soaring prices of consumer goods and services, prompting many Americans to live paycheck to paycheck.

References:

  1. https://www.foxbusiness.com/economy/wholesale-inflation-surges-january-more-expected-high-prices-persist

January 2023 CPI Inflation Grew at 6.4% annual rate

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January 2023 consumer price index (CPI) report showed that inflation grew at a 6.4% annual rate, slightly higher than expected, reports CNBC.

Stubbornly high January inflation reading and the December CPI report was revised to show a slight gain instead of a decline was largely better than feared, but at the same time unlikely to cause the Fed to back off from its tightening campaign.

“While there were no major surprises in today’s CPI reading, it is a reminder that while inflation has peaked it could be a while before we see it moderate to normal levels,” said Mike Loewengart, head of model portfolio construction at Morgan Stanley Global Investment office.

“The question remains if inflation will be able to fall to the Fed’s target levels with the labor market as tight as it currently is,” he added. “That could be the recipe for a soft landing, but it remains to be seen when the Fed will shift away from rate hikes and if the labor market will lose its resiliency.”

References:

  1. https://www.cnbc.com/2023/02/13/stock-market-today-live-updates.html

Invest with a purpose and a strategy. Pay yourself first.

The purpose of a system is to continue to play the game.

The Producer Price Index (PPI) Declined 0.5% in December

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Producer prices in December fell the most for any single-month since April 2020, as falling costs for food and energy more than offset rising prices across most other categories, the U.S. Bureau of Labor Statistics reported.

The headline number in today’s Producer Price Index report will be heralded by some as a sign that inflation has been defeated.  And while it certainly does look like peak inflation is behind us, we aren’t popping any champagne bottles just yet, states Brian Wesbury, First Trust Chief Economist. The Producer Price Index (PPI) measures the average change over time in selling prices received by domestic producers for their output.

What the above means in layman terms is that the producers’ input prices continue to rise, but price increases slowed for each of the three major final-demand components—services, goods, and construction. In other words, the rate of that rise in input prices have declined month-to-month. Slowing rate of increasing prices still equate to prices increasing and purchasing power declining.

While energy prices fell 7.9% in December and food prices declined 1.2%, “core” producer prices – which remove the typically volatile food and energy categories rose 0.1 % in December and remain up 5.5% in the past year, well exceeding the Fed’s 2% inflation target.

Looking deeper into core inflation, prices for both goods (ex-food and energy) and services (+0.2% and +0.1%, respectively) rose once again in December.  The service side of the economy will be the key area to watch in 2023.

What matters most for the economy, and the financial markets, is that inflation continues to run well above the Federal Reserve’s target, writes Brian Wesbury. Additionally, he desires that the Federal Reserve tightened enough to slow inflation, but not enough to throw the economy into recession.

Expect a 25 basis point rate hike at the Fed’s meetings in two weeks, along with guidance that the Fed is prepared to continue raising rates further in 2023.  The path ahead to tame inflation will test the Fed’s resolve.

References:

  1. https://www.ftportfolios.com/blogs/EconBlog/2023/1/18/the-producer-price-index-ppi-declined-0.5percent-in-december
  2. https://www.bls.gov/news.release/ppi.nr0.htm

Inflation is Bad

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Inflation is an economic term used to describe rising prices and a loss of purchasing power over time.

Written by Geoff Williams for Forbes Advisor

Inflation is an economic term used to describe rising prices of goods and services, and a loss of purchasing power over time. It occurs when consumers spend more on the same amount of goods and services today than they did a year ago, writes Geoff Williams, a contributor for Forbes Advisor. It is typically expressed as the annual change in prices for everyday goods and services such as food, apparel, transportation and toys.

When everybody pays more and gets less for it, it can have some profoundly devastating effects on the economy—and some consumers get hurt more than others.

“In every economic environment, there are winners and losers and inflation is no exception.  However, the longer high inflation persists, the harder it is to find winners,” says Jeanette Garretty, chief economist at Robertson Stephens, a wealth management firm. “Ultimately, high inflation seeps into the nooks and crannies of every balance sheet and income statement.”

There are three primary types of inflation:

  • Demand-pull inflation
  • Cost-push inflation
  • Built-in inflation

Right now, the country is dealing with all three major types of inflation, which is rare, according to Christopher Blake, assistant professor of economics at Oxford College of Emory University.

Demand-Pull Inflation – Demand-pull inflation describes how demand for goods and services can drive up their prices. If something is in short or disrupted supply, you can generally get people to pay more for it.

The U.S. is experiencing demand-pull inflation due to wages rising and Americans having a decent amount of money in their savings accounts, Blake explains, although some consumers are starting to empty those accounts.

“Consumer spending has remained high, despite the rising prices we currently see,” Blake says. “This is commonly referred to as demand-pull inflation, as consumer demand pulls prices higher because firms cannot keep up.”

Cost-Push Inflation – Cost-push inflation often kicks in when demand-pull inflation is going strong. When raw materials costs increase for businesses, the businesses in turn must raise their prices, regardless of demand.

“Increases to the prices that producers face put businesses in a tough spot,” Blake says. “They can either accept higher costs and keep their prices the same, or they can respond by trying to keep their profit margins the same.”

When the price of chicken keeps going up, for example, eventually your favorite restaurant will need to charge more for a chicken sandwich.

Built-in Inflation – As demand-pull inflation and cost-push inflation occur, employees may start asking employers for a raise. If employers don’t keep their wages competitive, they could end up with a labor shortage.

If a business raises workers’ wages or salaries and tries to maintain profit margins by raising prices, that’s built-in inflation.

Now, if you learn about your favorite coffeehouse raising prices due to the climbing cost of coffee beans, you’re a victim of cost-push inflation.

And if you’re going to buy that coffee even though the price is uncomfortably high, you’re engaging in demand-pull inflation.

3 Ways Inflation Hurts Consumers and the Economy

1. Less Purchasing Power

The most obvious impact of inflation is that it hurts your purchasing power. If you can’t buy as many goods and services as you did before inflation, your quality of living will eventually diminish.

Less purchasing power really hurts families that were already experiencing financial hardship. “Think more money spent on groceries and gasoline, and less spent on travel and entertainment,” says Angelo DeCandia, a professor of business at Touro University.

“Inflation hits the lowest-income families harder because items such as gasoline and food make up a much larger portion of their budgets, leaving less for discretionary spending,” says Dan North, senior economist at trade credit insurer Allianz Trade. “So, for example, where they used to have money to go out to dinner, even fast food, or [go to the] the movies once a month, now they won’t at all.”

A 2021 study from the University of Pennsylvania found that lower-income households had to spend about 7% more on goods and services last year compared to 2019 or 2020, while higher-income households had to spend 6% more. Remember, the annual rate of inflation for 2021 was 4.7%.

2. Less Savings

If rising prices for essentials is eating into your budget more than normal, you probably aren’t putting as much money into a savings account. A June 2022 Forbes Advisor-Ipsos survey found that 42% of respondents were saving less money than usual.

“Inflation makes all of our income and savings less valuable,” says Todd Steen, professor of economics at Hope College in Holland, Michigan.

If you’re not able to save as much as you used to, you may be less prepared for financial emergencies, forcing you to rely on costly credit cards or loans to pay unexpected bills.

And even if you have money in savings already, that decreased purchasing power means your emergency fund might not stretch enough to cover a financial crisis during an inflationary period.

If you have $1,000 socked away for a rainy day, you’re certainly better off than not having it. But here’s an example of how inflation can eat at the value of your savings.

Car repair prices went up 9% from June 2021 to June 2022 according to the CPI. If you had a $900 car repair in June 2021, in June 2022, that same car repair would have been $981. Suddenly your $1,000 saved up is a little less valuable.

“Inflation is a difficult problem to get rid of in an economy, because when prices increase, workers want to have higher wages and salaries to keep up,” he says. “This can lead to future price increases, and the cycle continues.”

3. Loss of Goods and Services

Some industries do pretty well during inflationary times, particularly ones in which you can’t hold off your spending indefinitely, like supermarkets, gas stations and funerals—but some businesses are completely devastated.

That’s because when inflation runs rampant, consumers spend their money on products and services that they absolutely need, and hold back on what they don’t.

You’re going to get your car repaired if you need it. You’ll keep spending money on food.

But you might not take your kids to a trampoline park. You might instead opt for a free city playground with the youngsters, instead. Decisions like that are understandable when prices are high but collectively, they can damage segments of the economy.

“That could mean your favorite pizza place closes, or your nail salon drops a service because it’s become too costly,” says Callie Cox, an investment analyst at eToro.

The renown economist Milton Friedman quipped that inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced
only by a more rapid increase in the quantity of money supply than in output of goods and services. Consequently, empirical evidence suggest that, if growth in the money supply is greater than the actual growth in GDP, inflation results.

References:

  1. https://www.forbes.com/advisor/personal-finance/why-is-inflation-bad/
  2. https://www.nytimes.com/article/inflation-definition.html
  3. https://www.forbes.com/advisor/personal-finance/types-of-inflation/
  4. https://www.caixabankresearch.com/en/economics-markets/inflation/inflation-merely-monetary-phenomenon

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