Category Archives: Inflation

Retail Investor Inflation Strategy

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Inflation refers to an aggregate increase in prices, commonly measured by the Consumer Price Index (CPI).

The federal government has pumped trillions of dollars into the economy through deficit spending and stimulus measures since the COVID-19 pandemic began. Meanwhile, the central bank of the United States, the Federal Reserve, has dropped interest rates to near zero and has committed to keeping them there through 2023.

The Federal Reserve’s mandates are to manage the money supply and set the federal funds interest rate in an attempt to keep inflation within a reasonable limit. This reasonable level of inflation is maintained because it encourages people to spend now, thereby promoting economic growth, rather than saving, as a dollar today is worth more than the same dollar tomorrow on average.

A constant level of inflation helps maintain price stability and is thought to maximize employment and economic well-being. Investors expect returns greater than this “reasonable,” average level of inflation, and workers expect wage increases to keep pace with the increasing cost of living.

The Consumer Price Index tracks prices for a broad range of products such as gasoline, healthcare, and groceries. The CPI rose 6.2% in October from the same month in 2020, the biggest spike since December 1990, according to the Labor Department.

High and variable inflation is considered bad for both investors and the wider U.S. economy because it can eat away at the value of financial assets denominated in the inflated currency, such as cash and bonds, particularly longer term bonds with more interest rate risk.

The prospect of variable or high inflation introduces uncertainty to both the economy and the stock market, which doesn’t really benefit anyone. This uncertainty or variable inflation distorts asset pricing and wages at different times. Prices also tend to rise faster and earlier than wages, potentially contributing to economic contraction and possible recession.

“Cash is not a safe investment, is not a safe place because it will be taxed by inflation.” Ray Dalio, Bridgewater Associates

In an inflationary environment, “cash is trash” since inflation operates like a tax which causes saved dollars lose value over time. High inflation rates decrease the purchasing power of money and it discourages people from holding cash assets and saving. “Cash is not a safe investment, is not a safe place because it will be taxed by inflation,” Bridgewater Associates’ Ray Dalio, the founder of the world’s biggest hedge fund said on CNBC Squawk Box.

Here are several suggestions for investors to consider to counter the risk and derisive impact of inflation on assets and the economy.

  • Consider buying equity stocks like bank stocks or consumer goods companies that will benefit from higher inflation or higher interest rates. Banking, consumer staples, energy, utility, and healthcare equities are likely to perform well. Banks would come out ahead if the Federal Reserve eventually raises interest rates to combat inflation, and banks’ spreads between loans and deposits widen. Also, look for companies that benefit from rising labor costs and be very attentive to how much you pay for (e.g., the intrinsic value) of risk assets.
  • Consider buying TIPS, or Treasury inflation-protected securities, which are a useful way to protect your investment in government bonds. These U.S. government bonds are indexed to inflation, so if inflation moves up, the effective interest rate paid on TIPS will too. TIPS bonds pay interest every six months, and they’re issued in maturities of 5, 10 and 30 years. Because they’re backed by the U.S. federal government, they’re considered among the safest investments in the world.
  • Avoid fixed income assets such as corporate and government non-TIP bonds. If rates rise sharply, their principal value will take a major hit. If rates climb, then certificates of deposit, fixed annuities, bonds, and bond funds purchased today will look less attractive in the future. Similarly, buying a lifetime income annuity is less enticing in an inflationary environment. The monthly check you get for the rest of your life will lose value more quickly with high inflation.
  • Keep the right sort of debt. Don’t pay off that home mortgage or real estate investment mortgages early, you’re better off paying it off over time with watered-down dollars. Homeowners carrying fixed mortgages with low interest rates are in a great position. It’s highly recommended to refinance your mortgage to lock in low rates. If inflation takes off, homes prices are likely to climb and your fixed monthly payment may appear like a real bargain in a few years.
  • Consider commodities or gold. Investing in oil, natural gas, wheat and corn can be good hedges against inflation. Gold has traditionally been a safe-haven asset for investors when inflation revs up or interest rates are very low. Gold tends to fare well when real interest rates – that is, the reported rate of interest minus the inflation rate – go into negative territory. Investors often view gold as a store of value during tough economic times.
  • Make essential purchases and charitable giving. If consumers expect to spend money on home goods, renovations, car repairs, or other products and services, they might be better off doing so now, before prices climb even higher.
  • Expect rising health costs. Health costs have risen faster than inflation for years. The pandemic, which is driving some health professionals out of the field, could accelerate that trend.

Keep in mind that inflation is always happening within the economy, but hopefully at a relatively low and steady rate, and kept under control by the Federal Reserve. Investors with a long time horizon, a high tolerance for risk, and a high allocation to stocks shouldn’t be worried about short-term inflation fears.

However, it’s perfectly suitable and even desirable for retirees, risk-averse investors, and those with a short time horizon to have some allocation to inflation-protected assets like TIPS, REITs and bank stocks.

Rising inflation is a big concern for investors, but it remains to be seen whether current high levels of inflation will persist or end up being due to “transitory” factors. Investors will likely come out ahead using assets like equity stocks, REITs, short-term nominal bonds, and TIPS to hedge against inflation.

References:

  1. https://www.barrons.com/articles/protect-finances-from-inflation-51637782342
  2. https://www.optimizedportfolio.com/inflation/
  3. https://www.bankrate.com/investing/inflation-hedges-to-protect-against-rising-prices/

Inflation and Investment Opportunities

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Fiscal spending proposal has the potential to overheat a U.S. economy that is already struggling to keep up with record demand.

Rising inflation has Americans worried about their future purchasing power and their retirement plans, according to CNBC. Yet there are some opportunities to make and save money in this environment, as well as protect your investments.

With consumer prices up in October 6.2% from the year prior, inflation is too high and appears to be a clear and present threat to America pocket books and wallets.

With inflation at its highest level in several decades, economists are concerned that the pending multi-trillion dollar fiscal spending package will further overheat a U.S. economy already struggling to keep up with demand. The concern is that the package would exacerbate more fundamental supply constraints in the economy, driving up inflation over the longer term.

Thus, cash in the bank or in low-yielding bonds aren’t the best option in an inflationary environment when the stock market has gained nearly 27% this year, explains financial advisor Delano Saporu, CEO of New York-based New Street Advisors Group. Inflation reduces the value and purchasing power of that cash.

“If you are sitting on too much cash, you are doing yourself a disservice,” Saporu said.

Thus, it is recommended that you keep only enough cash to cover expenses for 12 months to 24 months. This way, if inflation becomes a big issue and causes stocks to tank, you aren’t forced to sell in a down market.

Investors do not love high inflation, which can hurt the growth prospects of high-rising tech stocks, among others. Because, higher prices can result in higher interest rates, which can lower the appeal of growth stocks compared to less risky alternatives.

The stock market tends to beat inflation given its rate of return, although growth may be slowed during inflation periods. Yet investing is for growth, not inflation hedges.

Since inflation is typically considered a result of a strong economy, financial experts recommend cyclical companies, which follow the cycles of an economy. That means sectors like industrials, energy and consumer discretionary. Also, gold, which is near five-month highs, and possibly cryptocurrencies are seen as inflation hedges.

References:

  1. https://www.cnbc.com/2021/11/16/as-inflation-rises-here-are-opportunities-to-make-and-save-money-.html
  2. https://www.forbes.com/advisor/investing/inflation-worries-2021/
  3. https://www.bloomberg.com/opinion/articles/2021-08-12/inflation-worries-it-may-finally-be-time-to-bring-them-back

Best Business to Own When Inflation Spikes

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Invest in asset-light businesses with pricing power.

In a letter to Berkshire Hathaway shareholders, the best type of business to own when inflation spikes, according to Berkshire Hathaway Chairman and CEO Warren Buffett, have two characteristics that make a business well adapted to an inflationary environment:

  1. An ability to increase prices easily, and
  2. An ability to take on more business without having to spend too much in order to do it.

In other words, aim to invest in asset-light businesses with pricing power.

Buffett also stated that the best business to own is one that doesn’t require continuous reinvestment of capital because it becomes more and more expensive as the value of a dollar drops.

“The best businesses during inflation are the businesses that you buy once and then you don’t have to keep making capital investments subsequently,” Buffett said, adding that “any business with heavy capital investment tends to be a poor business to be in inflation and often it’s a poor business to be in generally.”

Businesses like utilities or railroads “keep eating up more and more money” and aren’t as profitable, he explained. He prefers to own companies that people have a connection to. That is why “a brand is a wonderful thing to own during inflation,” Buffett said. Owning part of “a wonderful business,” as Buffett said in 2009, is useful because no matter what happens with the value of the dollar, the business’ product will still be in demand.

Buffett also said that it’s particularly handy to own real estate during times of inflation because the purchase is a “one-time outlay” for the investor, and has the added benefit of being able to be resold.

Inflation quietly eats away at earnings and purchasing power.

When the economy exhibits strong economic growth, there is a higher demand for goods and services, which in effect increases prices of those goods and services; that’s attributed to inflation. Essentially, the rate of inflation increases when demand in the economy is higher than supply, causing an overall price rise.

Inflation also impacts money sitting in the bank. While you may be receiving interest on savings from a money market account, the growth of inflation can outpace that of the savings rate offered by the bank. Keeping all your savings in cash is warranting your liquid assets a definite loss to inflation.

Effectively, your money does not grow at a higher rate, but loses purchasing power over time compared to if it was properly invested in equity assets.

Inflation

“By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of [all] their citizens.” John Maynard Keynes

Inflation is tracked using the Consumer Price Index, known as the (CPI). This index, reported by the U.S. Bureau of Labor Statistics each month, measures the average change over time of prices consumers pay for goods and services.

The immediate effects of inflation are the changes in the behavior of consumption habits. In the long-term, inflation erodes the purchasing power of your income and accumulated wealth.

“Inflation reduces the ‘power’ of each dollar you have,” says Rob Isbitts, co-founder of The Hedged Investor in Weston, Florida. “A dollar is a dollar, but what it buys can be less in the future than it is today.”

Purchasing power risk – also known as inflation risk – is when the real interest rate, which accounts for adjusted inflation, shows the gain or loss in purchasing power.

“Inflation reduces the ‘power’ of each dollar you have,” says Rob Isbitts, co-founder of The Hedged Investor in Weston, Florida. “A dollar is a dollar, but what it buys can be less in the future than it is today.”

Assets That Protect Against Inflation

Inflation can pose a threat to investments since prices that increase over time can decrease the value of your savings.

And, financial experts agree that there is no way to fully protect your investments against inflation. Nonetheless, there are ways to help protect against this risk. These experts say having a substantial allocation to stocks is important for growth potential while offsetting against inflation risk.

In the long term, the stock market is expected to outperform the inflation rate. Stocks are commonly thought of as an inflation protection asset since, over time, stock performance will outpace inflation. These assets are seen as a hedge against inflation:

  • TIPS, or Treasury Inflation-Protected Securities, which are bonds backed by the full faith of the U.S. government and protect against rising prices, make a very safe asset
  • REITs, or real estate investment trusts, are an organic hedge against inflation. When prices increase, real estate values increase as well. This asset is highly correlated with inflation, which means REIT returns are higher when inflation increases.
  • Gold is an asset that might provide protection against inflation and a good safeguard of inflation over the long run,

Inflation can significantly weaken your purchasing power and the performance of your investments and thus impact their value. That’s why acting to suppress the dangers of inflation is important to preserve the value of your cash flow and wealth in the long run.

References:

  1. https://finance.yahoo.com/news/warren-buffett-says-best-type-195900081.html
  2. https://money.usnews.com/investing/investing-101/articles/how-inflation-and-deflation-impact-your-investments
  3. https://www.cnbc.com/2021/08/19/warren-buffett-inflation-best-businesses.html

Global Inflation Worries

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“Inflation will be higher and more persistent than people expect.” Mohamed El-Erian, Allianz & Gramercy Advisor

Higher and more persistent inflation may now be an unavoidable economic fact of life for Americans, and it’s starting to make a lot of economists, investors and public leaders worry. They, specifically economists, collectively believe inflation is primed for rapid growth domestically as trillions in federal stimulus spending is layered on top of the Federal Reserve’s loose monetary policy.

This level of unadulterated fiscal spending could mean that investors will have to get used to inflation, higher interest rates, more market volatility and lowered returns on invested capital.

In conjunction to domestic and global inflation concerns, there exist two significant global economic worries for individuals and investors:

  • Global supply chain constraints which are significant and will get worst whether it is disrupted supply chains or labor worries, and
  • Global tightening of monetary conditions and less liquidity.

But, major shocks to the economy tend to be caused by either a major policy mistake or market accidents. Yet, we’re unlikely to witness double digit inflation in the United States.

The Federal Reserve and the Biden Administration contend that the elevated inflation readings will prove transitory. The Fed and Administration view that the current inflation stems chiefly from temporary factors such as supply bottlenecks and a spike in post-pandemic consumer demand.

The August inflation report showed that prices increased by 5.4% year over year in July. Wages increased, too—but not by enough to offset inflation.

And, Americans know inflation when they see it: retail shops and restaurants are raising their prices on consumers, and prices of used cars and trucks were 32% higher in August than they were a year earlier, and workers are discovering bargaining power over wages for certain positions for the first time in years, according to Barron’s. “Inflationary pressures are likely to rise because everyone is spending—including the government—and it becomes a self-sustaining cycle,“ says Karen Karniol-Tambour, co-chief investment officer for sustainability at Bridgewater Associates.

“When you live in a world of abundant liquidity, investors tend to take on too much risk.” Mohamed El-Erian

Congress has assigned a dual mandate for the Federal Reserve: Foster maximum employment and maintain price stability. The FOMC has interpreted maintaining price stability as keeping inflation growing at about 2% a year over the long-term.

Over the past two decades, the Federal Reserve has been unable live up to its two percent inflation mandate. Using the Fed’s preferred gauge of inflation, core Personal Consumption Expenditures (PCE), which tracks price changes over time without volatile energy and food costs, inflation has remained stubbornly below the Fed’s 2% annual target since the 2007 – 09 Great Recession, except for a brief stretch in early 2012 and much of 2018.

Going from a disinflationary world to an inflationary world

Evidence that some of the issues that might spur inflation could abate ahead, particularly some of the supply chain issues. Additionally, unit labor costs remain low, meaning that companies still aren’t spending substantially more for productivity, which also could tamp down inflation.

Federal Reserve Chair Jerome Powell has been resolute in his commitment to seeing the whites of inflation’s eyes before raising rates or paring back quantitative easing. But some market observers believe the Fed is being too lax.

“Financial conditions should remain quite accommodative for a while and in our view risks an overshoot,” said Rick Rieder, BlackRock’s Chief Investment Officer of Global Fixed Income.

The drivers of global inflation are many and complex. They include global economic and policy forces as well as domestic. Yet, it’s important to keep in mind that the rise in inflation isn’t necessarily life altering. Although, policy makers can’t hold on to the “mystical attraction of transitory inflation” when the facts on the grow indicate the contrary, according to Mohamed El-Erian. Given the extraordinary level of fiscal and monetary economic stimulus, inflation may be less transitory than previously thought.

References:

  1. https://www.forbes.com/advisor/investing/inflation-worries/
  2. https://www.cnbc.com/video/2021/10/25/mohamed-el-erian-were-not-anywhere-near-risk-of-hyperinflation.html
  3. https://www.pimco.com/en-us/insights/viewpoints/want-to-mitigate-inflation-take-a-portfolio-approach
  4. https://www.barrons.com/articles/government-economy-stock-market-51633705211

The Debt Ceiling and Congressional Brinkmanship

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“I could end the deficit in 5 minutes. You just pass a law that says that anytime there is a deficit of more than 3% of GDP, all sitting members of Congress are ineligible for re-election.” Warren Buffett, Chairman and CEO, Berkshire Hathaway

Around October 18, Treasury Secretary Janet Yellen and the U.S. Treasury Department have warned Congress that the government will no longer be able to pay all its bills unless the $28.5 trillion statutory debt ceiling is increased or suspended.

Source: Congressional Research Service, Congressional Budget Office, and the Treasury Department. Data as of 05/01/2021.

Moreover, Secretary Yellen believes the economy would fall into a recession if Congress fails to address the borrowing limit before an unprecedented default on the U.S. debt.

While the U.S. has never failed to pay its bills, economists say a default would tarnished faith in Washington’s ability to honor its future obligations on time and potentially delay Social Security checks to some 50 million seniors and delay pay to members of the U.S. armed services.

“If you ask the question of Americans, should we pay our bills? One hundred percent would say yes. There’s a significant misunderstanding on the debt ceiling. People think it’s authorizing new spending. The debt ceiling doesn’t authorize new spending; it allows us to pay obligations already incurred.” Peter Welch (D-VT), U.S. House of Representatives Democratic Caucus Chief Deputy Whip

Increases to the debt ceiling aren’t new. They’ve occurred dozens of times over the last century, mostly matter-of-factly, a tacit acknowledgement that the bills in question are for spending that Congress has already approved.

One thing separating today’s debt debate from those of the past is the larger-than-ever national debt, according to Fidelity. Publicly held US debt topped 100% of GDP in 2020 and is expected to reach 102% by the end of 2021.

And the debt is projected to increase significantly in the future. The Congressional Budget Office (CBO) projects a federal budget deficit of $2.3 trillion in 2021—the second largest deficit since 1945.

Source: Congressional Budget Office, as of February 11, 2021.

Failure to address the current challenge could shake global markets even before the Treasury has exhausted its available measures to pay bills. A U.S. debt default, whether through delayed payments on interest owed on U.S. Treasuries or on other obligations, would be unprecedented.

The effect would be one of perception. And, perception can be tied to the reality that someone isn’t going to be paid on time, whether it be government contractors, individuals who receive entitlement payments, or someone else. The damage to U.S. credibility would be irreversible.

Even if a default were only technical—if payments other than interest on debt were delayed—the United States could no longer fully reap the benefits bestowed on the most reliable debtors.

Interest rates would likely rise, as would financing costs for businesses and individuals. Debt ratings would be at risk. The government’s own financing costs, borne by taxpayers, would increase. Stock markets would likely be pressured as higher rates made companies’ future cash flows less predictable. Such developments occurring while economic recovery from the COVID-19 pandemic remains incomplete makes the potential scenario all the more important to avoid.

Let it be said that no one doubts the ability of the United States to pay for its obligations, according to Vanguard. There is a minimal credit risk posed by the United States is supported by its strong economic fundamentals, excellent market access and financing flexibility, favorable long-term prospects, and the dollar’s status as a global reserve currency.

The House has passed a measure that would suspend the debt ceiling through mid-December of 2022, and the bill now goes to the Senate. Republicans in the Senate oppose any effort to raise the borrowing limit and appears intent on making Democrats address it as part of their sprawling investment in social programs and climate policy under reconciliation.

Senate Democrats could lift the debt ceiling without the GOP votes through reconciliation, although that would come with downsides. Under reconciliation, a simple majority of senators can pass a very small number of budget bills each year. The process is sufficiently complex that it would probably take a couple of weeks and distract Democrats from their negotiations over Biden’s “Build Back Bette” agenda.

Thus, the Democrats resist raising the debt ceiling through reconciliation if it means potentially sacrificing other policy goals. And, the rules for reconciliation would require Democrats to specify a new limit for the national debt which would expose them to potentially uncomfortable GOP political attack ads.

Republicans insist that since Democrats control both the executive and the legislative branches and are in a socialistic tax-and-spend binge, they should bear sole responsibility for dealing with the debt limit, which is rearing its ugly head again because the suspension included in a two-year 2019 budget deal expired on July 31.

Democrats argue that Republicans should share the burden of this unpopular chore, since (a) much of the debt involved was run up under Republican presidents and (b) Democrats accommodated Republicans on debt-limit relief during the Trump presidency.

For long term investors, it’s clearly in the best interest of the country to resolve any debt-ceiling issues, according to Fidelity. And, it’s important to understand that there will always be times of uncertainty. It’s important to take a long-term view of your investments and review them regularly to make sure they line up with your time frame for investing, risk tolerance, and financial situation.

References:

  1. https://investornews.vanguard/potential-u-s-debt-default-why-to-stay-the-course/
  2. https://www.cnbc.com/2021/10/05/debt-ceiling-us-faces-recession-if-congress-doesnt-act.html
  3. https://nymag.com/intelligencer/2021/10/democrats-can-raise-debt-ceiling-via-reconciliation-bill.html
  4. https://www.fidelity.com/learning-center/trading-investing/2021-debt-ceiling

Life Insurance

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If something were to happen to you today, is your family protected? 

Life insurance is a relatively low cost way to ensure that your family will have financial security if you or the primary earner should die prematurely. Furthermore, life insurance is often necessary financially because it provides peace of mind—not just for you, but for your whole family.

Conventional wisdom dictates that you don’t need life insurance if no one else depends on your income. While mostly true, there are many reasons why you should obtain life insurance if no one depends on your income.

  • Insurability and low premiums. Buying a policy both locks in lower premiums and guarantees insurability later in life. An existing insurance policy guarantees the ability to purchase additional insurance with no medical underwriting or physical exams. 
  • Cash Value Growth. Whole Life insurance policy provides attractive cash value growth. Access this cash value at any time using a policy loan. Or, if you cancel the policy, you get a return of all or a majority of the premiums paid, or the cash value – whichever is greater.
  • Funeral and burial expenses. From a practical perspective, in addition to the emotional devastation, parents also face significant expenses in the event of a child’s death. According to the Natural Funeral Directors Association, the median cost of a funeral with burial exceeds $7,000. Purchasing insurance for children alleviates the significant financial burden for a family coping with a tragic loss. 

Not only do rising prices make life increasingly expensive, but, as life’s circumstances change – you marry, buy a house, have children, and perhaps need to care for others – you have greater responsibilities and a need for better financial protection.

Key Takeaways

There are several excellent reasons to obtain insurance coverage for you and your family.

  • You can lock in low premiums while they are young and healthy.
  • You can lock in eligibility for other services while they have an active policy.
  • Permanent insurance provides a store of cash value that safely grows at a high crediting rate, which can be used to help fund future expenses like college tuition.
  • In the event of loss, a policy can cover the ever growing expenses of funerals and burials and protect your savings.

References:

  1. https://www.aafmaa.com/learning-hub/blog/post/2792/why-insure-your-child-or-grandchild-through-aafmaa
  2. https://www.aafmaa.com/learning-hub/blog/post/2810/your-life-will-change-so-the-way-you-protect-loved-ones-should-too

U.S. Labor Shortage Maybe Worse Than It Looks | Barron’s

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“Enhanced unemployment benefits have made it harder for employers to fill low-paying jobs, working parents continue to struggle with child care, and some workers are sitting out because of pandemic concerns.” Barron’s

According to a recent article in Barron’s Magazine, there are 9.2 million job openings and 9.5 million unemployed in the U.S. Employers, conservative politicians, economists, and policy makers blame the bottleneck on twin forces:

  • Generous jobless benefits that have made unemployment the better economic decision for millions of low-paid workers, and
  • A year of remote learning that has pushed some two million parents—mostly mothers—out of the labor force.

The expectation by many economists is that the labor shortage will resolve itself this fall once extra federal jobless assistance ends as of September 6 and parents send their children back to school. However, there are deeper problems besetting the labor market, from “an aging workforce and a new desire of many workers to be their own boss to a deep skills mismatch and a pandemic that hasn’t ended”.

The impact of slowing population growth on labor supply hadn’t been so apparent before the pandemic because many baby boomers worked past the traditional retirement age of 65. In July 2019, Pew Research Center said the majority of U.S. adults born between 1946 and 1964 were still working, with the oldest among them staying in the labor force at the highest annual rate for people their age in more than half a century. But now the oldest boomer is turning 75, the working-age population is falling for the first time in U.S. history, and the pandemic has led many older workers to retire ahead of schedule.

Geoffrey Sanzenbacher, an economics professor at Boston College, found that 15% of those over age 62 were retired a year after the coronavirus took hold in the U.S., up from 10% a year after the 2007-09 recession started and 13% right before the pandemic. As companies expect workers to return in the fall, he says another wave of older workers may choose to retire if they can no longer work remotely.

And, it isn’t just older workers walking away from the labor market, nor is it only low-paid service workers. Many departed workers are gone for good since they joined the gig economy or started new businesses that have flourished during the pandemic.

Yet, there is some evidence that continuing claims for jobless insurance have fallen faster in states that ended the extra payments ahead of the federal Sept. 6 expiration. Aneta Markowska, chief economist at Jefferies, says such claims have fallen 24% since mid-May in the states that have already cut the extra $300 a week, compared with a 0.7% increase in states that haven’t.

A record number of new businesses launched during the pandemic as workers turned into entrepreneurs. Immigration, the lifeblood of many services companies, dropped significantly in recent years. Retail day trading is still booming along with the stock market, keeping many who became amateur traders during the pandemic on the sidelines.

Many doubts persist that millions of moms will return to work in September. Many families have established new norms over the past year, and many parents still harbor COVID-19 virus concerns. While employment among working women without children has almost returned to prepandemic levels, mothers with school-age children are lagging, Misty Heggeness, economist at the U.S. Census Bureau says. Further, she is skeptical that trend will meaningfully change in September. “I think we’re underestimating the fear people have with the virus,” Heggeness says, adding that it’s plausible some parents will hold back children in the fall if virtual learning is an option and if parents themselves remain reluctant to return to workplaces.

June’s Unemployment numbers

The June jobs report looks almost perfect, with hiring beating Wall Street’s expectations and wages rising. One might be tempted to declare the labor shortage over. But investors shouldn’t take the bait just yet. While a nonfarm payroll increase of 850,000 is undeniably strong, it belies a labor market still plagued with supply problems.

  • First, consider that government hiring rose 193,000 last month. That accounts for the entire headline overshoot versus economists’ expectations. Company payrolls increased 662,000, which would be incredible for normal times. Yet it was still far off the one million mark that economists had anticipated by this point in the recovery, as the economy bursts open and vaccinated consumers spend the trillions of dollars in cash stashed during the pandemic.
  • Second, labor-force participation was flat in June despite better hiring. That rate, 61.6%, is still down 1.7 percentage points from its prepandemic level. The employment-population ratio, which Federal Reserve officials have said they are watching, was also unchanged in June; at 58%, it remains 3.1 percentage points below its prepandemic level.
  • Third, the slowdown in wage growth is deceiving. The 0.3% increase from May looks like a Goldilocks print—enough to drive continued spending without fueling inflation fears that have been building as shortages from labor to chips to food push prices broadly higher.

Hiring is being held back by supply, not demand: On an annualized basis this year, leisure and hospitality wages are up 12.3%, transportation and warehousing pay is up 8%, and retail wages are up 5.5%.

Labor force participation was stagnant in June, reflecting an ongoing labor shortage. The degrees to which transitory factors—generous unemployment benefits, child-care issues, and Covid-19 concerns—are capping hiring and driving up wages won’t be clear for months. Schools need to reopen to resolve child-care issues holding back working parents, and enhanced unemployment pay needs to expire before it becomes clear the extent to which such benefits are keeping workers home.

While about two dozen states either have started cutting or are about to cut the extra $300 a week in unemployment insurance ahead of the federal program’s Sept. 6 expiration  70% of those unemployed won’t be affected by those early terminations.

References:

  1. https://www.barrons.com/articles/labor-shortage-worse-than-it-looks-51627664401
  2. https://www.barrons.com/articles/the-labor-market-is-out-of-whack-job-openings-hit-record-high-as-hiring-slows-51625679925
  3. https://www.barrons.com/articles/jobs-report-investors-should-be-skeptical-51625267210

Buffett on Inflation

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“Inflation often feels like an abstract concept, but it hits everyday people the hardest.” Warren Buffett

Inflation is when the dollars in your wallet lose their purchasing power — either because the money supply has dramatically increased or because prices have surged, according to Bankrate.com.

Effectively, inflation occurs when the cost of goods and services in the economy goes up over a sustained period of time. Yet, inflation doesn’t happen overnight, and it also doesn’t happen when the cost of one particular good or service goes up.

From an economics perspective, inflation refers to price increases to the broader economy. And, price increases aren’t always synonymous with inflation — and some economic experts say a little bit of inflation is actually good for the economy. That’s for two main reasons: One, it prevents a deflationary trap, which experts say can be even worse than deflation because money loses value. Another reason is because households make better financial decisions when they expect stable and low prices.

“We may see prices rise on certain things like gas or milk, but it’s not necessarily inflation unless you see prices rising sort of across the board, across many different products and services,” says Jordan van Rijn, senior economist at the Credit Union National Association (CUNA).

The Berkshire CEO described high inflation as a “tax on capital” that discourages corporate investment. The “hurdle rate,” or the return on equity needed to generate a real return for investors, climbs when prices rise, Buffett said. “The average tax-paying investor is now running up a down escalator whose pace has accelerated to the point where his upward progress is nil,” Buffett added.

Buffett pointed out inflation can hurt more than income taxes, as it’s able to turn a positive return on investment into a negative one. If prices have climbed enough, people who make a nominal return on their investment may be left with less purchasing power than before they invested.

Inflation Causes

Given the federal government’s unprecedented loose monetary policy, fiscal spending spree and money-printing splurge over the last year, many economists have warned that such fiscal irresponsibility could result in a destructive wave of inflation.

‘I worry about inflation. I do not believe inflation is going to be transitory.’ Larry Fink, chairman and CEO, BlackRock Inc.

Defenders of federal government pandemic monetary and fiscal interventions have insisted that any resulting price inflation is just transitory. But recent data is showing that price inflation is hitting new highs and many economists believe that inflation is deep rooted and non-transitory.

However, the June’s Consumer Price Index (CPI) shows prices once again sharply on the rise. From June 2020 to June 2021, the data show that consumer prices rose a staggering 5.4 percent. Larry Fink, Chairman and CEO of BlackRock Inc., isn’t convinced by the Federal Reserve’s arguments that U.S. inflation pressures will fade away once supply bottlenecks and other temporary factors resulting from the COVID-19 pandemic fade away.

Economists lump inflation causes into two categories: demand-pull and cost-push inflation.

Cost-push occurs when prices increase because production is more expensive; that can include rises in labor costs (wages) or material prices. Firms pass along those higher costs in the form of higher prices, which then cycles back into the cost of living.

On the flip side, demand-pull inflation generates price increases when consumers have resilient interest for a service or a good.

While price inflation has many causes, much of the current inflation can be traced back to the policy of the Federal Reserve. The Fed essentially created trillions of new dollars to pump into the economy in the name of “pandemic stimulus.”

“The quantity of money has increased more than 32.9% since January 2020,” Federal Economic and Education (FEE) economist Peter Jacobsen explained in May. “That means nearly one-quarter of the money in circulation has been created since then. If more dollars chase the exact same goods, prices will rise.” 

“We are seeing very substantial inflation,” Warren Buffet said at a recent shareholder meeting. “It’s very interesting. We are raising prices. People are raising prices to us and it’s being accepted.”

The typical person’s standard of living declines as a result of price inflation, because what really matters is not what number appears on your paycheck but the purchasing power of your paycheck. Working-class Americans suffer tremendously when their energy bill increases by nearly 25 percent in just one year, for example.

It is not a secret that stocks, like bonds, do poorly in an inflationary environment, according to Warren Buffett.

“There is no mystery at all about the problems of bondholders of in an era of inflation. When the value of the dollar deteriorates month after month, a security with income and principal payments denominated in those dollars isn’t going to be a big winner” Buffet states. “You hardly need a Ph.D. in economics to figure that one out.”

Regarding stocks, the conventional wisdom believes “…that stocks were a hedge against inflation. The proposition was rooted in the fact that stocks are not claims against dollars, as bonds are, but represent ownership of companies with productive facilities. These, investors believed, would retain their value in real terms; let the politicians print money as they might.”

The main reason it, stocks as a hedge against inflation, do not turn out the way conventional wisdom believed, according to Buffett, is that “stocks, in economic substance, are really very similar to bonds”.

References:

  1. https://www.bankrate.com/banking/federal-reserve/what-is-inflation/
  2. https://fee.org/articles/inflation-just-hit-a-13-year-high-here-s-why-you-should-care/
  3. https://markets.businessinsider.com/news/stocks/warren-buffett-berkshire-hathaway-warned-inflation-prices-tapeworm-investors-businesses-2021-5
  4. https://www.cnbc.com/2018/02/12/warren-buffett-explains-how-to-invest-in-stocks-when-inflation-rises.html
  5. https://fee.org/articles/the-costs-are-just-up-up-up-warren-buffett-issues-grave-warning-about-inflation/
  6. https://fortune.com/2011/06/12/buffett-how-inflation-swindles-the-equity-investor-fortune-classics-1977/
  7. http://csinvesting.org/wp-content/uploads/2017/04/Inflation-Swindles-the-Equity-Investor.pdf

What the Inflation of the 1970s can Teach Us Today

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A Wall Street Journal survey finds that “strong economic rebound and lingering pandemic disruptions fuel inflation forecasts above 2% through 2023”.

The U.S. inflation rate reached a 13-year high recently, triggering a debate about whether the country is entering an inflationary period similar to the 1970s, according to WSJ. Americans should brace themselves for several years of higher inflation than they’ve seen in decades, according to economists who expect the robust post-pandemic economic recovery to fuel brisk price increases for a while.

Economists surveyed this month by The Wall Street Journal raised their forecasts of how high inflation would go and for how long, compared with their previous expectations in April.

On average, the WSJ survey respondents expect a widely followed measure of inflation, which excludes volatile food and energy components, to be up 3.2% in the fourth quarter of 2021 from a year before. They forecast the annual rise to recede to slightly less than 2.3% a year in 2022 and 2023.

That would mean an average annual increase of 2.58% from 2021 through 2023, putting inflation at levels last seen in 1993.

References:

  1. https://www.wsj.com/articles/higher-inflation-is-here-to-stay-for-years-economists-forecast-11626008400

Inflationary Pressures are a Real and Present Concern

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“Inflation jumped 5 percent in the past year, the fastest pace in 13 years.”

Inflation in the US has jumped to the highest rate since 2008.  For the past decade, inflation has averaged under 2 percent a year. But suddenly, inflation is rising much faster than anticipated and planned by the Federal Reserve. For instance, inflation rose 5 percent between May 2020 and May 2021, the Labor Department reported.

Inflation results when demand exceeds supply in an economy. When the economy grows faster than its ability to provide goods and services demanded by consumers, prices rise. When the economy grows more slowly than its potential growth rate, prices tend to fall. Factors that affect an economy’s growth rate include the supply of labor and the productivity of those workers.

Inflation is imply defined as the price of a good or service increasing over time. Conversely, you can also define inflation by looking at the value of the dollars purchasing those goods and services. Said another way, while you might agreed that the price of good and services have increased, you can also state the dollars you spend now purchase less quantity of goods and services … and by extension, the dollars themselves are clearly worth less.

Money supply and budget deficits

We’ve learned that inflation is, “always and everywhere a monetary phenomenon,” according to economist Milton Friedman. Money supply growth is a requirement, but in and of itself, it’s not enough to cause inflation. The money needs to find its way into the economy and turnover rapidly to generate inflation. (This is referred to as the velocity of money or ratio of M2 money supply to gross domestic product, or GDP.) In recent years, the velocity of money has fallen sharply.

Rising budget deficits are not necessarily linked to inflation, either, but can contribute to an overheating economy. It all depends on whether it stimulates demand to exceed supply. From a long-term perspective, there has been little correlation in recent years between the level of debt in the economy and inflation.

The causes of present inflation and the primary explanations are:

  • Pent-up demand following the COVID-19 shutdown.
  • Base effects (essentially older low values rolling off).
  • A massive increase in the supply of dollars.

Rising Prices 

“Inflation is taxation without legislation.” – Milton Friedman.

With commodity prices soaring, money supply growth exploding, and government spending surging, there is a palpable fear of a return to 1970s-style inflation. I get it. I remember those times.

Core inflation, which strips out volatile items such as food and energy, leaped to the highest level since 1992. It rose 3.8% year-on-year, up from 3% in April.
Other official data showed that the number of initial claims for jobless benefits fell to its lowest since mid-March 2020, when the first wave of Covid-19 hit.

The cost of used cars and trucks climbed 7.3% in May from April, accounting for a third of the increase in inflation. Prices were 29.7% higher than a year earlier. They have risen in recent months because of a global semiconductor shortage that has held back car production, pushing people to enter the market for second-hand vehicles instead.

Energy prices rose, by 28.5% year-on-year, including a 56% jump in gasoline prices compared with May 2020, when demand slumped due to the pandemic. And, gasoline prices are destined to go higher with the cancelation of the cross-border permit for the Keystone XL pipeline and suspension of the program for oil and gas leasing on federal lands and waters.

The cost of flights, household furnishings, new cars, rental cars and clothing rose during May.


 

What should investors do?

In response to inflation, investors should:

  • Must become awareness of inflation. Inflation is likely to increase throughout the year (and perhaps further), and bonds are likely to at least be less of a stalwart than they have over the past 40 years. It is important to realize that is possible and you should all be prepared for lower near-term performance in fixed income markets.
  • Diversification is key. Equities, for example, have historically been a reasonable asset during certain inflationary periods as companies can often pass through increased costs.
  • Explore other forms of inflation protection, as well as a broader diversification of fixed income instruments.

Inflation is clearly present for U.S. consumers in the grocery stores, at gas stations and in vehicle sales. Fears over rising prices has investors fearing that pent-up demand and supply chain bottlenecks would create inflationary pressures, and force the Federal Reserve to “tamper” their monetary stimulus program and dampen demand by increasing interest rates.

References:

  1. https://www.bls.gov/news.release/cpi.nr0.htm
  2. https://blog.massmutual.com/post/markets-inflation-vanderburg
  3. https://www.schwab.com/resource-center/insights/content/is-1970s-style-inflation-coming-back
  4. https://www.schwab.com/resource-center/insights/content/schwab-market-update
  5. https://www.theguardian.com/business/2021/jun/10/us-inflation-highest-rate-stocks-consumer-price-index