Strategies for the Road Ahead

An Inflation Report and Strategies for the Road Ahead

While some portions of the current inflationary spike may be temporary, the large increase in money supply, imbalances in supply and demand, and longer-term demographic trends suggest that a longer cycle of higher-than-normal inflationary pressures may have arrived upon our shores.

Federal Reserve Chairman Jerome Powell has stopped describing the current inflationary environment as “transitory” and a framework for raising interest rates over the next three years has been laid out. But while the headlines of the Consumer Price Index (CPI) are eye-opening, a more nuanced analysis is required. 

The CPI, the most-watched measure of inflation at the national level, rose by 6.8% over the last 12 months — a pace not seen since 1982. Stimulus and pandemic-related aid have bolstered consumer spending. Similar programs have helped businesses increase capital and capacity. Money supply has jumped to unprecedented levels.

Rapid increases in money supply often lead to an expansion in economic activity and to inflation. The US is also experiencing price shocks from supply chain disruptions and wages are rising at a more substantial pace. Each of these factors can be inflationary by itself, but in combination, can cause interest rates to rise rapidly.

In addition, over the past decade or more, Chinese labor had a downward pressure on prices of many goods.  Much of that impact is now in the past.

 Taking Action

The impact of inflation rates and rising costs are and will be different for each of us. In general, they tend to affect lower and middle-income earners more than those with high incomes. They typically hurt renters more than homeowners. They often impact retirees on fixed incomes more than working professionals. And they generally harm those with limited mobility or liquidity more than those who can pivot to counter rising expenses.

On the other hand, rent increases do vary geographically, utility price increases are not uniform across the country, and labor shortages will be more severe in certain industries. So in order to understand how much inflation and rising costs will impact you as an individual, you will need to assess your own situation and identify actions that can be taken to mitigate them.

The Basics

· Expense / Budget Review

Compare expenses now with those a year ago. Identify which items have risen and decide whether they can be lowered. Eliminate subscriptions and other items you may not be using. Buy local to avoid paying extra transportation costs for goods.

· Borrowing

Review any bank debt, reduce or eliminate variable-rate debt, and consider refinancing before rates rise further. Identify ways to have access to credit for future opportunities. Taking action isn’t all about playing defense. It’s also preparing to take advantage of opportunities that may arise.

· Homeowners

Homeowners should reassess insurance policies, as labor and material costs will cause property replacement values to rise dramatically over time, and some policies may not automatically keep up with inflation. Also consider whether larger projects can wait out labor shortages or supply-demand imbalances. When labor is short and materials hard to obtain, construction bids can be exceedingly high.

· Long Term Care

The price of long-term care can rise faster than allowed for in some policies, and changing policies may or may not be advantageous. If not, identifying backup liquidity or cash flow coverage may be warranted. 

Investments

There is no silver-bullet investment plan that can benefit from inflation and offset inflationary pressures with perfect correlation. As with most things, it is more complicated than it looks. History shows a loose relationship between various asset classes and inflation. Even gold, which is most often seen as an inflation hedge, doesn’t always benefit from inflation.

Key considerations here:

· Any portfolio adjustments made in reaction to inflation should factor in time duration. 

· In the short run, commodities tend to do well, as prices rise in the early stages of an inflationary cycle while most other assets tend to be more volatile.

· In the longer run, value stocks and real estate perform quite well as a result of inflationary cycles.

· Bond prices are negatively correlated with interest rates and tend to decline when interest rates rise. However, investors should be cautious about abandoning bonds in favor of a higher-risk asset class unless they can hold those assets for many years.

Consumer staples and healthcare companies, banks, and insurers are among several sectors that adjust pricing over time while controlling expenses. 

Conclusions

The real measure of progress toward any financial goal is seen best through analysis of your entire balance sheet. During periods of decline in stocks or bonds due to rising inflation, interest rate changes, or recessions, hard assets such as real estate may see a rise in value, and cash and other flexible assets may be stalwarts of liquidity. And since stock prices of quality companies and the value of real property tend to increase over the long run, owning these assets is one of the best ways to offset and even benefit from inflation.

As always, it’s useful to remember that a wise approach to investing involves having an allocation strategy that reflects current realities vis a vis future goals, the fortitude to stick with it through full market cycles, and a periodic review of the plan so adjustments can be made.