Inflation – Here to Stay
Like most investors, I’ve been surprised by both the magnitude and persistence of the inflation spike we’ve seen over the past several months. The forecasts continue to suggest that inflation should moderate somewhat by year-end and into 2023, but that doesn’t take the sticker shock out of the prices we’re paying today at the store and especially the gas pump.
The COVID pandemic badly scrambled supply chains that were already under stress from four years of rising trade tensions and tariffs. The third world countries where much of our goods are produced were hit hard by COVID, interrupting production as factory workers got sick and local efforts to slow the spread of the disease disrupted schedules and shipping. In addition, shipping containers were sent all over the world with supplies to help fight the pandemic. Finally, here at home, dock workers and truckers were hit hard by COVID so there were fewer people available to unload the ships that were allowed into port and get those goods to their destinations.
At the same time, the massive efforts by Congress to support the economy during the pandemic put money in people’s bank accounts that wasn’t being spent on things like eating out or travelling, so most peoples’ spending turned to manufactured goods and projects like home renovation. This economic support, low interest rates and a lot of pent-up demand has meant that American consumers have been on a spending spree for the past year or so.
An excess of demand on top of a constrained supply of goods has resulted in rising prices for the goods that are making it to market. While consumers have recovered their appetite for spending, workers have been slower to return to the labor force. Estimates vary, but there are roughly 1 million fewer workers in the labor pool today than in late 2019 when the pandemic began. Companies cannot find enough workers to fill the job openings in a red-hot economy and are paying the workers they do have more to keep them. Wage inflation like this is harder for companies to pass through to end consumers, but it does impact how they set prices in the future.
Just as it looked like things might be starting to improve, the Omicron wave hit hard in China and Russia invaded Ukraine, sending food and energy prices skyrocketing. This has contributed to additional increases in energy costs, even though the U.S. has been less impacted than other countries more dependent on oil and gas imports. Global food prices have also been impacted as Russia and Ukraine are two of the largest exporters of wheat.
Recent readings on inflation have been stunning, hitting heights not seen since the 1970s. In March, prices as measured by the Consumer Price Index rose by 8.5 percent from the prior year, though some hints in the report suggest we might finally be seeing a peak in the rate of change of prices. Most economic forecasters believe that prices gains will moderate, settling down to around 2.5-4 percent in 2023. That’s higher than we’re used to, but lower than recent readings.
In the meantime, economists debate just how temporary the inflation will be. On the one hand, getting back to something like a status quo would suggest a return to the modest inflation (around 2 percent) we’ve seen over the past two decades. A counterargument suggests that aging populations in the U.S., Europe and China, coupled with immigration restrictions and nationalist policies, could result in significant labor shortages and keep inflation on the higher end of that range for some time to come.
Persistently higher inflation could result in investors demanding higher interest rates than they have in the past, raising the cost of borrowing across the economy. In addition, expensive growth stocks that benefit from low inflation and low interest rates may lag other stocks that are less sensitive to perfect economic conditions.
So, while Inflation may be a transitory problem, it is a force to be reckoned with. Left unchecked, it can cause real damage. Central banks will work to tamp it down without stalling the economy in the process. All eyes will be on the Fed as they respond to the inflation surge. Buckle up, folks, we’re all in for the ride.
This column is prepared by Rick Brooks, CFA®, CFP®. Brooks is director/investment management with Blankinship & Foster, LLC, a financial coach specializing in financial health for physicians and people in or preparing for retirement. Brooks can be reached at (858) 755-5166, or by email at rbrooks@bfadvisors.com. Brooks and his family live in Mission Hills.
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