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Dear <<First Name>>,
As we wind down the last month of summer and prepare to lock into our fall and winter routines, hopefully you were able to get out (in some form or fashion) and enjoy yourself. Reconnecting with family and friends over the past few months was definitely a great experience for our family and pray you all were able to as well. One of the many things I noticed was the increase in prices: gas, food both in store and at restaurants, electronics, and of course housing among other items.
While the Fed continues to use the word “transitory” I am a bit skeptical that these prices are soon to drop to their prior levels. This month I wrote about inflation. Let me know your sentiments after reading it.
As always, thank you for reading these writings each month and providing your comments, thoughts, and questions, which continue to educate and inform me.
Walid L. Petiri
Chief Strategist
Financial Management Strategies, LLC
1330 Smith Avenue. Suite 7
Baltimore, MD 21209
(p) 410-779-1276
(f) 410-779-1302
Most people know this basic concept: “Inflation” is when prices go up. But prices are fluctuating all the time. When inflation makes the news, it's because the cost of a specific set of goods has risen over a defined period.
The tracking mechanism for these goods and time periods is the Consumer Price Index (CPI). Recently this gauge reported a level not seen in more than four decades as the annual inflation rate hit 5.4%. Further consumer expectations of future inflation were also higher.
The Federal Reserve has softened its stance on inflation, saying it will tolerate an average rate of 2% rather than treating that as the maximum acceptable rate. Measured by the U.S. Bureau of Labor Statistics, the CPI is reported monthly. The Bureau compares prices for the same goods month-to-month and year-to-year. The annual rate of inflation is the one figure most cited.
Inflation has been increasingly in the headlines lately. Some pundits say it's temporary. Others say it could lead us back to the economic doldrums of the 1970s. Still others remind us that hyperinflation can lead to chaotic social changes.
What's causing this inflation?
One cause is the costs of essential goods that urban residents are most likely to buy: food, gas, clothing, cars, medical care, utilities and housing, for example. Because the cost of certain categories tends to rise and fall each year, these prices are seasonally adjusted. One simple answer is that people have shown a willingness to pay more, and so prices have risen to reflect that. The pandemic has also disrupted the supply chain, and items that are scarce (or perceived as scarce) and in demand have been selling for higher prices. (For example, several months ago lumber prices spiked as supplies dwindled as people stuck at home decided to begin building projects.)
More money in circulation also contributes to inflation. As COVID lockdown rules eased, lots of people with pandemic relief money in their accounts decided to buy cars. As a result, prices for new and used vehicles have risen dramatically. Additionally, for the past year a supply chain shortage has pushed use car sales through the roof due to a shortage in computer chips that slowed car production to half its normal pace.
It’s also true that accommodative monetary policy, combined with extraordinary fiscal spending during the pandemic, is driving higher inflation expectations. It's easy to talk about inflation in an academic way. But quickly rising costs are hard on people whose pay does not keep up with the cost of living. This is one of the reasons the Federal Reserve aims to manage monetary policy to keep inflation in check.
The big question about the latest inflationary trend: Is it temporary? Already some prices in the CPI are leveling off. And economists point out that our steep annual rate is in comparison with last year's depressed prices. But nobody knows whether a higher rate of inflation is here to stay or not.
Should investors be worried that higher inflation is on the horizon? I would say, “Not worried yet paying good attention.”
The Fed is correct that the recent surge in inflation has been heavily influenced by the abrupt shutdowns and dramatic re-openings fueled by the COVID-19 pandemic. In addition, pandemic-related bottlenecks in global supply chains have resulted in shortages, driving up prices in certain sectors. Wages are also on an upward trajectory. The fight for higher a minimum wage and a living wage has found itself some broad market allies. The combination of millions of unfilled jobs, workers slow to or not returning to work and aging population without an influx of younger immigrants has wages in the first uptrend with potential staying power since the 1970s.
Now may be a good time to review inflation’s potential impact on your investments. First, we need to pay attention to is its immediate effect on performance. Inflation affects asset classes differently, some more positively than others. As we know over the long-term, from 1900 to 2017 stocks both beat inflation and had an overall return of about 11% per annum. Still, there were higher inflationary periods, like the 1970s and early 1980s most recently, where stocks had a rough time.
Investments in such real assets as real estate, energy, commodities, natural resources and farmland tend to hold up well. Precious metals, Treasury Inflation-Protected Securities (TIPS), private debt (loans) with floating interest rate terms and dividend-paying value stocks all tend to work favorably in rising inflation. This is because these assets show price appreciation during inflationary periods and/or provide income streams that grow as inflation rises.
On the other hand, growth stocks, valued in the present based on the higher growth rate for their future earnings, tend to get whacked in inflationary periods, as inflation causes the value of those future cash-flows to be worth less today. Likewise, long-term bonds and certificates of deposit (CDs) can also be bad ideas in a rising inflationary period, as they lock into a future interest rate that is likely to be less than the market is currently paying. Fixed income securities also generally perform poorly because inflation reduces the value of fixed payments.
For longer-term investors, the emphasis on higher real returns may be preferable. Historically, real assets have maintained their value during periods of rising prices, so making an allocation to this asset class can provide inflation protection. Commodities have historically also been a good bet during inflationary periods, as have floating interest rate adjustable loans (private debt). Which makes sense: For prices to rise it’s highly likely that the prices of commodities that feed into the various goods and services of an economy would rise, too.
Further, many dividend-paying value stocks are the manufacturing, industrial and finished goods producers with rising earnings due to growing prices of their products. Whether you select energy, metals, agricultural goods, private debt, dividend-paying value stocks or other commodities, most tend to rise during times of high inflation.
Decide today on what you would own should inflation stay high tomorrow.
by Walid Petiri
Walid Petiri is the owner of Financial Management Strategies, LLC (FMS), a Registered Investment Advisor established in 2000. He has over two decades of financial experience that covers virtually all areas of finance, from tax, insurance, stockbroker, personal financial planning, and personal banking to corporate credit, business planning, and consumer lending. In 2017 FMS Institutional Services was launched, and he leads the institutional consulting services delivered that include; investment policy preparation, asset allocation, manager search, due diligence and selection, and the design and implementation of diverse and emerging manager programs.
He is a graduate of New Jersey’s Montclair State University with a degree in both business management and finance. Mr. Petiri is a recipient of the Accredited Asset Management Specialist designation from the College of Financial Planning in Denver, Colorado.
Mr. Petiri has frequently been heard on WEAA (88.9 FM) as a financial commentator, who appeared on WMAR-TV 2 regarding the 2008 & 2009 economic downturn. Mr. Petiri has been interviewed and quoted by CNBC, the Investment News magazine, and Bankrate.com, written for the Journal of Personal Finance, The Register, Popular Finance (of China), Minority Enterprise Advocate Magazine, The Wall Street Journal, Aging News Alert, Morningstar.com, USAToday.com, TheStreet.com, Wall Street CheatSheet and publishes a monthly financial advice column called the Foresight.
Walid was featured in SmartCEO Magazine - Baltimore for the 2012 Top Money Managers Wealth Management. A member of Bethel African Methodist Episcopal Church, he is a devoted parent to his son and daughter. Walid serves on the Finance Committee of Associated Black Charities, and the Board of Directors for the Reginald F. Lewis Museum and has Chaired the Investment Committee.
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