I’ve heard the word “Inflation” more in the last few months than in the past few years.
Many younger people, some on my staff, have never heard the level of discussion around “Inflation” such as we do now. It seems appropriate then that some discussion is warranted here.
First, for those of us who remember the inflation of the 1970’s, with mortgages at 17% and money market rates at 12% or more, should we expect this history to repeat? This one is easy – a resounding “NO” at least in the near to mid-term, and not likely for the longer term of five to ten years. How do we know this? The Federal Reserve and many economists tell us that while we will certainly get a “transitory” increase in prices of goods, these increases will not last long but will even out and decrease back to an expected trend of 2% annual rise. That’s a far cry from the inflation of old.
This transitory rise in prices of “stuff” has been partially caused by cash building up in our checking accounts because we couldn’t spend on many things we might have liked during the pandemic. Also, for the first time ever stimulus money was sent directly to consumers, not financial institutions. Now that the economy is opening, the population is getting vaccinated, restaurants and entertainment venues are opening, we are spending – if the product is available. And that’s another problem which may push prices higher – supply chain bottlenecks – which we are told will also be transitory.
We may see inflation as high as 5% in the short term as everything from groceries and gas to houses and rental cars has been effected by the increased costs and availability of the raw materials which go into the finished product. But, as supply and demand come back into more equilibrium, semiconductors will become more available and the prices of lumber and copper, for example, should settle down.
What is still missing from this picture, and was a key driver of the 1970’s inflation, is wage inflation. To date, manufacturers and importers here in the US have been able to absorb most of the increases in the supply chain costs, and consumers have had the money to absorb the rest of the increases in the cost of that end product. The greatest cost to any business, however, is the cost of labor; as long as that cost remains close to an acceptable growth rate every year (missing for the last decade or more) inflation should remain within the acceptable, even desired, range of 2% to 3% as telegraphed by the Federal Reserve.
The stock market has priced into current valuations the assumption that the inflation trend will remain tame in both the manufacturing and the services sectors even while near term growth in the economy will run hotter than we have seen in over a decade. The stock market will enjoy the dual benefits of low interest rates, low inflation and above average GDP growth. Jeremy Siegel in a recent presentation states that a P/E (price/earnings) ratio of 20 is now the New Normal. In other words, a favorable confluence of low rates and a growing economy mean valuations can be higher than would have been deemed “too high” in past cycles. We are more than cautiously optimistic for a positive year for equities.
As always, we look for the opportunity in economic cycles, and we see opportunity today in International positions where P/Es are lower and dividends are higher. With the tailwind of a weak dollar and a hotter growth in the US expanding out to our European and Asian trading partners, we expect ex-US investments to add value to portfolios this year.
While our bond positions are not poised for what I will call opportunity, those positions will continue to offer a buffer against any negative volatility in the stock market, and so deserve a position in all portfolios.
To get a more detailed and graphic look at our outlook for both the economy and the investment trends our portfolios will be built on, we encourage you to join our Quarterly Investment Outlook call in July.
From all of us here at Erickson Advisors, Happy Summer! Wear a mask where you must and enjoy the outdoor events where “socially distanced” is the only request to keep us all safe and healthy.
The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change with or without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results. Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing