Equity markets have continued to reach all-time highs in 2021. The optimism that drove markets to those highs has now been impacted by inflation concerns. Investors are increasingly worried about inflation and how it might impact their portfolios. Here’s an overview of what inflation is, how it is measured, why we’re experiencing high inflation, and how to review your investment portfolio with inflation in mind moving forward.
What is inflation and how is it measured?
We measure inflation by the Consumer Price Index (CPI), which is defined by the U.S. Bureau of Labor Statistics as the change in price of all goods and services for urban household consumption. Inflation tends to rise when you have too many dollars chasing too few goods. In short, it is a lack of production.
Why are we experiencing rising inflation right now?
Since the start of the COVID-19 pandemic in 2020, there have been three rounds of stimulus funds sent out to help offset the devastating impact of COVID-19. Additionally, the savings rate went up significantly during that time for people who still had jobs but were not spending their income on travel, dining, and other entertainment due to restrictions.
Now that the vaccination rate is increasing and restrictions are loosening, consumers are ready to spend the savings they’ve grown throughout the past 15 months. However, with so many businesses having experienced production reductions last year, there is not enough supply to meet consumers’ demand.
This results in the rise in price of goods, or CPI. For the 12-month period ending in April 2021, CPI increased to 4.2%. For comparison, the CPI has averaged 1.70% on an annualized basis over the previous 10 years, so the current inflation rate is significantly higher than previous years.
What does high inflation mean for investors?
The question for investors is “Is higher inflation a long-term trend?” While the risk of inflation is clearly real, there are reasons to believe higher inflation may only be temporary.
One of those reasons is the improving unemployment rate. The current U.S. unemployment rate is 6.1%. In April of 2020, it was 14.7%. Americans are returning to work and businesses are getting the additional help they need to meet consumer demand.
Another reason is that we have a highly efficient economy that has benefited from technological advances that have improved worker productivity over the last 40 years. Additionally, the Federal Reserve has committed to keeping interest rates low until unemployment is near 4% thus allowing for additional capital formation.
What can we expect moving forward?
The last time the U.S. suffered through high inflation rates was the late 1970s and early 1980s, and since then, the world’s capacity to produce goods and services has increased significantly. Unlike in the 70s when only the U.S., Canada, Australia, Europe and Japan were considered “first world” countries, we now have countries like China, South Korea, Taiwan, Mexico, Brazil and Vietnam all contributing to production to meet consumer demand.
Moving forward, it will be important to evaluate the risk of inflation as it relates to portfolios. The unemployment rate, statements from the Federal Reserve, the CPI, global production data and corporate earnings are all key factors to watch to evaluate if inflation will be a trend.
Jason Egge is a Financial Advisor with Securities America, Advisors, Inc. Securities offered through Securities America, Inc., member FINRA/SIPC. Advisory services offered through Securities America Advisors, Inc. Bankers Trust, BTC Financial Services, a division of Bankers Trust, and Securities America are separate companies. Securities America and its representatives do not provide tax advice; it is important to coordinate with your tax advisor regarding your specific situation.
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