Articles

Worried About Inflation?

| By Matthew Snider

The topic of inflation and high prices has caught a lot of people’s attention this year. Talk to anyone that is building or remodeling a home and they can tell you how the price of lumber has skyrocketed recently. 

The Labor Department reported the March consumer price index, what consumers pay for things like groceries, clothing, vehicles, etc., for the year ending in March, has increased by 2.6%. That is the largest 12-month increase since August 2018, up 0.6% from February. 

Causes for the Increases

The biggest contributor was gas prices, which were up 9.1%, accounting for almost half of the monthly increase. Of course, part of the increase in gas prices was attributed to production problems resulting from severe winter storms. Issues like these tend to be a temporary shock to prices and certainly something for us to watch.

Beyond increasing gas prices, economists point to the pickup in inflation resulting from businesses with more pricing power now than they have had in a while. With a population that has been dealing with restrictions and closures over the past year, there is pent-up demand and eagerness to get back to enjoying activities they haven’t been able to. This, of course, means spending money.

One interesting fact of the pandemic is that most individuals who have received stimulus money over the past year haven’t spent it all. In fact, about 40% of the stimulus money is still sitting in savings accounts. When spending starts to pick up, a big benefactor will likely be the service economy. We saw prices for airfare, hotels, and sporting events tickets all increase last month. 

The Recovery Will Continue

Economists anticipate inflation to peak at around 3% in early summer, before trending to about 2.6% by the end of the year. While this is a higher reading than we’ve see in recent years, it is below the average of 3.7% since World War II.

The Federal Reserve keeps a close eye on inflation, and while they have acknowledged allowing it to drift above their 2% inflation target, they will be very closely monitoring its activity.

An important characteristic with near-term inflation data, as we progress into spring, is that at this time last year, prices on gasoline and oil had dropped dramatically. As the recovery continues, the percent increases over last year can be quite large. We saw this in March with gasoline and oil prices both up over 20% from March 2020. 

Now with the bump in inflation, we have been receiving more questions about potential investments to use as a hedge. At this point, we feel that a stock allocation will serve as an appropriate inflationary hedge. 

One reason is we expect that with the economy anticipated to grow at a high rate, this should translate into strong earnings growth for companies. Strong earnings tend to translate into higher stock prices.

Cyclical companies in industries such as materials, industrials and financials could be some of the biggest beneficiaries of this strong growth. Based on this, international stocks should be a consideration since these economies have larger allocation, currently 57%, to cyclical sectors compared to 38% in the U.S.  Looking at just estimated earnings growth, the MSCI All World ex-U.S. index is at 35% compared to 25% for the S&P500. This points to the potential for outperformance of international stocks. As we’ve seen in the past, trade tension and currency fluctuation can impact returns for international investments, so this, too, is worth monitoring throughout the year.

Inflation Hedges

Beyond stocks, there are a few other areas that have traditionally been used as an inflation hedge. Treasury Inflation Protected Securities, or TIPS, are treasury bonds that are indexed to the CPI. They will outperform Treasuries if inflation rises, but could underperform in a deflationary environment. It is important to realize that TIPs are long-term Treasuries. At this time, they don’t offer attractive yields.

Real estate can be an inflationary hedge. A word of caution is that not all real estate investments are created equal, especially given the impact of the pandemic. For most of us who are homeowners, we already own a real estate investment. With the strong housing market, our home values have been rising. 

Commodities may be the purest play on inflation. However, with the long-term uncertainty surrounding oil and gas, which make up large portion of the major commodities indices, one may want to be selective with investments in this area. 

Finally, gold would be a possible candidate.  It has traditionally performed well during periods where there are concerns about currency debasement and government creditworthiness. For the year, gold is down about 6%.

Finally, we’re monitoring the inflation data and feel comfortable utilizing stocks as our inflationary hedge at this time. If things change, we may elect to enter into some of the other asset classes mentioned. If you have questions or concerns, feel free to contact me.

DISCLAIMER: Past performance does not predict future results. This report is based on data obtained from sources we believe to be reliable. Hefren-Tillotson does not, nor any other party, guarantee the accuracy or completeness of this report or make any warranties regarding results obtained from its usage. All opinions and estimates included in this report constitute the firm’s judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation to buy or sell the securities herein mentioned.