By Mark Colgan, CFP®
With the recent trend of government spending, many people are becoming concerned about inflation. They ask not just with curiosity but with fear that the purchasing power of their savings may deteriorate. A reasonable concern.
Inflation can show up in one of two ways; either in the increasing prices of goods and services or in increasing asset prices. In this later instance, it would mean the prices for stocks, bonds, and housing would escalate. Today many economists feel asset price inflation is more of a concern. This phenomenon can be explained by looking at the drivers behind each type of inflation.
Inflation of Goods and Services (as measured by CPI)
Interestingly, the CPI has not budged as of late. As seen on slide 33 below, since 1983 CPI and core CPI have ranged between 1.6% and 3.9%. There are three reasons for this.
- The large and growing trade deficit. Because Americans continue to buy products overseas, the American-made products must keep their prices low to remain competitive. Additionally, lower costs for foreign manufacturing means more imports and lower costs to consumers. For example, almost all of the products sold at Walmart are made abroad.
- The rise of eCommerce. Never in history have consumers been better informed about the prices of various products. Online technology and merchants make it remarkably easy to discover who is charging what for nearly any product or service. Another point is that the middleman—and their costs—have largely been cut out. As a result, products are being more commoditized and price sensitive.
- The United States is much less reliant on energy from foreign countries. In fact, the U.S. has become a swing producer in energy markets, even exporting energy for the first time in 2019! This independence gives the U.S. much more control over commodity prices than ever before—a strong position that we could only have dreamed for back in the ’80s during OPEC.
So, if these things don’t change, then the inflation of goods and services is likely to stay in this low and narrow range. A contrarian would point out that around the world the pandemic has disrupted trade, driving up the cost of shipping goods. As a result, companies increasingly may not be able to justify the cheapest production facilities. This problem supports more production in the United States but raises the cost of producing products, pushing prices higher.
Asset Price Inflation
One reason asset prices are getting pushed higher is because more and more investors are buying stocks on margin. Because investors are able to borrow at low interest rates, the temptation to leverage investments has nearly tripled in 10 years. This is a significant flow of extra money into equities.
In addition to an increased money flow into stocks resulting from attractive margin rates, many believe that income inequality is a factor. More specifically, as the wealthy get wealthier, they buy more stock, bonds and real estate (assets). This phenomenon is better understood when inspecting the rising inequality of household income. Per slide 27 below (as measured by income), the bottom 90% of consumers typically spend 99% of their income, yet the top 10% only spend about 64% of their income. This leaves the top 10% with substantially more discretionary income, and as of late, the trend has been for them to invest it in real estate or the stock/bond markets. So, one could easily conclude that as the inequality of income continues to increase, the wealthy have more and more income to deploy into assets. This simple demand pressures asset prices to go higher.
However, this trend may reverse in the coming year. Not just because the government stimulus continues to pour trillions of dollars into the economy, but more so because it is purposefully and disproportionately being given to lower-income households. And as mentioned previously, it is this group of people that typically spends 99% of their income on goods and services. So, it is very possible that the accumulated savings and pent-up demand will release trillions of dollars into goods and services in the next 6 to 12 months. If so, this would likely result in inflation of goods and services, creeping up from 2% to possibly 3% in early 2022.
Arguments Against Higher Inflation
To some degree, we are just experiencing a variation of “reflation,” where some products are simply returning to the long-term trend. This reset is normal and in and of itself does not mean inflation will continue much past that. Additionally, one could point out that while consumer confidence has improved, it’s yet to translate to a significant spending increase. And if the growth in consumer confidence stalls, the pent-up demand will not translate to a surge in purchasing.
We’re Here to Help
The key takeaway is that inflation is likely to emerge, one way or another and depending on how investors position themselves, they can benefit or suffer from it. If you’re concerned about inflation diminishing the power of your savings, the good news is that you don’t have to continue your financial journey alone.
At Montage Wealth Management, our approach to financial planning incorporates life’s important changes (including inflation). Whether or not inflation is on the horizon, are you prepared for what comes next? Our team is here to help you face whatever lies ahead and make the most of your assets to help reach your goals. Call us at 585-419-2270 or email us at email@example.com to get started.