Gas prices above $5 and $6 per gallon. Spiking costs for airfare, cars, rent, and groceries. Significant declines in the stock and bond markets.
Earlier this month, the Department of Labor reported that in May, the Consumer Price Index (CPI) had surged 8.6% from May 2021. This marks the highest inflation rate in the U.S. since December 1981. (CPI is an index measuring what consumers pay for goods and services.)
What is causing the surge in inflation?
Perhaps needless to say, over the past year inflation has become a major economic and political issue. Both domestically and around the globe, rising prices have made a big impact on households and businesses alike.
There are a number of causes: Russia’s invasion of Ukraine and the continuing war there have interrupted the global supply chain, which had already been severely strained during the global pandemic and China’s recent Covid-related lockdown.
At the same time, there has been strong demand among consumers, who have more spending capacity due to low unemployment and wage growth, as well as emergency pandemic support.
Inflation more generally
High inflation is the unfortunate flipside of economic growth.
Recall that inflation, at baseline, means a loss of purchasing power over time. You can think of inflation as the annual change in prices for goods and services like food, clothes, travel, etc.
The Federal Reserve has a goal to maintain the inflation rate at around 2% annually. So the most recent rate of 8.6% is historically quite high and merits intervention by the Fed.
Responses
Unfortunately, there’s no pain-free path to easing this period of high inflation.
The main governmental tool for lowering inflation is the Federal Reserve’s ability to raise its benchmark short-term interest rate. After raising rates by 0.5 percentage points in March and May, the Fed raised rates by 0.75 percentage points in June.
It’s quite likely, over the coming months, that the Fed will raise interest rates again, with the objectives of reducing inflation and “cooling the economy,” if possible, without triggering a recession.
How long will this high-inflation period last?
It’s hard to say.
Even government economists and members of the Federal Reserve are reluctant to offer predictions. But there will be a sustained effort to reduce inflation.
More inflation means greater uncertainty for the economy. Businesses you’ve invested in might cut back on hiring or expansion plans. Households might reduce their spending.
These responses, naturally, can lead to reduced activity in the economy. And, as we’ve seen over the first several months of 2022, as interest rates rise quickly, the prices of stocks and existing bonds tend to go down.
What can help reduce the impact of inflation for your portfolio?
Diversify:
Stocks have historically been an important part of investment portfolios, as a means of increasing your purchasing power over the long-term.
As for bonds, rising interest rates do reduce the value of existing bonds. But, the higher rates mean bondholders will receive the benefit of more interest income over time. This can be a long-term benefit for savers.
Stay calm:
Headlines are blaring about inflation. This will likely be a major topic for the news media to cover over the months to come.
Generally speaking, the financial industry benefits when you feel panicked and pressured to do something, which often results in a transaction fee. But doing something, especially when asset prices have declined, tends to lock in losses.
And since timing when to re-enter the market after sales is exceedingly difficult, if not impossible, investors who sell often miss out on the recoveries that, at least historically, have followed.
Retain perspective:
As noted by The Wall Street Journal’s Jason Zweig in his “Intelligent Investor” column, “U.S. stocks, even after this year’s setbacks, have still gained nearly 13% annually over the past decade.”
“Invest like clockwork”:
Dollar cost averaging is another strategy that helps diminish the possibility of remorse about bad timing and/or subpar returns.
As Zweig writes, “Those who invest like clockwork tend to worry less about buying at the wrong time, making it easier for them to stay the course” and avoid selling at the wrong time.
Stay flexible:
When portfolios decline, some adjustments may be necessary.
For those nearing or in retirement, reducing spending, maintaining some continuing work and income-producing activity, and delaying Social Security until age 70 are all strategies that can help avoid the negative impact of selling during market declines.
Remain focused on goals:
The key priority is to stay focused on your goals.
If long-term, then the longer time horizon is likely to smooth out these inescapable rough patches. If shorter-term, then it’s important to ensure that your asset allocation reflects the shorter time horizon, with more bonds and fewer stocks.
As always, please reach out to your Park Piedmont advisor with any follow-up thoughts or questions.