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If you recall from our Fourth Quarter Economic review, our topic was Stay on Target. At the end of the newsletter we stated, “Targets can shift or be moved” and “we need to know how to separate the news from the noise.”
As we have seen from rising inflation during the second half of 2021, the theme of stay on target remains true. It is important to research the drivers of the increase in inflation, what has been impacted, and what the future may hold.
We have all seen the news headlines stating that this new hyper-inflation is the highest it has been in over three decades and people were eating Thanksgiving meals from a can this year.
While they are not completely wrong, we must digest this news, determine how bad it really is and assess what can be done.
When reviewing the data provided by the Bureau of Labor Statistics, it is clear inflation has been rapidly increasing and it is high. It is also important to see what inflation rates have been at in prior years.
We cannot predict the future, but we can generate a plan that will reduce the casualties of certain events. Having a plan makes unforeseen market and economic events more tolerable.
Inflation has caused many of us to worry about the rising prices of goods and services. The Consumer Price Index, or CPI, is a measurement used to track inflation provided by The Bureau of Labor Statistics.
We have all seen our grocery bills go up, gas prices soar, and the news headlines about hyper-inflation. It is important to take a step back and look at what is driving this.
From this chart on the left we can see the history of inflation and on average we should be around 2% a year. From 2013 – 2019 we averaged 1.8%. The low rates from these years have made the spike in inflation seem dramatic in comparison.
This chart below illustrates recent core CPI in the last two years compared to our baseline of 2%. Core CPI is the same basket of goods that makes up CPI but takes out food and energy.
It was below 2% for the first year of the pandemic and is now above 2%.
INTEREST RATES & CONSUMER SENTIMENT
Interest rates will be important to watch. As inflation increases, it is a widespread practice for the Federal Reserve to raise rates to try and slow spending and lending which is a driver of inflation. Here we see rates are higher but not dramatically so.
Consumer sentiment has started to decline in the last month.
Our research indicates this is due to Americans lacking confidence in our ability to implement policies to reduce inflation.
While sentiment is declining, spending remains strong. This is unusual. Typically, consumers react by reducing spending.
Supply chains have also been at the top of headlines. The bottlenecks from imports have caused headaches for companies and consumers. These issues have had a direct impact on inflation and the increase in prices.
For example, the cost of renting a shipping container has risen from $4500 a container in September 2020 to over $25,000 as of September 2021.
However, there does appear to be a light at the end of the tunnel. Auto manufactures who had to cut production due to semiconductor chip shortages, have reported factories and production lines are back to full operation. The backlog of container ships waiting outside the ports also declined more than 50% during October and November.
The Baltic Exchange Dry Index, which is a leading indicator for inflation and measures the cost of shipping materials, has declined since peaking October 7, 2021.
UNEMPLOYMENT AND LABOR DEMAND
We continue to see record job openings and strong demand for labor. Unemployment levels have also declined significantly since the height of the pandemic.
This implies that inflation will decrease in the near future.
As labor and wages increase, we hope to see productivity increase which would be a win-win for the consumer and the producer.
Economic activity continues to increase. Travel, hotel occupancy, and spending is increasing and moving closer to pre-pandemic levels.
This demand has been a factor in higher prices of airline tickets and average hotel room prices.
This demand is increasing prices.
HOUSEHOLD NET WORTH
Household net worth has been increasing steadily since the financial crisis of 2008-2009. It continued to increase even during the pandemic. Household debt has declined sharply over this same time.
This debt service ratio is an indicator that even through an increase in inflation, most Americans are positioned to afford the increase in prices of goods and services, and we are starting to see credit card debt increase as of late.
It is also a key reason Americans are leaving the work force…because they can!
THE DOLLAR, RATES, AND STOCKS
The US dollar remains strong and will lead foreign countries to continue buying US debt and invest in US companies’ long term. This will offer a counterbalance to rising rates and will be a positive influence on the real estate and stock markets.
The first week of December was an important one. The Fed announced that they will “accelerate the taper” and they are likely to have two rate increases in 2022 instead of one. Yields on the 10-year Treasury declined, and the stock market suffered four straight weeks of declines.
This has caused growth stocks to correct. This is a necessary and expected correction. We are incredibly careful not to make substantial portfolio changes at the end of the year for tax reasons
However, our Investment Committee is watching our Christmas list of great companies whose prices are too high (in our opinion) but are getting closer to reasonable buy ranges.
Our base case is that the Fed and the natural economic forces will allow inflation to drift to more normal rates but not “get out of control.” We are sticking with our long-term strategic allocations and using corrections to rebalance portfolios.
CORPORATE EARNINGS AND GDP
Corporations are seeing strong earnings reports and employees are seeing benefits as well. These are all indicators of a healthy economy with continuous growth.
GDP has risen from pandemic lows and are close to pre-pandemic levels. We will have to see how the Covid variants affect travel and leisure companies and their growth and outlook.
FROM THE DESK OF
ALEXANDER WOLFE, CFP®, Associate Planner
SCOTT PINKERTON, CFP®, CIMA®, CPWA®, Partner, Planner
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