With the recent spikes in the Consumer Price Index (CPI) and perceivable price increases at the gas pump and grocery checkout counters, there are mounting concerns over a resurgence of inflation. Interestingly, except for most of the baby boom generation, few people alive today have experienced real inflation, so several generations may not know what it is or how it could impact their finances or investments.
Whether the recent spike turns out to be transitory (short-lived) or a return to the sustained inflationary environment that we saw in the 1980s, now would be an excellent time to better understand the relationship between inflation and your money.
What Exactly is Inflation?
The first thing to understand is that inflation is always with us. That’s because, except for some brief interludes, the economy is constantly growing. Mild inflation, such as we’ve experienced over the last decade, is actually good for the economy. However, when the economy starts to overheat and demand starts to outpace supply, the increase in the prices of goods and services, as measured by the CPI, accelerates. At its simplest, inflation or rising prices is the result of too many dollars chasing too few goods.
Why Increasing Prices Don’t Necessarily Translate to Inflation
However, an increase in prices doesn’t necessarily portend the return to an inflationary environment. As we have seen over the last year, many of the price increases can be attributed to pandemic-related issues having to do with supply lines. Many suppliers shut down along with the economy last year.
With the economy reopening and suppliers ramping back up, there has been a lag between supply and demand in several industries, such as lumber. When the lumber supply lines catch up with demand, as it is now, prices will recede. The same is happening with food and gas production. To some extent, the higher prices we’ve been experiencing in many products are likely to be transitory, which is not inflationary.
What About the Massive Government Stimulus?
In recent history, inflation has been more of a creature of the money supply. Staying with the traditional “too many dollars chasing too few goods” definition, a sharp increase in the money supply by the Federal Reserve can also trigger inflation. The massive injection of government stimulus to boost the economy and almost unbridled printing of money by the Fed to keep interest rates low has sparked inflation concerns.
However, at least until recently, those cheap dollars have not been finding their way into consumer prices.
Keep an Eye on Wage Growth
Of greater concern is the sharp increases we’re seeing in wages, which, if it continues, could be inflationary. Higher wages create higher demand and, unless the economy continues to chug along, it could begin to outpace supply, which would increase inflationary expectations. But are the wage increases temporary in response to a higher demand for workers? Or will the trend continue, which could lead to a longer-term supply-demand imbalance?
One or Two Months Does Not a Trend Make
The thing about any of these factors—price increases, money supply, wage growth, or any others—one or two months is not enough to determine a trend. All factors that impact inflation must be measured over quarters or years. Even if some higher prices persist for a year or two, it doesn’t necessarily mean we are in an inflationary cycle, which tends to last for several years or more.
Please don’t misunderstand me. I’m not trying to sugarcoat what people are experiencing right now. Everyone is feeling the pinch of higher prices, unlike anything we’ve experienced for more than a decade. As consumers, we all need to grin and bear it, hoping they turn out, as many experts believe, to be short-lived.
Investors Need to Keep Their Investing Hats On
However, I am concerned about how investors are reacting to the doomsayers hyperventilating over a return to inflation. All this discussion about inflation becomes a distraction for investors with a long-term outlook and investment portfolios built to withstand the various economic cycles.
Do these factors affect the stock prices in our portfolio? Yes, but primarily due to the contagion of temporary, short-term concerns, which affects nearly all stock prices. But fundamentally, nothing has changed with the companies in our portfolio. All of them are still well-positioned to capitalize on the strong tailwinds driving their growth. They were selected based on their demonstrable ability to generate cash flow and their willingness to reinvest their capital to strengthen their leading market positions.
Investors can inoculate their portfolios against the threat of rising inflation by investing exclusively in high-quality, well-managed companies with strong brands and dominant market positions. If they carry little or no debt, they are mostly immune to rising interest rates. If they dominate their markets, they enjoy the kind of pricing power that allows them to raise prices in response to inflationary pressure to maintain earnings growth.
