What about inflation?

We’ve had several discussions about inflation lately.  Inflation is everywhere you look– the summer trip and rental car you just booked, last week’s grocery bill, gas back to $3/gallon, and your neighbor’s house just sold for $60,000 above ask, all cash, no inspection required!  Here are the two most common questions we’re discussing around inflation.

Will inflation be transitory?

The word transitory will make a case for trending word of the year (at least within financial media).  We believe the rate of inflation may be transitory, but absolute price levels are likely here to stay. 

For example:

You bought lunch for $10 last year.

Twelve months later, the same lunch costs $11.  That’s 10% inflation.

Another twelve months go by, and your lunch costs $11.22.  That’s 2% inflation.

Thus, the 10% rate of inflation was “transitory,” ie not going up 10% every year. However, as a consumer we think, “I remember when lunch was only ten bucks two years ago!”

Now a few pockets of industry are having a unique spike in prices driven by hot demand and supply chain issues such as used cars and lumber.  Major shipping squeezes across global ports and semi-conductor chip shortages have also contributed to concentrated jumps in price.  As these supply chains come back online and pent up demand is serviced, these specific pockets may see prices decrease.  But in general, don’t expect the majority of prices to decline over time, even if the rate of increasing prices proves transitory.

What should I do in an inflationary environment?

Our three favorite tools to use during an inflationary environment are:

1.       Dividend growing stocks: quality businesses can pass rising costs to customers, so profits continue to rise, and dividend payments grow with or faster than inflation.

2.       Borrow with fixed rate debt: for example take a 30 year mortgage with a fixed 3% interest rate.  The payment for the 1st month will be the exact same as the payment 29 years and 11 months later.  Inflation over time would make the payments feel cheaper to the borrower and worth less in real purchasing power to the lender. 

3.       Real Estate: As a hard asset, real estate like your home has historically kept pace with inflation.  This dovetails with fixed rate debt; the value of the property may increase over time while the fixed payments tied to the property decrease in real value.

If your bank pays no interest on your cash deposits and inflation moves higher, you will experience a negative real return.  In an inflationary environment, holding cash long term that’s earmarked for investment (beyond your normal reserves) is NOT the place to hide! Having a defined plan for putting cash to work is key.

Most importantly, high inflation is only one possible risk, not the sole risk to portfolios.  We build long term financial plans and diversify portfolios with the goal to withstand multiple risks, including high inflation.

Andy Michael, CFA

Portfolio Manager