It’s not too hard to notice that everything costs a lot more than it did a year or two ago. It seems like everything- from gas to housing to food at the grocery store- is considerably more expensive. And with these surging prices come scary doomsday headlines and new investment and inflation fears. The talking heads have already painted grim pictures of relatively normal inflation turning into runaway hyperinflation that will diminish the value of the dollar and bring about the demise of our country. The thing to keep in mind is that as an investor, you will always face an imminent “apocalypse du jour” or crisis waiting right around the corner. In the last 16 months alone, the financial “news” has claimed several imminent crises that would devastate the market:
- Covid-19 (Our own modern-day Black Plague!)
- The Election (Both sides claimed it was the end of American democracy if the other candidate won!)
- Overvaluation (The market’s all-time high is a market bubble that will implode at any moment!)
- Gamestop/Robinhood/Dogecoin (This meme madness will surely cripple the mainstream capital markets!)
All of this is not to deny recently rising prices and inflation fears. That begs the question- what is causing this recent inflationary pressure?
Drivers of Inflation
As far as factors driving inflation, we can point to supply chain imbalances leftover from the pandemic, an exploding economy, and massive fiscal and monetary accommodations as factors causing inflationary pressures. Although we have observed prices and wages rise recently, it does not mean high inflation is a foregone conclusion or that it will be long-lasting. For instance, we expect that some of the supply imbalances resulting from the Covid-19 pandemic will work themselves out. Economic growth will also eventually move back towards its long-term trend, and the Federal Reserve won’t stand by and let inflation run away.
Risks to Investors
When the prices of goods and services increase over time, consumers can buy fewer of them with every dollar they have saved. For example, about 100 years ago, nine cents would buy a quart of milk. And today, nine cents would only buy about seven tablespoons of milk. This erosion of the real purchasing power of wealth is called inflation. Therefore, keeping pace with inflation is a crucial goal for many investors, particularly those in or approaching retirement.
Hedges to Inflation
Due to some of the recent headlines, some investors may be tempted to pare back their stock market exposure in anticipation of long-term hyperinflation. However, inflation isn’t a signal to flee stocks. In fact, it’s the very reason we own them in the first place. Because over the long-term, mainstream equities have been the most efficient hedge against inflation. For example, from 1926-2020, the S&P 500 has returned an average annual compound return of 10% whereas CPI inflation (a common price benchmark for a basket of basic goods and services) has compounded at just less than 3%. This long-term growth of your purchasing power is the precise reason why your portfolio should likely include a diversified basket of stocks to a certain degree.
This stands in contrast to gold, which is often touted as a hedge or protection against inflation. But compared to mainstream equities, gold has actually been one of the least effective inflation hedges one could have owned. It is far more volatile than a broad basket of stocks such as the S&P 500 and has significantly trailed the S&P in performance over the long term.
Regardless of what will transpire, goal-focused long-term investors shouldn’t make major portfolio changes in anticipation of an event we can’t predict, quantify, or time accurately. Please contact us with additional questions about inflation fears or any other.