The temperatures this time of year aren’t the only thing running hot. After staying in the background for the past 20 years, inflation has come roaring back.
Prices of used cars, coffee, meat, fruit, and gasoline have all contributed to a 5.4% inflation rate this year. You have to go all the way back to 1974 to find a year where inflation topped 5%.
WHY IS INFLATION BACK?
What are the reasons behind these price increases? One component can be attributed to supply chain disruptions caused by the pandemic. Another factor is the unprecedented government spending that has created a “witches brew” of too much money chasing too few goods. Every Econ 101 student recognizes this as the classical inflation scenario.
Those in the government say the current inflation cycle is “transient.” Only time will tell if that's true, but generally, once inflation heats up it’s usually “sticky.” Professor Eugene Fama said recently “Historically what’s happened is, when there’s a spike, the spike persists for a long time. Inflation tends to be highly persistent once you get it.”
WHY DO YOU INVEST?
It’s worthwhile to remember that the primary reason for investing is to maintain the purchasing power of your money. The only way to do that is by investing in “risky” assets like stocks that historically have provided returns in excess of underlying inflation. Willingness to accept some uncertainty is ultimately the reason for these returns. You don’t get the returns without the risk.
Some investors believe they should try to time the market in order to navigate inflation expectations. Opportunities for missteps are plentiful. Sticking to your long-term strategy serves you better.
Is inflation a meaningful signal or does it amount to random noise? Historically there are recurring patterns that appear in the broad economy and the markets. It’s easy to misinterpret noise and wreck your investment strategy.
In the modern world, investors process random information in a way that tends to extrapolates the immediate economic/market data well into the future. It’s instinctual to flee danger, but these emotions can work against you when making money decisions.
HOW TO MOVE FORWARD
For investors saving for retirement or already retired, inflation can be extremely problematic. Erosion of purchasing power is enemy number one. Even with the 2% per year inflation we have experienced over the past 20 years or so, the purchasing power of an uninvested dollar has been cut almost in half.
It’s understandable why investors worry so much about noisy markets. After all, fear is the main output of the financial media. The past 18 months have surely brought that point home. It’s easy to let random noise drown out the signal. Just remember history, not headlines and the signal, not the noise. Start there.
Related: Is It Time to Change Your Portfolio