You cannot turn on the TV or read a newspaper without seeing articles talking about inflation lately. While you may hear economic data reported from time to time like GDP or unemployment rates, inflation is the one statistic that we can’t help but notice as it touches us so directly. The most recent monthly inflation estimate reported by the U.S. Labor Department was 8.3% for the month of April1. While down for the first time in eight months from March’s annual rate of 8.5%, it is a far cry from the 1.2% rate we experienced only last year. We haven’t experienced these levels since 1982, and it feels shocking to most of us.
Inflation is the annual percentage increase in the Consumer Price Index or CPI. The CPI measures what consumers pay for goods and services through a sampling of 80,000 items across 75 different urban areas in the U.S. Sectors include housing costs, energy, food, services, transportation and healthcare. Surprisingly, the one sector that we historically focus upon but has contributed the least is healthcare inflation. Recent increases in the rest of the sectors more than make up for that, unfortunately.
Economists have largely changed their outlook from their 2021 predictions. Last year, many economists predicted the rise in inflation would be transitory. As supply chain issues worked their way through and the economy returned to normal pre-pandemic levels, they believed inflation would subside. In 2022, economists now anticipate inflation will decrease from the forty-year highs we are currently experiencing but believe that the days of zero to one-and-a-half percent inflation that we experienced in the late 2010s are a thing of the past. According to a recent Bloomberg survey, economists expect full-year 2022 inflation of 6.9%, decreasing to 2.4% by 20242. Consumers are more bearish, according to a recent survey by the New York Federal Reserve, expecting inflation of 3.9% through 20243. While the current highs are not expected to be sustained, the consensus is that a higher level of inflation will remain.
Most directly, inflation affects the cost of goods and services we buy every day. Whether it is the price of gas or the cost of bread and eggs, our usual expenses have increased and there are fewer dollars in our wallets at the end of the month if we haven’t compensated and cut back on other purchases.
Corporations are also affected by inflation. Their profits are reduced to the extent that companies are not able to fully pass on their increased costs. Whether it is higher wages paid to employees or increased cost of commodities or other goods and services they sell, if the company cannot pass on those increases quickly enough, the company’s profits and stock price falls in the short term. As companies pass on their higher expenses and raise prices, corporate profits and their stock prices rise again along with inflation, making stock investments a potential way to keep up with inflation over the long term.
Interest rates are affected by inflation. The Federal Reserve increased the Federal Funds Rate, the rate at which banks borrow from the federal government, twice this year, most recently by 50 basis points (half a percent). The markets expect continued increases over the next year. Increasing bank borrowing costs tends to lead to higher interest rates on all types of loans. The increasing cost for businesses to borrow slows their rate of expansion. It also makes it more expensive for consumers to borrow, slowing consumers’ rate of spending, whether by reducing the amount they can borrow for a mortgage or increasing the interest expense on their credit card debt.
Stocks trade at a multiple of what investors expect the company to earn over time. Investors compare the future earnings to what they could either buy now or earn in an alternative investment such as owning Treasury bonds. As interest rates and inflation rise, investors are re-evaluating different investment opportunities, causing a period of volatility in stock prices.
A financial plan is based on assumptions including savings and spending rates and investment returns. Let’s look at each while remembering that a financial plan has a long time horizon that incorporates shorter term variability. As part of your plan, Moller Financial Services has and continues to assume a consistent rate of inflation over the long term.
We also utilize an annual increase in withdrawals to compensate for inflation, expecting that some years will have smaller increases and other years may have larger ones. When thinking about your own plan, consider the following. As daily expenses rise, are you still able to meet your savings goals you set in your plan? Can you adjust short-term spending plans to maintain your saving goals while working or your withdrawal plans if you are in retirement?
On the other side of the financial plan are the investment return assumptions. This is where a well-diversified portfolio with a systematic plan for rebalancing becomes most important. We examine your plan using a probability analysis of one thousand different sequences of positive and negative market returns to determine the confidence level of success for your financial plan, using history as our best guess for the future (although not guaranteed). Diversification tends to reduce portfolio swings as not all areas of the global investment markets will perform similarly all the time. As interest rates increase, we also anticipate some return from cash and fixed income holdings after so many years of near-zero rates.
As the markets continue to decipher what inflation means for the economy, we also anticipate a period of higher volatility. Our systematic approach to rebalancing removes the emotional ups and downs of investing from the equation and takes advantage of trading opportunities as they occur.
There are many uncertainties and twice as many opinions of what all the recent events mean – whether you are talking about the impact of Covid-19, supply chain issues, the war in Ukraine, government policies, interest rates or inflation. Taking a deep breath, being intentional with your short-term spending, and having a long-term financial plan that takes systematic advantage of market volatility are the best prescriptions for these uncertain times.
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