||Inflation – A Predictable Surprise
by Craig Swanson, Senior Asset Manager
In life there are many things we would label as “predicable surprises.” For instance, many people who don’t save regularly are surprised when they don’t have enough money to retire. Planning ahead for things we know are likely to happen makes us more successful at reaching our goals and fulfilling our values. One “predictable surprise” we foresee is more quickly rising prices, or inflation. We don’t know when inflation will rise or by how much, but based on history, the government and the Federal Reserve’s current policies, and everything we know about economics, we feel confident that at some future time inflation will rear up again.
Inflation is the result of two primary factors: First, too many dollars chasing too few goods; or second, a limited supply of labor or materials. When the Federal Reserve “prints” money, they increase the money supply, which results in more dollars to buy the same amount of goods. Subdued bank lending has kept the money supply in check, but eventually the Fed’s money printing is likely to result in higher prices. If the economy recovers, we will see an increase in demand for both people resources and raw materials; workers will be able to demand higher wages and material sellers will be able to increase prices. Companies will eventually push these costs onto consumers in the form of higher prices. We can already see this type of inflation occurring in the healthcare sector, where demand for healthcare is outstripping supply, resulting in a whopping 8% annual increase in costs.
We believe it is prudent to position retirement portfolios to plan for inflation. A traditional stock and bond portfolio is not sufficient. Bonds tend to do quite poorly during inflationary periods. When prices start to rise, interest rates usually rise as well, resulting in falling bond prices. Equities are a bit more complicated. Rising prices increase input costs, such as labor and raw materials, but also give companies the ability to raise prices. As a result, equities tend to perform well during periods of moderate inflation, but perform poorly in periods when inflation runs rampant. Adding assets that have the potential to perform well as prices rise is a key way to hedge portfolio against inflation. While we do not know when we will see an uptick in inflation, we do believe that higher inflation rates in the future are likely. As a result, we watch the markets for signs of this predictable surprise and strive to adjust our portfolios accordingly.