In case you haven’t turned on the news, social media or been to a store in several months, prices are going up. Prices are up for housing, rent, cars of every type (especially rental cars), gasoline, groceries, airfares, cryptocurrencies and lots of other things I haven’t thought of but will probably notice on my credit card bill.
The headline consumer price index (CPI) as computed by the government’s Bureau of Labor Statistics is up 5.4% year over year – the increase from June, 2020 to June, 2021. Some categories are up a lot over the past year – energy is up 24.5%, used cars 45.2%, natural gas 15.6%, transportation services 10.4%. Remember when oil prices went negative last year? Now oil is $70 a barrel and gas is about a dollar more per gallon than last year.
Those increases all sound pretty imposing when you hear them reported in the news. I’ve heard lots of stories about how we are headed into a 1970’s style inflation – prices increasing with stagnant economic growth. I haven’t heard any positive spin on the 1970s economic environment; in the media; stagflation is about as popular as lake effect snow in late April.
The other side of the inflation story to keep in mind is what’s called the “base effect.” Since inflation is measured year over year, the base, or starting point is critical. In many cases, base measuring points from early to mid 2020 are very low. Looking back at the year over year inflation report from June 2019 to June 2020, inflation was just 0.6% year over year. Last year at this time in the middle of the pandemic energy prices were down 13%, used car prices down 2.8%, transportation down 7%. You get the idea, the “base effect” impacts how inflation is measured.
No one likes to see prices go up quickly, especially for things like gasoline, where the price is broadcast in huge numbers that are impossible to miss. Car prices and airline tickets are also easy to find online and notice when they’re up. The important point about “base effects” is that the start of the measurement is key. When you stretch out the measurement over many years, inflation has averaged about 2.7% per year over the last 20 years.
Is inflation going be permanently higher in the future? It seems likely that many of the dramatic price increases as the economy reopened will moderate. Lumber prices spiked but have already fallen back to pre-pandemic levels. Oil prices are $4 per barrel less than the $74 level they were at in late 2018. Copper, a reliable indicator of growth, is at the same price it was in late 2010. Wages have increased, but still at a moderate pace in recent years.
What is probably a safe bet is that prices will continue to go up at some rate. And that’s not a bad thing – if prices fell there would be no incentive to spend now because things would cost less in the future; the economy would suffer because demand and production would go down and less jobs would be needed.
As an investor, the goal is to earn enough to keep up with whatever level of price increases the future holds. What we know from the last 18 months is that bonds, CDs and fixed interest savings accounts aren’t keeping up. The 10 year US treasury bond is yielding 1.17% as of today. That means money invested in a treasury bond is losing about 1.5% of its purchasing power each year if we assume 2.7% annual inflation continues. 1.5% doesn’t seem like much until you add it up every year for 20 years, then it starts to matter.
Investing in an environment where some level of inflation is almost certain and interest rates are low means holding assets that can increase their value over time. Owning parts of companies that grow their earnings at a rate faster than inflation can erode them has historically proven to be a successful investing strategy.
More on how stocks, commodities, bonds, real estate, cash and other asset classes have fared in an inflationary environment in another post to follow.
Enjoy the lazy hazy days of August!