There has been a lot of hoopla in the media around resurging inflation this year. Most of us heard that lumber prices increased almost 400% from 2020 through May of 2021, which has increased the cost of the average new house by almost $39,000. Yikes! But that’s not all, we’ve also seen costs increasing for other commodities, including copper and oil.
Many restaurants cannot get enough workers, so they have been jacking up wages and throwing in hiring bonuses. McDonalds, for example, just announced wage boosts to $15.00 an hour for workers and $20.00 for shift managers.
The auto industry expects to be unable to produce enough new vehicles for another six months because they can’t get the electronic chips they need to run the cars. Needless to say, that production shortfall will drive chips and new car prices higher.
So what the heck is going on? Well, the vast majority of problems we’re seeing are related to dislocations in the economy caused by, you guessed it, the onset of the pandemic last year, and now the waning this year. Companies shut down production lines in 2020 because of a collapse in demand, and now that the demand has suddenly turned back around, they have not been able to ramp up production as quickly as needed. Anyone who took an Econ class in college knows what happens when demand exceeds supply—prices go up.
The big question being discussed now is whether the current wave of COVID-19 related inflation will morph into longer-term, more systemic inflation that will remain with us for the foreseeable future. Some point to government spending, which could reach as high as $6 Trillion this year, as one major catalyst.
Many Baby Boomers remember the late ‘70s and early ‘80s when the cost of living rose as fast as 15% annually. Yeah, those days. My first home mortgage had a 12% interest rate, which was actually a buy-down offered by the city from the prevailing rate of 16%!
A Wall Street Journal survey of economists taken this month showed expectations that slightly higher inflation (in the low 2% range) will remain with us through 2024. However, economists are professional talkers that get paid to expound on their opinions. They also tend to anchor their expectations for the future on what they have been seeing in the rear-view mirror.
A smarter approach would be to look at what the bond market is telling us about inflation. After all, the bond market represents the cumulative opinion of every market participant, and these are people whose very financial future directly depends on whether they are, right or wrong, in what they believe the future holds. Earlier this year, the 10-year Treasury Bond interest rate spiked up as high as 1.8%, reflecting a consensus that inflation would be spiking higher (but not THAT high—given the 1.8% rate). Bond investors do not want to lose money to inflation, so the 10-year rate is highly watched as a barometer of longer-term inflationary expectations.
Lately, however, the 10-year Treasury interest rate is trading closer to 1.35%, reflecting reduced concerns in the bond market over systemic inflation. 30-year mortgage rates below 3% are still plentiful also. While oil prices remain high as we all see at the pump, lumber prices have dropped by 50% since May. Simply put, we may see a small increase in long-term inflation, but there are no indications that hyperinflation is in the cards.
Part of our strategy at Del Monte Group, is to have several layers of inflation-insurance built into your portfolio. Commodities, gold, real estate, and Treasury Inflation-Protected Securities (TIPs) all tend to do well in inflationary environments. While stocks can get hit in the short-run, due to higher inflation as interest rates increase, they also tend to do well over the long-term in inflationary environments, because companies have the ability to increase their prices (and profits) to offset the inflationary effect. Finally, we tend to keep the maturities on our bond portfolio pretty short. This means the bonds in the portfolio will mature faster and get reinvested at higher interest rates sooner, which tends to protect the value of the bonds.
The bottom line is we do not need to sweat higher inflation at this point. Spikes in inflation are most likely related to the receding pandemic and not some other more malevolent force coming to get us. So, you can relax and enjoy your summer, while you pay $5.00 a gallon for gas!
Have more questions or another topic of discussion in mind? Get in touch. You can reach our office by calling 925.736.6410.