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Inflation: Does What Goes Up Come Down?

 Deborah Adeyanju, CFA

Inflation is on everyone's minds these days. After rousing itself White Walker-like from a decades-long slumber, it’s made a stunning turnaround this year. It’s hard to go through the day without hearing about, seeing, or experiencing soaring food and fuel costs, not to mention housing prices. Worse, the latest Consumer Price Index reading – 9.1% for June – is the highest it’s been since the 1980’s. With doomsday comparisons to the stagflation of the 1970s and 1980s-style runaway price increases abound, it’s worth doing some time-traveling. 

Is history repeating itself? 

  • 1970s – Supply shocks created by the Arab oil embargo and the Iranian revolution combined with the Fed’s loose monetary policy;  

Source: Historical Inflation Rate  

  

While today’s surge has parallels with yesteryear, there are differences too. Costs are being stoked by the pandemic's ongoing disruption to supply chains, Russia’s war against Ukraine (which is crippling grain exports and tightening oil supplies), labor shortages which are driving wage rates up, and a stronger than anticipated recovery in consumer demand for everything from travel to housing to dining out. There is also evidence that businesses are taking advantage of the inflationary environment to increase their profit margins.  

In contrast with past recent periods of high inflation, the Fed is arguably more attuned to threading a path between bringing inflation to heel and provoking a recession. Consumer interest rates and unemployment levels are significantly lower, making for healthier consumer finances.1  

 

Inflation and your investment portfolio 

Historically, periods of high inflation have driven down real returns for both stocks and bonds, with bonds turning in negative returns when inflation is high. One way to gird your portfolio against inflation’s worst effects is to revisit your investment allocation, adopting a defensive posture.  

Within equities, that means favoring companies that pay dividends and/or have some protection against inflation through contractual cash flows, such as utilities; production of necessities, such as consumer staples (e.g., food, clothing, and hygiene); or with the ability to raise rates in line with interest rates, e.g., banks.  

Within fixed-income, that means investments that are less sensitive to changes in interest rates, such as shorter-dated bonds; or that adjust as rates rise, such as inflation-protected bonds and floating-rate loans.  

Additionally, investments that act as inflation hedges, such as real estate  should be part of the mix.  

 Economies, markets, and the Fed move in cycles. More often than not, Fed rate-hiking cycles tend to end in recession. However this one plays out, two things are certain. The cycle will eventually end, and one way or another inflation will be slain.   

Chart of Historical Inflation Rates.

About GRID      

GRID 202 Partners is an African-American and woman-owned Registered Investment Adviser (RIA) specializing in fee-based, comprehensive financial and investment planning for individuals, couples, businesses and institutions. We serve successful, ambitious professionals and business owners, mission-driven organizations, and households that are committed both to creating wealth for themselves and future generations and to aligning their financial assets with their social impact objectives.