The “topic of the day” in the financial press lately has been inflation.  As the economy has started back up, coming out of the lockdowns, there have been a variety of supply chain disruptions, leading to spot shortages and price increases.  Are these indications for the future, or transitory growing pains? Should investors be concerned?

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Inflation affects everyone, so it would seem fairly simply to look at one’s spending and intuitively know when costs are on the rise. However, everyone doesn’t consume the same basket of goods, and some prices rise at a much faster rate than costs generally (as recently explored in our article on college tuition). Inflation reflects higher prices, so those living on a fixed income are justifiably concerned that they may need to make adjustments to their budget, and likely are paying close attention.

When looking at inflation generally, the Federal Reserve looks at both the Consumer Price Index which looks at what people are paying for a defined basked of goods, and the Personal Consumption Expenditure (PCE) price index which looks at where their money is going. They take a long-term view that accounts for the idea that when demand goes up, prices follow, but supply also rises to meet that demand, which then may bring those prices back down. So we are left wondering, what prices will come back down if any, and what will we be left with?

Is the current increase in inflation transitory?

Are recent price spikes representative of long-term price increases, or only a hiccup related to supply chain shortages? One recent example is the price of lumber, which spiked to remarkably high levels recently, but in June has fallen as much as 40% from its highs on May 10th. The price is still historically high, and likely will be for a while, but the May price didn’t end up representing the new price moving forward as supply rose to meet the increased demand. In the long term, we’re likely to see similar pull-backs to other hot sectors experiencing demand overwhelming current supply, such as housing and used cars.

Context is also important. One can look at the hospitality and travel sectors and at hotels and airline tickets costs. When comparing year over year for May, the prices in 2020 were significantly depressed for both of these categories due to the lockdowns, as compared to 2021 as travel became more accessible.  Current prices look high year over year, but when you take a step back to a two or three year review and compare the 2019 prices to the 2021 prices, the increase is much more narrow. It’s mostly a return to normal.

On the other hand, some of the commodity increases may not change for many years because the supply can’t be adjusted easily by the market. We also are seeing wages increases, and some employers must pass these costs on to consumers increasing prices. For example, Chipotle recently announced they were increasing their minimum wage, and subsequently raised the costs across their menu by up to 4% to cover those additional costs. It’s very hard to decrease wages after increasing them, so some of the inflation that is occurring is likely to persist over time.

If we see inflation rise persistently, we can expect to see the Federal Reserve raise interest rates.

What does high inflation mean to me?

As consumers, we don’t dictate prices, so general inflation doesn’t affect our day to day lives severely. We may decide to hold off purchases if there’s a spike in a particular commodity and we can afford to wait (such as a car), or decide to buy more apples if the price of oranges shoots up.

As employers, we need to realize that if dollars don’t go as far as they used to, we’ll need to do even more to attract and retain highly talented employees. Keeping up with the competition may mean adding benefit programs such as healthcare, a retirement plan, or other fringe benefits.

As investors, we need to be aware that the Federal Reserve increasing interest rates to reduce inflation can have an effect on our portfolios. Bonds in particular may be at risk, as bond prices fall as interest rates rise. On paper a portfolio may contract in value, but if bonds are held to maturity then their value stays the same. Depending on your time horizon and risk profile, bonds may still be an important part of your portfolio even if you are expecting interest rates to rise. In the last ten years, inflation has been kept at levels where we could largely forget about it, but with the potential increases on the horizon it may be worthwhile to consult with an Arvest client advisor to review your portfolio based on your current objectives.

What can I do now?

These recent debates and market fluctuations don’t change the dynamic for long-term investors. Instead, it can serve as a reminder to revisit their investment portfolios, and make sure they are growing as quickly as reasonable given their time horizon and risk profiles.

If you are approaching retirement, it’s a good idea to look at not only the last ten years where inflation was less of a concern, but take a bigger historical perspective when considering your budget and how long your assets will need to last. Inflation is the silent killer of assets. Whether it’s low inflation or high inflation, whether it’s predicable or spiking in different areas. When one needs assets to last a lifetime, “preserving the principal” of an asset base may not be enough. One might want to instead consider a portfolio in terms of preserving buying power, or the principal plus the current inflation rate.

Arvest Wealth Management takes a team approach, so meeting with one of our client advisors to discuss these concerns also means you have access to insights from our fixed-income specialists.

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