Inflation: 1958-Today (December 2021 Newsletter Excerpt)

Lately, the two headline challenges to the stock market are inflation and the omicron variant of COVID. It seems that everyone has become armchair immunologists, eager to share high-conviction ill-informed opinions. The professionals are saying it’s too early to have any reliable insight on the new variant and so we defer to future data.

We will however mutter from our armchair, that if history is our guide, we can hope for a parallel with the 1918 Flu. The strange thing is that the 1918 Flu never went away, it just mutated into the regular “flu season” – which could be better described as “it’s winter and people are inside more and nasty stuff spreads more … season.”

While there’s no guarantee that COVID will follow the same pattern, the 1918 Flu lost its virulence by around 1922 and in a sense, we’re still living in that pandemic today. Mutations and new variants are not necessarily bad news.

Inflation

The other headline topic is inflation. If we focus on individual items, this can seem much worse than it is on the whole. Over the past 12 months, we’ve seen prices go up sharply on these items:
-Beef +24%
-Eggs +12%
-Bacon +20%
-Gasoline +51%
-Natural Gas +28%
-Used Cars and Trucks +26%
-Vehicle Rentals +39%

If we look across the board, in the past 12 months, prices have gone up 6.2%. However, to reduce the noise, economists normally exclude energy and food from inflation numbers (because the prices change so much). When you remove those, the inflation rate drops to 4.4%. Certainly elevated, but less scary.

Expert opinions are all over the place on this matter. While it’s hard to be dogmatic on any short term economic opinion, our belief is that inflation data will continue to show elevated numbers and eventually wane 6-12 months from now. Inflation is simply not a persistent modern day phenomenon among industrialized nations. In fact, many of our peers in the world are battling deflation, even the ones engaged in heavy deficit spending.

We see the current inflation spike as a temporary phenomenon caused by:
-Deficit and COVID relief spending
-Extremely low interest rates compounded by asset purchasing by the Federal Reserve
-Pent up demand compounded by high consumer confidence
-Lower supply compounded by supply chain problems

For extra credit, we could add rising asset prices such as stocks and real estate. When people see their net worth grow, from a psychological standpoint they feel richer and spend more. If your house value jumps up $100,000, suddenly you feel more comfortable buying a new car – even if your ability to afford one hasn’t changed.

To put our current inflation spike in a longer term context, here is what this has looked like the past 63 years:

Many of you remember the era of double digit inflation in the late 70s and early 80s. Since that era, inflation has generally been about 2-3%. We haven’t seen a spike this high for 30 years.