Every Quarter, headline news offers at least one new reason to become nervous about investing in the global economy. Second Quarter 2021 was no exception. With vaccination levels up and hospitalizations and deaths down drastically, businesses around the world reopened and production lines started making up for lost time. Pent up consumer demand exploded as people sought therapy in the pursuit and perusal of all things retail. Workers laid off during the closures came back to work, even if not to the level before. Business owners desperately sought more employees. As a result of all the pent-up demand and inadequate supply, prices started rising from the pandemic shutdown levels. Not surprisingly, attention turned to a controversial if not potential portfolio threat: “inflation.”
Every time I hear the word, “inflation,” I think about the first CD I ever bought. It was 1981 and the rate on that 2-year was 14 ½ %. Just out of grad school, newly married, and still driving an old VW, life was very simple. Inflation was just a word in the news. However, it didn’t take long to learn that after taxes on the interest and inflation of 11%-12% on household purchases, the once wonderful savings rate didn’t look so hot. Inflation finally was hitting home. Though down from the 1980 rates of 13%-15%, it was still eliminating any return on bank savings.
Those inflation rates 30 years ago give some perspective to the current U.S. annual rate of 5%. Although it is the highest reading since August 2008 when rates peaked just before turning negative during the Great Recession, the rise is considered temporary. The economy is finally recovering from the 0%-1% inflation we were so worried about just a year ago. Supply constraints and rising consumer demand after the total Pandemic shutdown has pushed up prices: gas (56%), used cars and trucks (30%), utility gas (13%), transportation services (11%), and apparel (5%). Food and shelter were up a bit more than 2%. (Bureau of Labor Statistics). This recovery demand push with supply shortages will not last. As production catches up with demand, inflation is projected to fall to the 3% range. Indeed, Trading Economics forecasts the rate to drop below 3% in 2022 and below 2% in 2023!
This outlook is shared by the Fed, which has continued to balk at raising interest rates. They have loosened their inflation target from a firm 2% to a “flexible average inflation targeting” to allow volatility without kneejerk reactions that could put a damper on the much-welcomed new recovery path. Still, they are closely monitoring the inflation trend line and announced they could have a first hike in 2023 instead of the earlier forecast of 2024.
What this means for the portfolios is…nothing. There is no reason to change the allocations. It may be time to change your investment model, but this would be needed only if your goals and risk tolerance have changed. If your goals and risk tolerance are the same, as with all headline news, it is important to avoid overreacting and changing course. Instead, focus on your big picture, your long-term, rest-of-your-life plan. The big picture for the economy is continued growth over the next year with possibly slightly higher bond yields. After that, we can expect a Fed rate increase but worrying about it now is premature.
For now, net returns on your investments can be enhanced by avoiding interest on loans at a higher rate than what the bank is paying you on your savings. With savings accounts paying less than ½%, that means none of us should be carrying any debt of any kind to spend on depreciating assets (cars, vacations, pools, etc.) Delay your wishes as long as you can. Save your cash to pay cash for those items that you know will not hold their value. In effect, be your own banker. Your long-term returns will be higher than paying to borrow your own money!