By Investment Associate Bobby Adusumilli, CFA.
It’s hard not to notice inflation these days - we see it in higher gas prices, higher grocery bills, and higher housing costs, among other areas. This is true beyond the U.S.: inflation rates in countries around the world are higher compared to recent history.[1]
For the one-year period ending May 31, 2022, the U.S. inflation rate (as measured by the CPI for All Urban Consumers Unadjusted Index) is 8.6%.[2] While most of the U.S. economy is experiencing some inflation, energy - which includes gasoline, oil, electricity, and other commodities - has experienced an outsized amount of inflation, approaching 35%.[2]
Source: “Consumer Price Index Summary“. U.S. Bureau of Labor Services, 10-Jun-2022, bls.gov. The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. See Important Disclosure Information.
While these higher prices are difficult to handle right now, we believe there are some reasons for optimism regarding inflation. Energy prices spiked largely in response to effects from the COVID-19 pandemic as well as the war in Ukraine.[3] While we may experience elevated prices in the short-term, companies and markets tend to respond when there is high demand for a product, creating more competition and thus more supply, which should help constrain energy prices over time. Additionally, the Federal Reserve has been aggressively raising interest rates to combat inflation.[4] While this has hurt stock and bond prices recently, we believe this will help decrease inflation over time.[4]
Global bond markets are also expressing optimism that the U.S. inflation rate will fall back to more normal levels. For example, the 10-year breakeven inflation rate - which is a measure of what bond investors expect U.S. inflation to be over the next 10 years on average - is 2.33% as of June 30th, 2022.[5] While this is higher than the Federal Reserve’s goal of 2.00% inflation, bond markets do not expect medium- to long-term inflation to be anywhere close to the recent inflation rate.[5][6]
Source: FRED, as of June 30, 2022. The breakeven inflation rate represents a measure of expected inflation derived from 10-Year Treasury Constant Maturity Securities and 10-Year Treasury Inflation-Indexed Constant Maturity Securities. The latest value implies what market participants expect inflation to be in the next 10 years, on average. See Important Disclosure Information.
Given all of this information, we have designed MarketPlus Investing portfolios to have some built-in inflation protection. For example, MarketPlus Investing model portfolios with fixed income allocations have exposure to U.S. Treasury Inflation-Protected Securities (TIPS) as well as short-duration (<5 years) bonds, which tend to provide some protection from inflation. And while global stocks can underperform inflation over the short-term (< 5 years), research has demonstrated that global stocks tend to provide inflation protection over the intermediate- (5-10 years) and long-term (10+ years).[7]
Investors looking for additional inflation protection can also consider purchasing Series I Savings Bonds, which are 30-year savings bonds offered by the U.S. government designed to match the Consumer Price Index for All Urban Consumers inflation rate. Each individual can buy up to $10,000 worth of these bonds per year, and you can sell after one year, subject to some conditions.[8] While SJS cannot buy these bonds for you directly, we are supportive of Series I Savings Bonds as potential investments for inflation protection. You can find additional information on the treasurydirect.gov website.
Global stock and bond markets have been tested by inflation many times in the past, and these markets have historically demonstrated their resilience in providing returns higher than inflation over time.[7] While it may be difficult in the short-term, we believe that staying invested is the key to getting through this market volatility and inflation.
Important Disclosure Information & Sources:
[1] “Inflation Rate - By Country“. Trading Economics, June 2022, tradingeconomics.com.
[2] “Consumer Price Index Summary“. U.S. Bureau of Labor Services, 10-Jun-2022, bls.gov.
[3] “How High Is Inflation and What Causes It? What to Know“. Gabriel T. Rubin & David Harrison, 10-Jun-2022, wsj.com.
[4] “Fed Raises Rates by 0.75 Percentage Point, Largest Increase Since 1994“. Nick Timiraos, 15-Jun-2022, wsj.com.
[5] “10-Year Breakeven Inflation Rate“. Federal Reserve Bank of St. Louis, 30-Jun-2022, fred.stlouisfed.org.
[6] “Why does the Federal Reserve aim for inflation of 2 percent over the longer run?“ Board of Governors of the Federal Reserve System, 27-Aug-2020, federalreserve.gov.
[7] Stocks for the Long Run. Jeremy Siegel, 2014, McGraw Hill.
[8] “Series I Savings Bonds”. U.S. Department of the Treasury, June 2022, treasurydirect.gov.
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