One of the big headlines over the last few weeks has been inflation. I've recieved numerous questions from readers and YouTube comments about it. I'm not a macroeconomist nor do I find predicting such things to be particularly relevant for my investment strategy, but here are some interesting thoughts from others on the topic (and a few of my own; just take mine with a grain of salt ;)
I tend to be in the camp that thinks we’re going to get more than the market seems to appreciate. Eric Rosen sums it up well just based on casual observation of what's going on in our daily lives:
I struggle to agree with Jay Powell that inflation is transitory, but again, I am not a macro economist. I am just observing my surroundings and looking at the stimulus coming and it is hard for me to fathom more inflation is not on the way. You can’t find a house or an employee (Montana ending extra unemployment pay due to worker shortage), you pay more for everything you use (food, consumer goods, oil, gas, plastic, logistics, services, education, healthcare, rental cars, fitness equipment, golf clubs, toys, cars, chips, lumber, services….). The semiconductor shortage has now hit Ford Bronco, SUV and pick up truck production. KFC is looking to fill 20,000 part and full time positions and are struggling to find workers.
On the other hand, there is evidence that the inflation has (so far) been driven mostly by a few categories. Matthew Klein wrote in 'Don't Be Fooled by April's Inflation Jump. It's Being Driven by Reopening Quirks.':
Most of the increase, however, can be attributed to a few categories that collectively account for just 13% of consumer spending.
George Pearkes posted a chart on his Twitter account illustrating the impact that Hotels, Auto Rentals, and Used Autos contributed to inflation vs. all other categories:
Still, when you have businesspeople as high profile as Warren Buffett saying they see ‘significant’ inflation, you’ve got to listen. The US economy may be entering the mother of all booms as a year of pent-up demand explodes into the summer months. When you top it all off with massive stimulus and continued easy monetary policy, it’s not hard to imagine we get some inflation.
What Protects Against Inflation?
If we do get some inflation, there won’t be many places to hide. Inflation consumes financial assets of all kinds. It, in effect, acts as a tax on earnings. Consider a 0.6% APY at Ally Bank. Even a 0.6% inflation rate is equivalent to a 100% tax on those earnings. If inflation jumps to 10% you are, in effect, eating the entire long-term return of the stock market. Nominal dollar values may go up, but the actual purchasing power of those assets goes down.
Classic inflation hedges are Treasury Inflation Protected Securities (TIPS) and gold. I tend to be in the camp that the best way to protect against inflation is to own real income-generating assets like real estate and businesses. The general upward trajectory of rental income as well as earnings and dividends help protect real wealth. As Ben Carlson points out in 'The Simplest Asset to Hedge Inflation':
Since 1928, the U.S. stock market is up 9.8% per year while inflation has averaged 3% per year. So stocks have grown at nearly 7% more than the rate of inflation. One of the reasons for this is the fact that earnings and dividends also grow at a healthy clip above inflation. Over the past 93 years, earnings have grown at roughly 5% per year. Stocks also have perhaps the greatest income stream of any asset. Dividends have grown at roughly 5% per year.
Regardless, if we get meaningful inflation and it lasts longer than a few CPI readings, the stock market (or bond market) will not like that.
We Need to Build More Houses
Speaking of inflation, home prices are rising at a blistering pace. House values rose in 99% of all metro areas with the median sale price is up 16% from Q1 2020 to Q1 2021.1
Part of the problem is that there are simply not enough houses to go around. Ben Carlson explained it well in 'We Need to Build More Houses':
There were roughly 210 million people in the United States in the early-1970s and they were building more than 2 million houses a year. There are now 330 million people and last year there were less than 1.3 million houses completed.
That is bullish for the US economy, which is roughly 15% housing-related.2 It is particularly good news for homebuilders (like NVR) and home improvement stores (like Home Depot and Lowe’s).
And one of the best ways to fight inflation? Own your own home with a 30-year mortgage on it. The prices of homes tend to increase with inflation and the value of the dollars you pay back will generally go down over time.
Dollar-Cost Averaging vs. Lump Sum Investing
In case you missed it, I posted a bit of research on the statistics behind dollar-cost averaging vs. lump sum investing from 1871 to 2021 (paid link). This was for premium subscribers; however, if you aren’t able to cover the cost of a subscription ($5 per month or $50 per year) I would be happy to forward you a PDF. If you are already subscribed, thank you for supporting my work. It's greatly appreciated and helps keep things going here and on YouTube.
Speaking of YouTube, if you missed my latest video, you can find it below. In this one, I compare the results of investing every single year at the highest price for the S&P 500 compared with the lowest and average. I hope you enjoy!
Have a great weekend!
Disclaimer: This is entertainment only, not investment advice. All opinions expressed are my own. Any stocks or ETFs mentioned may be owned or taken a position within the next 48 hours. Neither the information nor any opinion expressed it so be construed as a solicitation to buy or sell a security of personalized investment, tax, or legal advice. This is prepared for informational purposes only. It does not address specific investment objectives, or the financial situation and the particular needs of any person who may receive this report. The information herein was obtained from various sources. Dividend Growth Machine LLC does not guarantee the accuracy or completeness of information provided by third parties. The information in this report is given as of the date indicated and believed to be reliable. Dividend Growth Machine LLC assumes no obligation to update this information, or to advise on further developments relating to it.
- https://www.cnn.com/2021/05/11/homes/home-prices-rising-feseries/index.html ↩
- https://awealthofcommonsense.com/2021/05/we-need-to-build-more-houses/ ↩
Subscribe to Nathan Winklepleck, CFA
Subscribe to the newsletter and unlock access to member-only content.