“To reduce inflation, you have to squash the perception that we are going to have it.” – Eddy Vataru, Osterweiss
Inflation is a self-fulfilling prophecy. If we believe prices will be higher, then producers keep prices higher, and this positive cycle continues.
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Higher inflation may continue for many years into the future. However, our investment experts do not believe that these record-high rates of inflation will continue. Instead, they say things will continue to get more expensive, at maybe 3% per year, compared to the past decade where inflation averaged (historically low) 2% per year.
The Fed’s Limited Power
A lot of us read and hear about the Federal Reserve. But many of us do not understand one of the key reasons why the Fed has limited power. Our research partner, iMGP (iM Global Partner), describes the limits well:
As inflation climbed to alarming levels the Fed has committed to act as aggressively as necessary to bring it back under control – a process that is now underway. Their basic toolkit involves raising rates to suppress economic activity, with the resulting lower demand leading to lower prices. However, the problem is that this simple cause and effect assumes the supply side of the economy remains steady. This is not the case due to the pandemic-driven supply chain disruptions and the Russia/Ukraine war’s impact on energy and agricultural commodities. We all hope and expect that over time these shocks will dissipate, but the Fed can’t do anything about them, which makes it more difficult to engineer a slowdown of appropriate (but not excessive) magnitude, often referred to as a “soft landing.”
Inflation’s Effect on Equities
Again, from iMGP:
“Higher inflation and coincident higher interest rates affect companies differently, both in terms of revenues/earnings and in terms of how investors value their stock. Generally speaking, higher rates favor stodgier value stocks over high flying growth stocks because the valuation of growing companies is driven by future earnings. When those earnings are discounted back to present value at a higher interest rate, the present value is lower. Companies more reliant on increasingly costly raw materials may suffer relative to those that are not. Companies carrying higher debt loads are more apt to be hurt by higher borrowing costs.”
Inflation may last a while. The Federal Reserve has only limited ability to control rates. There may be different investment opportunities for all of us as we navigate a higher inflation world. For the complete report, contact your financial advisor!