I went nearly a decade without eating breakfast. Whether I had a radio show to do or a client to advise, it just wasn’t part of my routine. Then, about six months ago, I discovered what I was missing. Now, I’m all in. At this point, if forced to choose between one of the three square meals, it’s breakfast all the way.
Think about inflation in terms of breakfast. I’ve got four boys. One won’t eat eggs. Another doesn’t like bacon. His brother can’t stand jelly. The last one thinks orange juice is too sour. If you take them all to one of the many wonderful breakfast joints in Atlanta or your neck of the woods, there’s going to be enough on the menu, but what would the bill look like at the end of the meal?
According to data released for July inflation measured by the Consumer Price Index (CPI) by the Bureau of Labor Statistics (BLS), cereal is going to cost 17 percent more than it did last year. The flour to make pancakes is 23 percent higher. Want toast? 14 percent higher. Fresh biscuits? Up 14 percent. Sausage is up 15-16 percent. Butter? That’s up 22 percent. The most painful of all is eggs. They’re up 38 percent.
Inflation isn’t fun, but there is some good news. It looks like it may have hit its peak. That would mean from here on out, it shouldn’t get worse. But, unfortunately, peak inflation doesn’t necessarily mean low inflation. I see it staying relatively high for the foreseeable future, but that doesn’t mean it’s time to curl up in the fetal position. There’s still plenty of delicious breakfast to look forward to as long as we keep our expectations in check.
CPI numbers recently fell a little. It was nothing earth-shattering but potentially a good sign. We’ve seen energy, metals, agriculture, and a lot of other market categories start to pull back. We’ve even seen oil go from $120 per barrel to around $90 per barrel. Recently the Producer Price Index, or PPI, came in negative for the first time in a good while. As a reminder, PPI measures the prices that producers of goods pay. This means raw materials and manufacturing.
Yes, we’re still in a very high inflationary period, but wages seem to be keeping up with inflation and the job market remains strong. This has led some people to say inflation is in the eye of the beholder. It depends on the industry but overall we are job-plentiful, which means we may be right on the line, but we’re keeping pace.
At the risk of oversimplifying, there are two sides to the stock market—growth stocks and value (dividend-paying) stocks. As the name would suggest, growth stocks can lead to faster growth but, for the most part, do not pay dividends. Value stocks are typically more established companies. They may have slower growth but pay dividends. Both categories tend to perform about the same in normal inflationary times. But, they react very differently when inflation is abnormally high or abnormally low. As a reminder, we classify normal inflation at about 3 percent.
When inflation and interest rates are low, investors tend to favor growth stocks because future profits sound more appealing when money in the bank isn’t paying much. Investors tend to favor value stocks when inflation and interest rates are high because future profits don’t look as good when cash or money in the bank is paying pretty well in the present.
Another way to say it is—value stocks are bird in hand while growth stocks are two in the bush.
Inflationary Periods Throughout History
For some historical context and peace of mind, let’s look at the most recent inflationary periods. My team and I researched back to the 1960s to map out each one.
This was a period of normal inflation, averaging 2.9 percent. Growth and value stocks behaved similarly. Growth stocks grew 9.3 percent annually and value stocks grew 12.5 percent annually.
Now this was a period of ultra-high inflation. We had an energy crisis and oil prices went through the roof. Have you seen footage of stressed-out people waiting in lines at gas stations? That’s why. CPI averaged 9 percent during this period. So far, we’ve only had one month in 2022 that hit 9 percent. Imagine if it had lasted years! Growth stocks were barely positive during this time, up 2.1 percent per year. Two in the bush was not the way to go. Value stocks did well, averaging almost 10.9 percent per year.
Much like Goldilocks’ preferred porridge temperature, the inflationary environment was just right—not too hot and not too cold. Inflation averaged 3.2 percent. Growth and value stocks behaved similarly, with growth increasing annually at 9.5 percent and value increasing at 8.5 percent annually.
Post GFC (Great Financial Crisis) (2009-2021)
Here we saw very low inflation. Consumers recoiled from the mortgage meltdown and were scared to spend. We were at the height of globalization and the height of new technology. Television prices were dropping 20-40 percent per year. CPI was almost non-existent, averaging 1.6 percent per year. The Federal Reserve was more worried about deflation, and this encouraged folks to invest for future profits with growth stocks, seeing an annual increase on average of over 18.4 percent. Technology stocks were king. How did value stocks do? Not as well, but not terrible—just north of 12.4 percent per year.
Value-oriented stocks have historically been the best place to invest during periods of higher inflation, and that’s playing out today. Growth is down 11 percent, but value stocks are only down 5 percent so far on the year (as of August 25, 2022).
Why are we where we are?
Our current inflation is due to excess savings from cash dumped into the monetary system as a response to the pandemic. Between the CARES Act and the American Rescue Plan Act, $5-$6 trillion dollars were injected into the economy. Additionally, the Federal Reserve moved interest rates to zero. Ultimately, the money supply went up 40 percent. Too much money, too few goods.
What about over the next five or more years? The inflationary periods mentioned provide some insight. As we were getting out of the late 1980s and transitioning into the 1990s economy, we began to live in a world of globalization, which is deflationary by nature because so many more goods become available with outsourcing. Finding cheaper places for goods and labor essentially helped keep prices down all over the world.
Several years ago, as we saw some tariffs on goods from China, deflation slowed a bit, and then the pandemic accelerated the trend. We learned that relying on other countries for goods during a health crisis can lead to supply chain challenges. Differing international policies mean ships either can’t get to us, or they find a bottleneck waiting for them at the ports. This has had the effect of motivating companies here in the U.S. to focus on more self-sufficient production. We’re now building semiconductor plants in the United States and lowering dependence on foreign manufacturing.
There are pros and cons to less globalization, but the negative effect is that it tilts us toward inflationary tendencies. This is hopefully counterbalanced by increased job opportunities domestically and an overall robust economy. If we can manufacture more goods at home and truly utilize the benefits of advanced logistics and technology, we might just find ourselves getting the best of both worlds.
From a practical standpoint, I know that going out to breakfast is going to cost me 13-38 percent more than it would’ve previously, but am I still going to enjoy those pancakes? You bet. And with each bite I can taste the sweetness of peak inflation, meaning as time marches on my breakfast bill probably won’t keep rising.
So, the message of the day seems to be to brace ourselves for continued high inflation while feeling good about summiting the peak. Think of it like Wednesday during the work week. Why do we call it hump day? Because once it’s over, you’ve made it over the hump. The distance between you and the weekend is now shorter than what you’ve already suffered through. Unless you work at my firm, and then you love work more than the weekend. Right, team?
None of this is a quick fix, but it’s enough for me to keep my appetite, as long as there aren’t any supply chain problems with maple syrup.
*Inflationary periods for the S&P 500 data sourced from Bloomberg
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