Home|Inflation: Still Heating Up
Published On: August 2nd, 2021

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Inflation: Still Heating Up

Inflation continues to top investors’ worries. But is it transitory or here to stay? Creative Planning’s Peter Mallouk and Jonathan Clements discuss the different types of inflation, which can have long-term detrimental effects on your portfolio, and what you can do to help mitigate its effects.

Hosted by Creative Planning Director of Financial Education Jonathan Clements and President Peter Mallouk, Down the Middle takes a closer look into topics that affect investors. Included are in-depth discussions on financial planning issues, the economy and the markets. Plus, you won’t want to miss each of their monthly tips!

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Jonathan Clements: Hi, this is Jonathan Clements, Director of Financial Education at Creative Planning in Overland Park, Kansas. With me is Peter Mallouk, President of the firm, and we are Down the Middle. Peter at two months ago on this podcast, we talked about inflation because that’s what everybody was talking about. Guess what? They’re still talking about inflation, perhaps even moreso because inflation keeps heating up. Over the 12 months through June, the Consumer Price Index rose 5.4%, the largest increase in 13 years. But basic question that we were tackling two months ago, we’re still tackling today. Is this jump in inflation transitory, or is it permanent? What’s your take, Peter?

Peter Mallouk: I think it’s both. And I think this is a very important topic. It’s not like us to revisit that topic so quickly, but it has such repercussions for investment decision-making and the way an individual, it translates to an individual in terms of what an individual wants is to make sure that they can meet their needs in the short run, the intermediate run, in the long run. And the biggest threat to an individual’s ability to meet their needs in the long run is inflation. If you get the pile of money you think you need to be retired, but what that pile of money can buy goes down – that’s the biggest threat to a long-term investor. So it’s worth spending some time on and revisiting. And I suspect this won’t be the last time. And when I’ve written about this and we’ve talked about this, there’s three important themes that are taking place all at once, and we’ll just break them down one at a time: transitory inflation, normal or high inflation, and then deflation.

So, when we look at transitory inflation, a lot of what the Fed is saying, the Federal Reserve is saying is, “Hey, yeah, there’s inflation. We don’t feel the need to do too much about it because we think it’s transitory.” Meaning what we’re seeing now is going to go away. COVID was like a blizzard. Everybody went inside, the blizzards over, everyone came outside, there’s all this sudden demand. There’s no supply that’s ready to go. There’re containers still in China that should be in the United States. Their lumberyards weren’t operating and so on. So you have all this demand coming out and it’s going to take a while for suppliers to meet the demand. And when that happens, prices will come back down and normalize. That’s the idea of transitory inflation. And we’re seeing that there’s examples like lumber’s down 40%, 50% from its high, as supply comes to meet demand, and as high prices diminished demand.

We’re also seeing housing markets showing signs of softening a little bit. So we’re starting to see some of this massive demand finally being met with some supply and logistical issues around world being worked out. When we look at the debate, the real debate is most of this permanent high inflation, because that’s really would be a really big fear to investors. And just yesterday, the Fed said in their committee meeting, they said, “As the committee reiterated in today’s policy statement with inflation, having run persistently below 2%, we will aim to achieve moderately above 2% for some time, so that inflation average is 2% over time and longer-term inflation expectations remain well anchored at 2%.” Now, I mean, people were laughing out loud when they heard that because nobody, very few people when you hear them talking, believe that inflation is going to normalize at 2% or that we’re anywhere near that today.

And if you look at what it costs to make a cake, that’s actually up over 5% right now. Now the Fed would have us believe that that’s transitory and maybe it is, maybe it isn’t. We don’t know how much of this is going to stick. How much of this is going to stick. But the Fed has done a lot to really encourage inflation. When you have rates very, very, very low, it makes it easier to buy a car. It makes it easier to buy a house. It makes it easier for a business owner to hire people and grow their business. All of these things are inflationary pressure that drive the prices of things up. People have more money to spend. Interestingly, on the last time we talked about this, I use the Chipotle bowl as an example. Because I like going to Chipotle.

And when you look at all the ingredients that go into one of those bowls, I said, look, if the price of everything that goes in those bowls goes up, then don’t be surprised when Chipotle finally says, “We’re going to raise prices, and see what happens.” And then you start to get permanent higher inflation. Interestingly, last week, Chipotle had a conference call and their, I think it was their CFO who said, “Hey, all the prices in our bowl, our burritos went up. We raised prices expecting we might get some resistance. We didn’t. It’s going really well. We might raise prices again.” So that gets passed on to the consumer, but it’s also reflected in the stock price.

The question is, how many times are they and everybody else going to do that? How long will all these prices go up? This is the uncertain part of the formula. The bond market, because people are willing to buy CDs and bonds for long periods of time that pay a low percentage, the bond market is telling us it expects high inflation to go away. No one would buy a five-year bond paying 2%, if they thought inflation was going to be 5%. No one would go to the bank and buy a five-year CD paying 2%, if they thought inflation was going to be 5%.

Jonathan: One of the indicators Peter just mentioned here that a lot of people look at is the difference between conventional Treasury bond yields and yields on inflation-indexed Treasury bonds. And, you know that indicator, looking at the gap between them, that had been increasing and people were saying, “Hey, that’s a sign that the bond market expects inflation in the years ahead.” Well now, in recent months that started to come down again, which seems to suggest the bond investors, who are a