Depending on whether or not you include food and fuel in the consumer price index, prices in 2021 went up 5.5% without fuel and food or 7% if you include them. This is the highest level of price inflation since 1982 at which time inflation was coming down from its 1979 peak of 15%. Everyone is feeling the pinch at the grocery store and gas station but our concern today is how bad will inflation become for your investments? Do the tech giants have it in them to sustain the market’s ability to keep creating and increasing wealth?
How Inflation Affects Interest Rate Investments
How inflation affects investments depends on what your investments are. The investments that are traditionally the safest are US Treasuries, AAA bonds, and CDs. Bank deposits are insured by the FDIC, AAA bonds (Microsoft and Johnson & Johnson) are very secure, and US Treasuries are backed by the US government. So, your dollar amount is secure with these investments. Unfortunately, inflation reduces the purchasing power of every dollar. Thus the real earnings yield on these investments is negative in terms of purchasing power when inflation is high.
How Inflation Affects Stocks
The effect of inflation on stocks is mixed. Inflation typically comes with a strong economy so many companies will be earning more money and their stock prices and dividends will go up. But, companies that have high labor and raw material costs due to inflation will often suffer instead of benefit as costs go up. In our current era of a seemingly unending pandemic, companies in the travel and hospitality sectors especially will typically be hurt more than helped by inflation. The big tech companies that prospered during the pandemic are, perhaps, the best equipped to weather the storm of higher consumer and production prices.
How Inflation Affects Alternative Investments
During the rampant inflation of the 1970s gold and other precious metals were seen as a refuge from the effects of inflation. When Nixon took the USA off of the gold standard for the dollar, gold was $32 an ounce. It peaked briefly in late 1979 at over $800 an ounce and then settled into the $400 per ounce range for the next 15 years. Today’s young investors are not in love with gold like their parents were but have fixated on today’s investment fad, cryptocurrencies. As bitcoin and the rest have no fundamental value it is unlikely that they will function as a hedge against inflation like gold did in the 1970s. Rather one will be betting on another flurry of activity in that market. The key word is betting.
How Long Will Inflation Last?
The consensus of most economists as well as the Federal Reserve was that we would see a brief inflationary surge as the economy emerged from the Covid Pandemic. It turns out that with a new variant or two we are still in the pandemic and the world supply chain is still bogged down. The cost of labor is going up and companies are raising prices. We will be seeing a move toward reshoring manufacturing to the USA which will need more skilled labor than factories in the old days. This will likely be an inflationary issue. However, as is often said, you can’t fight the Fed. And, the Fed is taping out of its stimulus program to be done in March. They will be lowering their balance sheet. And, we can expect at least two and probably more interest rate increases in 2022. They will be able to bring inflation down but the price of taming inflation could be a recession and years or higher unemployment. How long inflation lasts and the degree of success the Fed has in taming it will determine how bad inflation will become in affecting your investments.
