Everywhere you look, people are talking about inflation. The topic of rising prices graces the front pages of newspapers, can be heard on the radio, and is increasingly talked about by politicians and pundits alike.
Of course, inflation is also being felt, sometimes acutely, by individuals and businesses. Prices, as measured by benchmarks such as the Consumer Price Index, have been on something of a tear, at least relative to the last number of years.
There isn’t much of a debate about whether prices are rising. Yet there is no consensus about why the phenomenon is happening, and if the nascent trend will continue.
Team Transitory vs. Team Secular Shift
Broadly speaking, there are two camps when it comes to the question of why prices are rising and whether inflation will continue to remain elevated.
One camp, led by policymakers and some economists, maintains that the current inflation readings will ultimately prove transitory. Today’s high CPI numbers, this group believes, are simply the result of short-term supply chain issues caused by the COVID-19 pandemic. Once these bottlenecks abate, this line of thinking goes, so too will red-hot inflation numbers.
On the other side of the debate are investors and economists who see rising inflation as something of a new normal. This group argues that we are in the midst of a secular trend change. At the heart of their case is the idea that the inflation we’re now seeing is mostly due to wage growth. Labour markets are tight, giving workers leverage over companies. And businesses, forced to pay more for employees, are simply passing along the cost to consumers.
What Investors Need to Know
We’re not in the business of making predictions. That holds true for the markets, and it also applies to economic debates such as the current one about rising prices. Both sides marshal impressive data to make their point, but we think the jury is still out on the outlook for inflation.
That said, we do think it’s wise to give some thought to what a prolonged period of sharply rising prices could mean for our clients. Inflation, as we’ve written about previously, comes with notable risks for investors.
For one thing, anyone holding government bonds—and in particular long-dated bonds—could easily see their principal eroded if high prices persist. If you’re earning 3% on a bond and inflation is running at 6%, you are losing purchasing power as a result. This makes us cautious about these types of fixed-income securities.
And then there are equities. While many people believe that inflation is bad for the stock market, the data seems to suggest otherwise. Ben Carlson, a financial expert south of the border, crunched the numbers recently. His work shows that high inflation historically has actually been associated with fairly decent returns, on average, in the stock market.
This fact may not make front page news, but it’s definitely something worth keeping in mind the next time you hear about the threat of rising prices.