Inflation Roundtable: Talking About What Investors Should Be Talking About
For the past several months, market pundits have directed much of their focus on a single topic: Inflation. But many news articles and conversations are void of perspective. In a wide-ranging roundtable discussion, Dana Investment Advisor’s portfolio managers shared their views on inflation, including why moderate inflation is OK for markets and the economy, why excessive inflation like the 1970s is unlikely, and what investors should be thinking about in an era of reasonable price increases. A synopsis of their discussion follows:
Q: How real is the inflation threat?
Mike Honkamp: Here’s where perspective is lost. The Consumer Price Index (CPI) has averaged 1.9% annual growth since the financial crisis. That’s really subdued. Average inflation should be around 3% annually. If we get to that, it’s a big pickup in the near term, but it shouldn’t be a scary scenario.
We’ve had some short-term price rises, due largely to supply chain bottlenecks and shortages, and suddenly people are using the 1970s as a guidepost for what’s ahead. There were a lot of factors at play back then that are not now including Lyndon Johnson’s economic agenda, a disentanglement between the dollar and gold that caused all monetary instruments to find a new equilibrium, an expanded U.S. balance sheet to fund the war in Vietnam and an oil price shock. Many of those forces aren’t an issue today.
Q: How should investors interpret recent inflation signals?
Mike Honkamp: A lot of people are extrapolating long-run inflation from the jump in different commodity prices, but those markets are prone to overcorrection. When you get high prices, you quickly get new supply to meet it. More recently we’re already seeing that some commodity markets may have peaked. Fed regional surveys are also showing some high frequency economic data, data available more than just monthly such as the jobs report or consumer spending, has come down.
Housing prices have also gotten a lot of attention, in large part because they touch asset owners across the country. What’s lost in that conversation is that there’s been a shortage of housing for quite some time. At the same time, there’s been a boost in demand due to cheaper loan costs and cultural reasons, such as the millennial generation entering the home ownership stage. At some point, supply catches up and this jump in prices will likely prove transitory.
Sean McLeod: Another point I would add is that a lot of the inflation we’re seeing now is because businesses had to make cuts during Covid, and simply weren’t ready for a V-shaped recovery. For example, if you’re a business looking to rehire 100 people at once, you’re suddenly competing with everyone else rehiring and competing with the government providing stimulus and an increase in unemployment benefits that will make some people delay re-entering the work force. It will take some time to hire everyone back, but you’ll see things normalize as stimulus levels off.
Capacity utilization is still around 70% … so it’s not like we’re using every square foot of capacity space and still can’t address demand. That’s a good sign that supply issues will normalize.
Q: What is the case for why we won’t have higher long-term inflation?
Mikhail Alkhazov: There are several secular, macroeconomic and societal trends working against it. Technology advances are deflationary. Higher debt burdens are deflationary — as more tax revenue goes toward servicing debt, there is less left over for more productive activity. A growing population segment that is aging also works against deflation, as people naturally spend less in retirement.
Q: What are investors missing about the inflation conversation:
David Weinstein: Bottom line: If the economy is strong, it should produce inflation. Four percent price increases are fine in the context of 6% economic growth. The Fed has been begging for this for years. A lot of businesses would welcome a 3% to 4% inflationary environment — it’s an easy way to grow revenue. Worry when high prices stagnate growth, but I really don’t believe that’s going to happen.
Q: What questions should investors be asking?
David Weinstein: Some people are thinking we’re in the 1970s, and they’re worried about the market tanking. That shouldn’t happen with 6% to 7% economic growth. They should care about how to position their portfolios in light of 3% - 4% CPI increases. You want to have exposure to economically sensitive sectors, companies that will benefit from higher interest rates, companies with pricing power that can pass those cost increases to customers, and maybe businesses tied to commodities that will see an increase in prices.
Q: On the other hand, what should investors worry about?
Duane Roberts: I think we’ll have permanent, moderate, inflation but probably not enough to overwhelm the stock market. However, one thing to be mindful of is that while a little inflation isn’t alarming for the upper half of the income spectrum, it does have a greater impact on those with lower income.
Q: Any closing thoughts?
David Weinstein: I think sometimes we underappreciate that the U.S. business environment is dynamic enough to handle moderate pricing pressures. I’ll use the restaurant company Darden as an example. They’re having trouble rehiring people, and have said wages will be up 6% next fiscal year. That’s a headwind. But at the same rate, they’ve made operational changes to become more efficient. When they hit 90% of their (pre-Covid sales), their profit margins will be 1.5% wider. It’s just an example, but it’s illustrative of how businesses are responsive.