Drawing from history to help lessen inflation’s impact on investors

This is the tale of two investors: One who experienced the widespread inflation that lasted from 1973 to 1982 and the other who didn’t but may remember a brief and fairly centralized inflation period in 2008.

Unfortunately, after months of this most recent spate of inflation, those more experienced investors are realizing they haven’t fully healed from their first encounter with inflation and aren’t appreciating déjà vu as they are either nearing or already in retirement. For those newer investors, they aren’t sure what to expect, how to react or where to put their money. Many may not even understand what causes inflation or how it may be affecting their investment strategy.

The probability of a recession continues to increase due to the impact of policy decisions to combat inflation. We won’t really know immediately if or when we’re recession, until it’s confirmed by the data. Regardless, the combination of higher inflation and slower growth is doing investors no favors as no one knows how long it will take for inflation to normalize or the impact it will have for years to come.

For the most part, inflation is the rate of increase in the prices of goods and services over a given time, resulting in a decline in purchasing power, which means spending more for something than you did before. It’s perfectly normal for there to be an annual inflation rate. In a healthy economy, it’s around 2%. The Bureau of Labor Statistics monitors fluctuations with the consumer price index (CPI), which it issues monthly. The CPI measures the average change in the prices for “a market basket” of consumer goods and services. In 2021 and 2022, the CPI’s annual inflation rate was 7% and 6.5%, respectively. The highest it has been since 1981, when it hit 8.9%.

Prior to this inflationary period, the leading culprit for more recent periods of inflation was oil prices. Today’s inflation was caused by multiple factors — energy was a contributor and not the primary source. Rather, there’s a direct line to the federal government pumping money into the economy in an effort to stabilize it as COVID-19 raged. Supply chain delays that started during the peak of the pandemic are improving, but still causing disruptions, especially for homebuilders and carmakers. Pent-up consumer demand continues unabated. We did see gas prices rise due to the war in Ukraine and sanctions on Russia which decreased the supply and increased prices, particularly for European nations. Altogether, these components are pushing prices higher and higher. And though it seems it should be good news that the employment market is strong, it’s not good for inflation because it means even more people are spending money.

Enter the Federal Reserve Board, which has tapped into former Fed Chair Paul Volcker’s playbook from the 1970s of aggressively hiking the fed funds rate to “slay the inflationary dragon.” At that time, it worked but it also sent us into back-to-back recessions. So far, the Fed has taken a more measured approach in how quickly it’s raised rates; nonetheless, it’s hiked it nine times in the last year to stave off a recession. That said, we are seeing progress being made on the inflation front, with the most recent CPI (April 2023) rising by .4% to 4.9%, lower than estimates.

However, we continue to see stickier inflation in parts of the index, mainly shelter which makes up roughly one-third of the index. Most recently, shelter costs rose 0.4%, which puts them at 8.1% on annual basis. While it wasn’t as high an increase as previous months, the gain reveals a major contributor to inflation isn’t letting up yet. And although the Fed initially thought the inflation was transitory and acted too late to flatten the first impact, the abovementioned indications that inflation is slowing doesn’t mean we are in the clear. The Fed hiked rates another 25 basis points at its May meeting, reiterating it will continue to make future policy decisions based on the incoming data. Also, the war in Ukraine doesn’t seem to be ending any time soon, shelter and food prices are still high and the unexpected volatility in banking earlier this year could extend our current economic situation.

With that in mind, investors of all types are seeking shelter to wait out the inflationary storms.

Knowing that the natural order after inflation is deflation, with banks tightening lending standards, the stock market correcting itself and the Fed lowering rates again, there is no easy answer for where to put your money.

For short-term liquidity needs, investors should take advantage of money markets that are now paying higher yields, giving investors a place to wait on the sidelines. These yields are directly correlated to the Fed’s interest rate policies, and investors should remain diversified and look to selectively increase duration in the fixed-income portion of their portfolio.

On the equity side, being aware of the impact higher inflation and rates have on the companies you own is important. Companies with the ability to pass on increased costs to the consumer should perform better during periods of higher inflation. However, balance is the key and investors should remain diversified across size, sectors and industries. Eventually, inflation and rates are likely to normalize and will make longer-duration bonds (those with cash flows farther in the future) more attractive.

The key to investing in times of economic uncertainty and elevated inflation is understanding that history doesn’t repeats itself, but it often rhymes.

To learn more, connect with our team.

Baker Tilly Wealth Management, LLC (BTWM) is a registered investment advisor. BTWM does not provide tax or legal advice. BTWM is not an attorney. Estate planning can involve a complex web of tax rules and regulations. Consider consulting a tax or legal professional about your particular circumstances before implementing any tax or legal strategy. The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Securities, when offered, and transaction advisory services are offered through Baker Tilly Capital, LLC, Member FINRA and SIPC; Office of Supervisory Jurisdiction located at 4807 Innovate Ln., Madison, WI 53718; phone: +1 (800) 362 7301. Baker Tilly Wealth Management, LLC and Baker Tilly Capital, LLC are controlled by Baker Tilly US, LLP. Baker Tilly US, LLP, is an independently owned and managed member of Baker Tilly International. © 2023 Baker Tilly Wealth Management, LLC