Inflation and the Market

1.  Prices on many items will go up

This is the very definition of inflation.  Inflation occurs when there is an imbalance between supply and demand – too much demand and insufficient supply.

What caused the imbalance?  There are multiple causes.  Handing out money to people during the pandemic certainly contributed heavily to excess demand.  Why work when money is given to you for not working?  This helped decrease the supply of workers and products.  The war in Ukraine has further hurt the supply of food and energy.  It also seems that the supply of goods started to deteriorate in March 2021 when one of the worlds largest container ships got stuck in the Suez Canal and blocked other ships from delivering supplies and parts.

Another problem?  Tariffs.  While the U.S. tariffs were intended to protect American industries, they have largely hurt the U.S. economy.  The tariffs caused foreign countries, primarily China, to retaliate with their owns tariffs, which have damaged the U.S. economy.  There are no winners in a tariff war.

2.  Businesses will pass costs on to consumers

If the Producer Price Index (PPI) goes up, the Consumer Price Index (CPI) will follow.  If businesses are facing higher prices, they eventually need to charge their customers more if they want to remain profitable and stay in business.  In addition, companies are trying to make up for ground they lost during the pandemic.  This is the part that is hard for the Fed to control by increasing interest rates.

3.  Interest rates on savings should go up, eventually

You may see higher interest rates as the Fed raises rates, but the return you get for money kept in the bank or other “savings” accounts rarely keeps up with inflation.

4.  The stock market will be volatile and scary

Many investors are experiencing a volatile stock market for the first time.  They may wonder “Why isn’t the market behaving like it is supposed to behave?”  The market doesn’t go either up or down in a straight line.  There is a lot of interest rate fears in the market since it doesn’t like higher interest rates.  But the market will return.  It’s just that no one knows when.

Keeping some money in cash can be good.  But take advantage of lower prices.  If cat food goes on sale (and you have a cat), you stock up on cat food.  (If you don’t have a cat, think prime rib steaks.)  When stocks go on sale, people tend to do the opposite; they are hesitant to invest, fearing the market will go lower.  While they might be right, this is a good time to dollar cost average.  (Dollar cost averaging means buying a fixed amount at fixed intervals, such as monthly.  You get more shares when the price is down, reducing your average cost.)

We have been and will continue to invest in quality investments and taking a conservative and defensive position.

5.  Variable-rate debt will increase

People who have a home equity line of credit (HELOC) or variable mortgage rate will find that their cost of borrowing will rise as the Fed increases interest rates.  If you are in this situation, either pay down the variable debt or shift to a fixed rate loan.

6.  Social Security payments should increase

The Social Security cost-of-living adjustment (COLA) should be in the 8% range next year. This should help if you are living on a fixed income.  The bad news is that the COLA probably will be insufficient to completely erase the effects of inflation.

7.  Your fixed income purchasing power will erode

This is an obvious point.  A $10,000 10-year bond paying a fixed rate of interest will pay you back in 10-years the full $10,000 you invested.  But $10,000 in 10-years will be worth less than it is today due to inflation.

8.  Many people will tend to stockpile

If you knew something you need will cost more tomorrow, wouldn’t you buy more today?  Most people would.  This contributes to supply shortages.

9.  Some expenses rise faster than the rate of inflation

Health care costs are a good example.  They have exceeded the rate of inflation for many years.  Gasoline is another example.

Bottom Line

Inflation isn’t pretty, fun, or easy to tame.  No one knows when the stock market will bottom, though many on TV will be claiming otherwise.  There is a lot of uncertainty about future economic conditions, which contributes heavily to market volatility since the stock market hates uncertainty.  I think the market could be nearing a bottom.  I see obstacles, but there also opportunities.  In the long term, it favors those who continue to invest and take advantage of bargain prices.  In this market, I like to keep some money in cash but try to take advantage of market dips.

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