Is High Inflation in the U.S. Inevitable?

Some strategists are warning about the possibility of rising inflation in the U.S. Take the boom in government spending and borrowing, to start. Add the pent-up demand for vacations, concerts, dinners out, and nice clothing for special occasions (all the things that we have not spent money on during the pandemic).

Now, consider that many American families saw an increase in their real personal income in 2020 — starting with those who did not suffer job losses yet received stimulus checks. The combination of those factors looks like it could lead to a surge in consumer demand and rising prices.

Here is our take on what inflation might look like in the future — and what that means for you.

Double-digit Inflation: Concerns and Trends

In our opinion, inflation is likely to increase over its current level.

To provide full context, inflation has been below the central bank target in recent years. A weak dollar can go hand in hand with U.S. inflation rising, and we would not be surprised to see inflation numbers spend a few quarters over the 2% target and then resume oscillating above and below the 2% mark.

However, at this time we do not believe there will be a repeat of the 1970s -1980s double-digit inflation for a few reasons.

For one, the Federal Reserve takes inflation seriously. Its primary tool to combat inflation is to increase very short term interest rates. With the Federal Funds rate currently targeting 0.25%, the Federal Reserve has a lot of room to raise those rates — and an entire arsenal of strategies at its disposal. Keep in mind also that the Fed has more tools today than were available back in the ’70s and ’80s, and that the institution’s track record in recent decades has earned it a measure of trust and credibility.

The second point here is that there are several persistent counter-inflationary trends in our economy that we believe are not showing signs of immediate reversal. For example, lower reliance on foreign oil and Amazon driving prices down may serve as a damper on a possible upward inflation trend.

Now, it is important to acknowledge that there are several inflationary forces in the works, as well. The most obvious one is the possibility of a reopening boom as the nation recovers from the COVID-19 pandemic. However, we believe the tight labor market and COVID-related supply chain disruptions are not expected to be multi-year phenomena (which is to say, they are likely to be short-term and temporary).

You may be thinking to yourself, “But what about the current boom in governmental spending and borrowing?”

The injection of those funds into the economy could potentially trigger multi-year upward pressure on inflation. However, in the real-world Japan experiment, much higher levels of government debt in proportion to economic activity have been paired with inflation that has been stubbornly too-low (and occasionally negative)¹. Here at SYM Financial, we will continue to watch the inflation trend, yet at this time we cannot conclude that hyperinflation is imminent.

Bond ownership during inflationary periods

If we should see higher-than-expected inflation in the near future, it may cause bond volatility (pushing prices down temporarily).

Currently, bonds have a “baked in” expected inflation of around 2.4% per year.  In this environment, SYM Financial is generally suggesting caution when it comes to bond allocation.

What does that mean for our investment strategy? While there are no guarantees in the investing world, it can be helpful to understand what risk/return boundaries we are targeting. Our target returns may or may not come to fruition (we do not pretend to have a crystal ball), but here are some assumptions and broad brush stroke thinking.

First off, we avoid concentrations in the lowest-yielding U.S. Treasury bonds, because we believe they are likely to get hit the hardest in the event of rising inflation.

Second, we aim to select bonds with shorter maturity cycles. Those shorter cycles could potentially allow us to reinvest at newly higher rates if inflation numbers continue to rise, or if other factors spike bond volatility.

By deploying those strategies together, our best target is around 3% in total return (average, per year) for investors who stick with this path for around four years. If yields become meaningfully higher in four years, we could potentially target a higher total return at that time.  For clients who need access to liquid funds in the short term (such as six months or less), we may consider a cash holding instead.

Cash ownership during inflationary periods

Let’s get the bad news out of the way first. There isn’t much to squeeze out here, as inflation scrapes away the purchasing power of cash every year. That sting gets worse when inflation is on the rise.

Generally, we would prefer to avoid excessive cash holdings in an inflationary environment, especially when interest rates are low. However, some cash is appropriate for many of our clients, especially those who wish to prudently take risk off the table for a host of personal and financial reasons. SYM Financial Advisors can assist clients with determining the right balance of cash, bonds (which can potentially attempt to tie or do better than inflation without locking up the funds for an extended period of time), and stocks for their situation.

Stock ownership during inflationary periods

When it comes to appreciation, a diversified stock portfolio can have stronger potential than bonds, especially in an inflationary environment. While it is likely that the stock market will experience some volatility to the downside, historically, and especially over the longer term (7-10 years or longer), stocks have typically appreciated.

It’s true that the purchasing power of stocks can be partially eroded by inflation, but nevertheless we believe diversified stock investing has historically been the right choice for long-term holdings. However, it is important to understand your personal financial needs and income sources over time. That way, your advisor can help you position the funds you need in the short term without having to sell investments at a low point in the market.

At this time, many experts expect the U.S. dollar to weaken in the coming years and anticipate foreign stock appreciation to outpace that of American stocks². For that reason, we currently do not hedge our foreign stock holdings back to the dollar. We also hold meaningful allocations to international stocks within our strategies to potentially benefit from the rise in foreign stock appreciation in the future. This is not a prediction or a guarantee, and yet it can be helpful to understand how we think about these risks and opportunities as we face an uncertain future.

Real estate ownership during inflationary periods

At SYM Financial, we consider real estate investments in the context of both bonds and stocks for our clients, predominantly as diversified equity REITs. We know that the risk and return profiles for real estate strategies can span a wide spectrum, so it is difficult to generalize. As a strategy, we look for opportunities to add real estate investments to client portfolios when the risk/return profile makes sense for the big picture of that client’s needs and resources. Our strategy and its global stock benchmark hold around 1.5% to 3.0% in real estate, but, again, that is a target — not a guarantee. We will continue to evaluate the place REITs should have in our investing strategy as time goes on.

What does inflation mean for you?

Our approach to analyzing inflation and making predictions about what will happen in the future should not overshadow the most important question.

If inflation continues to rise above its current levels, what would that mean for you personally?

Most individuals are curious about the geopolitical and macroeconomic aspects of inflation, but their primary concern is usually less theoretical. Will prices rise to the level where I can no longer afford my lifestyle? What would it mean for my ability to pay for the things that matter, retire on my terms, and afford what I need in retirement?

One way to think about the answers is by remembering the economic sectors that have recently seen relatively high price inflation: specifically, healthcare and higher education³.

If you are concerned about those, consider some of the strategies we have recently covered on our Insights blog related to Health Savings Accounts and 529 plans. Our SYM Financial team is here to help you apply those ideas to your situation — or help you think through aligning your savings and investment decisions to move you closer to meeting your goals. Give us a call or schedule an appointment today to get started!

1. https://www.oecd.org/economy/growth/Japan-s-challenging-debt-dynamics-OECD-Journal-Economic-Studies-2014.pdf

2. https://grow.acorns.com/2021-stock-market-outlook-what-experts-predict/

3. https://www.aei.org/carpe-diem/chart-of-the-day-or-century/