Recently, we’ve been hearing a lot about inflation, and the government statistics released on April 15 didn’t help to quiet the chatter. The government reported that the Consumer Price Index for All Urban Consumers rose to an annualized 2.7% in March, up from 1.6% in February. Troll through the latest batch of YouTube videos, and you see pundits and other observers suggesting (even screaming) that the Federal Reserve Board is printing money, leading the U.S. to become another Zimbabwe or Weimar Republic.
The March jump is eye-catching, although the raw numbers are hardly alarming. Since 1914, the inflation rate has averaged 3.38% in the U.S.; so the current rate is still below average. Moreover, a closer look at the various components of the U.S. inflation rate suggests that prices, in general, are not rising (as you would expect if a drunken Fed were printing money). Most of the price rise is taking place in the energy sector. The gasoline index is up 27.5% over the past 12 months, which most of us could suspect based on our last visit to our favorite gas station. The index for all items minus food and energy rose just 1.2% – a rate one would hardly compare with the multi-million percent inflation experienced by the unfortunate citizens of Zimbabwe.
As if the United States will suddenly slide from productive bastion of capitalism to a non-functioning economy overnight. The headlines reach in and resonate with primal fears concerning survival and enjoying the very fabric of your life. As we age, our health and wellbeing start to dictate what we can and cannot do. It is a natural progression in life and we see it with loved ones who are aging. At some point, travel, new cars, large homes and other belongings become more burdensome than pleasurable. However, that does not mean that proper planning is not important and useful. What it means is that planning can only do so much and is not a panacea for all things, especially emotions. That is why the above discussion on inflation is so important. It highlights the vagaries of life.
In fact, if you look at two charts created by the St. Louis Bank of the Federal Reserve Board, you see something interesting. The first chart is the inflation rate since 2006. The second chart is the price of West Texas Intermediate Crude oil, which can be used as a proxy for global oil prices. Notice that the two charts look virtually identical. When oil prices have risen – over the past five years, at least – so too has inflation, and in roughly the same proportion. Oil prices go down, and so too does the inflation rate. Price changes elsewhere, while not perfectly stable, have been moderate enough that this one factor has tended to control changes in the overall cost of living.
Is there a lesson from this? First, we don’t know how oil prices will fluctuate in the future, but even if they stabilize at the current higher rates, the inflation rate – which measures changes in cost of living – will moderate. If the various uprisings in North Africa and the Middle East ever calm down, and an optimist might anticipate that they eventually will, then oil prices could fall. Then, suddenly, you might be reading about how the Fed has somehow engineered a disastrous round of deflation. And so goes the cycle of panic and reasoning and panic and reasoning.
What is important to understand that as an investor, these prices move in cycles. We have been in a low inflation environment since the mid-1980s. We are looking at close to thirty years with relatively low inflation, we are now probably transitioning to a period of higher inflation, but that is not going to occur overnight. Portfolios will be adjusted slightly to reflect the current situation and anticipated changes. What we find difficult to account for are unexpected shocks to the investment environment such as the triple whammy that pummeled Japan recently: Earthquake, tsunami and Nuclear meltdown.
More in the headlines, let’s look at some recent shocks to our global economy, such as the global economic (or investment) impact of the Japanese earthquake, or the no-fly zone over Libya, or the expected bail-out of Portugal and write-downs on Irish bank debt. WhatEXACTLY is the impact? It appears that nobody really knows.
Nicholas Bloom of Stanford University has reported his latest research, where he and a group of graduate students looked at the behavior of companies in the face of 17 different “uncertainty shocks”. These shocks ranged from the Cuban Missile Crisis to the 2008 credit crunch. He found that industrial production typically falls by about 1% in the first months after an uncertainty shock – an effect similar to a seven percentage point hike in interest rates or a $70 dollar move in a barrel of crude oil.
But, interestingly, industrial production has tended to surge six months after the uncertainty shock, and these heightened levels of production can last for more than two years. We really don’t have a good economic model for evaluating the aftermath of disasters, except that they seem to have an odd tendency to surprise on the upside once the shock has worn off.
What this information points to is that in times of shock, it is best to make minor portfolio adjustments, assuming the portfolio matches your financial goals. Adhering to a plan can be the most difficult practice in a crisis because often it means do not “DO” anything. However, more often than not, being in the discomfort rather than reacting is the best practice to survive and thrive through the uncertainty. The ability to function with discomfort is a muscle not exercised often enough so when we reach those times where we feel discomfort we panic. There is no need to do anything other than to acknowledge what comes up and you may be wealthier, wiser and happier when the discomfort passes. We believe this is important because we are looking ahead at increased inflation and making small changes to reflect that new reality and to match your portfolio needs. Often the most prudent shifts are decisive incremental changes made over time and this is our approach. There are few financial rewards for being early and significant financial punishments for panicking. So we encourage you to keep up with the headlines but do not to let the headlines steer you in a direction that is not in your best financial interest. It is a great practice to build new muscles, which help you to build your financial wealth and increase your well-being. Just accept the feelings of discomfort and not do anything… No matter what occurs, as Joe Knight says, “you are not going to fall off the face of the earth.”
Sources:
Average historical inflation rate:http://www.tradingeconomics.com/Economics/Inflation-CPI.aspx?Symbol=USD
