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Inflation: Nuances matter for investors

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By Kyle Tetting

As the debate over the transient nature of our current inflationary environment rages on, it’s worth noting just how much nuance exists in the very ways we measure inflation. In most environments and during most times, those nuances are lost to the broader perspective. Either inflation is high or low, rising or falling. But the nuance does matter, and it’s especially relevant to the way we invest.

A prime example, most articles that focus on common measures such as the Consumer Price Index fail to recognize just how much underlying data is included in the CPI report. While it’s nice to know a broad overall measure, the actual report from the Bureau of Labor Statistics includes a trove of information on category-specific prices. We can break out the price of food vs. alcohol, for example. Or we can look more granularly at a certain category: For example, proteins – meat, poultry and fish – compared to fruits and veggies.

The granular nature of this data matters for two very important reasons. First, as a consumer, certain items are more relevant to you than others. The cost of shelter, (representing about 33% of the CPI) or household furnishings (4%) aren’t likely to impact you much if you are already settled into your home and not shopping for a new couch. On the other hand, we all eat, so food prices matter.

Second, beyond relevance to consumers, the granular data can help inform where we invest. As investors, we want to determine what changing prices mean for the markets at large, but also for our specific positions.

Of course, as we approach investing with inflation in mind, it’s also worth noting that the data may tell a story that’s different than what’s most often portrayed. Namely, amid headlines of high prices, the actual long-term rate of inflation remains below the long-term target. The average annualized inflation rate for all items in the CPI is 1.92% over the last 10 years.

More articles and videos from Kyle Tetting on Money Talk

With the Federal Reserve’s focus on the labor market and the fact that the CPI’s long-term average remains below target, it’s no wonder there’s no hurry to tighten the screws of monetary policy. Add in that the 10-year Treasury yield – a canary in the coal mine for inflationary pressures – seems to have settled into a bit of a range the last six months, and investors appear comfortable with the idea that the Fed isn’t in need of major policy shifts in the immediate future.

None of this is to say that inflation isn’t a concern. Chip shortages continue to lead to all kinds of bottlenecks, as do shipping delays. These are real concerns with real consequences. However, the problems are solvable, and increased prices in these areas attract more competition and investment, which typically drives prices lower in the long run.

Consider that over the last 10 years, the price of “computers, peripherals and smart home assistant devices” in the CPI has declined an average of 4.7% per year. I admit this is a particularly specific category, but it’s instructive. Technological innovation, both through improved manufacturing processes and upgraded end products, has meant that while the cost of a computer may not have changed much, you’re getting far more processing power for your money. It’s no wonder these types of businesses have been a large part of the past decade’s investment returns.

The goal as investors is to understand that great businesses are well positioned for any inflationary environment. In that regard, stocks remain one of the best tools for investors concerned about inflation. Consumers are willing to pay a bit more for a great product in periods of rising prices, while competitors see opportunity if prices increase too much. Historically, that has helped keep inflation in check, while ensuring reasonable profits for stockholders.

For now, the inflationary pendulum may have swung a bit too far to one side. A COVID-induced lockdown and changing global trade patterns have disrupted supplies while demand returned quicker and stronger than many companies anticipated. For investors, I’m cautiously optimistic about a normalization of those disruptive forces. It will take time — hence the need to remain balanced — but stocks remain an excellent way to capture the opportunity that lies ahead.

Kyle Tetting is director of research and an investment advisor at Landaas & Company.

Learn more
Uneven recovery suggests balance, by Kyle Tetting
Stocks offset fears of inflation over time, by Joel Dresang
Stocks: Long-term, consistent returns, a Money Talk Video with Dave Sandstrom
Key economic indicators every investor should know, from the Financial Industry Regulatory Authority
(initially posted October 29, 2021)

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