Is Inflation Here to Stay? | Brandon Averill, Justin Dyer | AWM Insights #66
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Episode Summary
The most recent Consumer Price Index (CPI) report shows a continued rise in inflation – the fastest pace of higher prices since 2008. So, while it’s safe to say we’re seeing some inflation as the economy continues to recover from the impacts of COVID, the big question to ask is if inflation is here to stay?
In this week’s episode, AWM’s managing partner, Brandon Averill, and CIO, Justin Dyer discuss the signs of transitory inflation and some of the best ways to build your portfolio to protect against periods of rapidly rising inflation.
Episode Highlights
The market news you need to know (00:48)
Is inflation here to stay? (2:30)
What is transitory inflation? (3:21)
Why it’s impossible to buy a bicycle right now (4:26)
What Brandon would say if he was a conspiracy theorist (8:29)
Some of the best ways to prepare for inflation (10:10)
In-N-Out burgers and the importance of participating in the ownership of the market (11:07)
Why deflation can be disastrous for the health of the economy (13:04)
Portfolio building that helps to hedge against rising inflation (15:07)
How to cut through the noise of the financial media (16:38)
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+ Read the Transcript
Brandon Averill (00:00):
Hey, everybody. Welcome back to AWM Insights. It's your power two, cause our third power three happens to be on a beach somewhere in Mexico, probably sipping a margarita, but today you've got one CFA, it's Justin, and one CPWA, it's Brandon. As you know, at AWM, we're a community of athletes, founders, and investors on a journey to be the best of what we do. And we believe that you deserve the same when it comes to your wealth. Each week, we cut through the noise of what Wall Street's selling you. And we're trying to bring you the knowledge, skills, and access that you need to invest like a pro. And we're going to continue this week with our topic of inflation. We hit on it last week, but we're back for some more. But before we do, let's recap what's going on in those markets. We'll start with that.
Brandon Averill (00:48):
The inflation rate did come out. We hit on it last week, came out last Thursday and at nearly 5%, which was the fastest pace of higher prices since 2008. So we're going to dive into that a little bit. What's the impact? How do we plan for it? We had have big news. The ProPublica leak, the treasury department is hacked and we found out what everybody already knew, that the richest don't pay any taxes. But very controversial. I think it's a big topic. Should they pay the taxes on gains that they can't eat? So there's a bunch of nuance there. I see a future AWM insights on the topic, but as we know, planning always wins. So no different there with that story. Then we saw us household wealth jump to a record 136.9 trillion. So people are getting wealthier despite all the noise that's going on with financial markets, et cetera.
Brandon Averill (01:48):
And then lastly, we talked about the private markets quite a bit on this podcast, but the private capital industry soared beyond $7 trillion. So there's no doubt there's a lot of money out in the system Justin. It's what's leading to this whole topic of inflation. We hit on it last week. We tried to define some terms, but obviously with the news of the inflation rate coming out this past week, we're diving in a little bit more and I know we'll get into some of the nuances, is the what's making up that inflation? Is it here to stay? So maybe start there. Justin, what do we got? Is inflation here to stay? Are we going to ride this rocket ship for a little while? What's going on?
Justin Dyer (02:30):
Yeah, sure. So what you're saying there is, is it transitory? This is a super dry topic, but it's important. And it's obviously being covered quite a bit in the media. And so Brandon, to your question, right? Is it here to stay? Well, first of all, as everyone knows, and I know we say this ad nauseum time and time again, we can't predict the future and we truly can't. However, what we can do is, is look to see what, the markets if you will, are doing or pricing in for the future as a pretty good indicator of what we could expect. I'll get into a little bit more of that later. But let's first define, what is transitory inflation? And it really is at the heart of the question. Is inflation here to stay? If it's not here to stay, it is what's called transitory.
Justin Dyer (03:21):
If it is here to stay for some length of time, let's say a couple of years at a minimum, then we would say, it's not transitory, it's permanent arguably. The powers that be, or the, let's call it the market, like I said, and the regulators, the people that are pulling the strings within the federal reserve are pretty adamant in saying that this is transitory, and inflation's only going to spike up for a short period of time. And it does. There's a pretty good rationale for that, right? We're coming out of a very unique and stressful time in the economy. The COVID shock shut down, however you want to frame that. It was unprecedented. There were supply shocks as a result of what happened with COVID. And what I mean by that is factories in China got put offline because they had to shut down or all of a sudden orders fell off a cliff because demand in the United States was no longer there.
Justin Dyer (04:26):
And so that's what's called a supply shock. All of a sudden where the supply chain was running like a machine, basically throw a wrench in that cycle. And all of a sudden it takes a little while to readjust, right? So, perfect example of that is trying to buy a bicycle. I don't know if anyone's done that recently. I had to do that for my son not too long ago. But I mean, it's impossible. It literally is impossible to buy a bicycle right now. And that is a perfect example of a supply shock. These factories, most bicycles are made in Asia somewhere. These factories are essentially running at full capacity right now, but there's such a backlog that, I mean, you go online and you can't even figure out when you could get it.
Justin Dyer (05:13):
They just say, hey, out of stock. We don't know when we're going to be back in stock here. So that's a perfect example of supply shock. And so, as a result of that, think about it, just kind of economics 101. That bike company can now charge a higher price because there's probably so much more demand than supply of bikes that they have. And so that is prices going up, right? That's a supply side of things, interacting with the demand side of things. Arguably, as supply chains catch up and this crazy period of time and, and COVID subsides and, and shipping channels and all that stuff, supply chains get back to their normal, to their normal functioning status. Then we're not going to have the problem with bikes going back to that example. And that pricing, that increase in price from bicycles probably will go away, right?
Justin Dyer (06:09):
That's that's the argument here for transitory inflation and then going back to this normal, or more normal what we were used to inflation environment. So that's really where the heart of the debate is. I mean, there's a lot more to it right around... you can also factor in what's going on in the employment markets. We're still far off of peak employment, and there's a very strong argument there that no one, I think we touched on this last week, no one truly believes inflation will take hold if the entire working population is actually not working. And I think that's another strong argument, why this is a transitory shock to the inflation statistics. Now, and we'll get into kind of how you invest around this and impact on portfolios, which I know we also talked about, but I think it's important to understand what this idea of transitory inflation is.
Justin Dyer (07:11):
Is it here to stay? Is it going to be here permanently again? The short answer is we don't know the market. And like I said, these policy makers certainly believe pretty strongly that it is a temporary shock to the system. And what I mean, and I'll wrap up with this, with respect to the market, you can go and look at certain investment vehicles. There's things called futures markets where your pricing, you're able to essentially bet on what, on some measurement or some statistic in the future. So there are futures contracts that price in inflation in the future. And it's taken the collective knowledge and information of market participants to price those contracts, right? That's a supply and demand mechanism as well. And you look at what those contracts, that part of the market is pricing in. And it's around 2% inflation, which is generally where we've been for the last 10, 15 years. Inflation's been pretty dang low for quite some time. And in general, the market is still believing that that will exist for the near future. You can go out about five years. And it's about that level.
Brandon Averill (08:29):
Which I think is a great reminder to Justin, right? Inflation, and we talk about it, like it's a bad thing. But we want inflation, right? We don't want over-hyped hyper inflation. We don't want a persistent 5% inflation number. But there's also like this, if I'm the conspiracy theorist, ooh, the federal reserves out there and they're messing with things and they're going to create inflation. Well, newsflash guys, that's their job mandate, right? They're supposed to get up in the morning and go, how do we inflate the economy at a sustainable level? And so, part of this probably is transitory, but it's also not bad to see a little bit some of these recovery inflation numbers, right? And get us back on that path. Deflation where prices go down is actually what we should all be afraid of.
Brandon Averill (09:22):
So the fact that the fed wakes up every morning and is trying to create inflation, is trying to make sure that we're on that path is a good thing, right? And it kind of goes back to our message from last week is, we don't know. We can't predict where things are going to go. We can look at things like the futures contracts, et cetera, and try to just distill where things might be going. But at the end of the day, it comes back to making sure you have the proper plan for whatever is going to happen. And beyond things like keeping your lifestyle inflation, right? During this period where so much money is out there. And maybe there are... Is this feeling that you have a little bit of extra? And so now you let your lifestyle kind of creep up.
Brandon Averill (10:10):
That's potentially where you get in trouble, but as long as you can keep your lifestyle reasonable, and your pay continues to increase. If that's the type of job you have, then the best way to hedge against rising prices against inflation is the good old, boring just stay invested, right? Stay invested in the stock market, make sure you have the right financial structure. Because what do we know is that if we do have this period of inflation coming, what are the places that have performed the best? We hit on it last week, but it's stocks and real estate. They've historically performed the best. Now that doesn't happen time in and time out, but it certainly has persisted. And so that's where it kind of goes back and you're like, shoot, this is the basic building blocks anyways. I'm going to have my bonds to make sure that they cover the short term, make sure that they're that short run they're really protecting me.
Brandon Averill (11:07):
And then I want to allow the rest of my portfolio, the ownership side, the stock side, and probably a small allocation to real estate to protect me against the long-term and make sure I stay ahead of head of prices, right? And I think a good example of how ownership plays itself out on that side is, as those inputs change, it's like you go to In-N-Out, right? The lettuce costs a little bit more. The meat's going to cost a little bit more, the burger is going to get a little more expensive. You're like, shoot, now my $2.50 burger costs 3 bucks. Well, if you're participating in the ownership of the market, then you own theoretically ownership in companies like In-N-Out. And so your value of your portfolio is going to continue to outpace the inflation side of that because business adjusts, business want to make money.
Brandon Averill (11:58):
So as their costs changed, they're going to increase prices to make sure the profits still there. Real estate's no different. I mean, many of you listening have either gone through the process of building a custom home or dream of building a custom home. We're telling all our clients right now, we don't like to time things, but lumber prices, the supply side shocks, et cetera. As costs go into building homes and they're higher, well guess what, people are going to require higher prices if they go to sell those homes. So we're also going to see home values increase or real estate in general increase. And that's why over those periods of inflations, when inputs get more expensive than typically your assets, those things you own grow along with that. So I think you could definitely probably crystallize this or put a bow on it a little bit more Justin. But from an investment perspective, being prepared, making sure you have that financial structure in place sounds like is still, and quite frankly, always the best way to prepare yourself.
Justin Dyer (13:04):
Yeah, no doubt about that. I mean, and I do want to hit on real quick. You mentioned deflation. Deflation's way more of a concern than inflation. Not necessarily, it's a kind of a contradiction because as a consumer, I want prices to go down. I want things to cost less. But from an economic health standpoint, deflation is disastrous. And so to your point, I want to underscore that, that the fed is, is waking up each and every day, way more concerned about deflation than increased inflation. And I think the media kind of hypes this up as well. I don't want to say it's much ado about nothing. I think it's an important topic for investors to be aware of because to your point, going back to financial structure, right? If there is inflation in the economy, and there always is a little bit, then you need to plan for that in a prudent structured way.
Justin Dyer (14:03):
And that gets back to exactly what you were saying. Okay. How do you do that? Your financial structure, your investment portfolio group plan should all talk to one another and coordinate so that, let's say you have a long-term spending goal. You want to build that custom house in 10 years. Okay. Well, the way we build our portfolios in our financial structure is we are going to match that spending goal in 10 years with some amount or some blend, and usually a fairly heavy blend of inflation protected securities. Because we, what we want to make sure, if that's a known very high priority goal for you, that we are putting your assets into the market and into a portfolio in a way that really, really, really strengthens your ability to meet that goal, right? We don't want to put at risk capital that is supporting that goal.
Justin Dyer (15:07):
And so we do that, that's it that's built into our DNA. That's built into our planning. That's built into our portfolio management, regardless of what inflation is doing. Because that's just the higher probability way of, of building portfolios. Now, if inflation happens to be higher than expected, guess what? You're taking care of because the way treasury inflation protected securities operate is it will match the price of the cost of that home. So you're, to use the financial term you're immunized against inflation in that sense. So yeah, to your point. I don't know if I put a better bow on that, but the structure matters. The plan matters. Being prepared ahead of time is what matters. And then yeah, to your point, really, I guess I'll summarize it here. Is that the worst thing to hold within, in a higher inflationary environment is cash.
Justin Dyer (16:04):
Now that doesn't mean don't hold cash at all, right? You still need cash. You still need liquidity for the day to day. But cash, just lose it, especially right now where you're getting maybe 10 basis points on your savings or checking accounts. You are losing money because there's something around 2% inflation in the environment right now. And maybe it's going to take up a little bit. Maybe it's not, we'll see, it might be transitory, like we said. But holding substantial amounts of cash for that is not needed for the short term. It doesn't make any sense.
Brandon Averill (16:38):
I think that's a fantastic point, Justin. I think again, going back, it's an important point because I think so many investors, they get in these periods and we're hearing all of this noise, right? You go on Yahoo finance or the FT, or the Wall Street Journal. It's like, inflation's going to kill us and prices are going through the roof. And then the next week it'll be something else like, markets are imploding or everything's cheap, go crazy, invest. Their whole job, as we've said so many times, right is to sell advertisements and all this kind of stuff. But when you hear this noise as an investor, I think so many people want to retreat and go, you know what? I'm kind of scared. I'm just going to put the money under the mattress. I'm going to sit in cash.
Brandon Averill (17:23):
But what we know is that if we do enter into this inflationary time, and at most times, right? Like we just talked about it, a healthy economy where we want to be in general is in an inflationary environment to some extent. All your money does at that point is it loses purchasing power. And everybody's familiar with this concept, but it's the concept of what did a quart of milk costs back in 1916? It costs 9 cents. Well, what does 9 cents buy us in milk today? It's probably five tablespoons of milk, right? So, I think what we have to keep these things in mind and it goes back to your structure and your plan. And if you have the privilege of working with an advisor, making sure they're coaching you through these periods, but you know, it's not the time to be scared. The best way to deal with inflation is to stay invested for the long-term.
Brandon Averill (18:18):
So I think we'll end it there today. But as usual, if you want more information, we definitely encourage you to head over to AWMinsights.com. We're going to have a download there for that concept, short little article, but talk about how, how does inflation actually impact investors? A good brief summary on all of that. So we encourage you to visit over there and with that, until next time, own your wealth, make an impact and invest like a pro.