The latest Consumer Price Inflation Index suggests 9.1% inflation. How bad is that and what, if anything, can we do about it?
The Consumer Price Index is 9.1%, that’s record-setting. We haven’t seen anything like that in 40 years. It was a 40-year peak in May for inflation, but it’s actually two numbers. You’ve got the CPI and you’ve got the core, and the core number actually dropped from 6% to 5.9%. This is very important because we’ve stripped out energy and food. Now you’re saying, “Yeah, but I’m putting a lot of gas in my car. I’m spending a lot of money.” You’ve probably noticed gas prices have slightly eased off. The reason they strip these out is because when it comes to food and it comes to gas, those are very reactive to changes in prices. High prices crush demand, so they’re not as accurate. Much more important is that core number, and that core number actually dropped 1/10th of 1%.
It’s also important for a number of other reasons. We use 6% as the magic number from a core perspective, but corporate earnings are actually helped more than they’re hurt. When that core goes beyond 6%, corporate earnings are hurt because of distortions. But companies sell product today that they bought in the past. With more modest inflation, that’s good for their bottom line. It may not be good for all Americans, and we certainly need this to end. The biggest fear and the one that the Fed and their equivalents around the world share is that these expectations get baked in the cake, and they’re working very hard. We may get to 75 basis-point. We may even get a 1% increase in the short-term interest rates at the next Fed meeting.
So certainly inflation is not behind us, but what can we do, if anything? There are two things that we’ve done in the past, and I’m citing a report to this by Vanguard. Recently, we increased our TIPS exposure, Treasury Inflation-Protected Securities, and also commodities exposure. In the long term, we haven’t been great fans of commodities because of some contango, backwardation. These are technical terms that basically mean it’s a zero sum game from an investor point of view, but not in inflationary times. And so we did load up on that a little bit at the beginning of the year. We’re going to revisit the correct exposure going forward.
The markets do believe that inflation will come down, but not necessarily to where it was pre COVID, and there’s some very good reasons for that. Pre-COVID, we didn’t have the labor shortage we have today. Now this labor shortage is not caused by COVID. It’s caused by the natural demographic change of the baby boomers retiring. It was exacerbated by COVID. Those baby boomers have retired. They’ve opened up jobs that are a lot less favorable, a lot less interesting, a lot better benefits, better pay. So people at the bottom rungs are getting better jobs, and it’s looking like there’s a massive worker shortage.
There is a massive worker shortage, but it’s a top down worker shortage. People are retiring out at the top and those jobs are getting filled at the bottom. It’s very difficult for single people to pay for daycare these days. $2,000 a month is a lot of money for someone on 15 bucks an hour or even $1,200 a month. So we are seeing, especially on the female side of things, less workers in the workforce because the numbers just don’t add up. All of these things are going to cause long term inflation expectations to be slightly higher than in the past.
The other thing that’s probably going to affect inflation going forward is the massive investments that are going to be required globally in infrastructure. They’ve been put off for too long, and finally economies around the world are seeing it. There are two types: there’s general infrastructure that’s just being ignored for 10, 20 years, and there’s also infrastructure in the new electrification that’s going on globally. Whether or not one is concerned with climate change, the reality is we are seeing an electrification of our societies. It’s a slow move from fossil fuel energy sources, and there’s a lot of money that will be invested that will create demand for resources. Demand will result in higher interest rates. This as there’s less money to go around.
Two things we can do about this, commodities and tips. We’ve done that. There are two more things that can be done, and that is hard assets and debt. If you remember back in the ’70s, people that bought a house, especially in the West Coast but anywhere, they paid numbers that seem fantastic to us, $80,000, $120,000, and they had a mortgage. That house quadrupled in value, but the mortgage didn’t quadruple in size. If you’ve got a house with a mortgage, you’re sitting pretty. If you’ve got a house with a mortgage and you’re paying two and a quarter percent, for the first time in my career, I’m telling people don’t pay off that mortgage because inflation’s paying it for you, and it can’t pay it if it’s already paid off. Hard assets are always something that will help people during these periods of inflation.
I’m actually very optimistic about what’s going to happen in the future. The central banks know what they’re doing. They understand the problem. This is not the 1970s. We’re going to work through this. Is anyone to blame for this? It’s so easy. You point a finger; you’ve got three fingers pointing right back at you. Every single country in the world is running into these problems to some extent or the other. We had to print money to get through COVID. Debatable with how much, how fast, but it’s easy with hindsight to say. This is the indigestion that was going to have to happen for printing so much money to get us through such an environment. What we didn’t get is a Great Depression. And it’s always very difficult when you don’t have two planets, one with, one without, to see which would’ve been better. But I’d put my money on dealing with inflation today is better than dealing with the Great Depression.