Q&A: Should we be worried about inflation?
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Inflation (as measured by consumer prices) have risen more than expected recently, but some economists are arguing that some of these indicators might be temporary as the economy adjusts to a new situation with more vaccinations and greater normalization of life. What’s your take?
Inflation is definitely something to watch, but I don't know that I'm making a big bet either way. Yes, the inflationary environment has influenced how I’m structuring some portfolios, at least somewhat. That’s because inflation is one of those things that can catch you off guard.
But my biggest concern here is more about market reaction to the Fed.
Inflation has been low for a long period of time, and that can make investors complacent. In that regard, inflation is probably a risk that the market is underpricing. But the market has also been overly conditioned that if things go bad, the Fed will always step in to “rescue” the economy.
After all, that seems to be how the Fed is looking at the economy right now. The Fed seems to be trying to solve an outdated problem.
“For investing purposes, I think questions about inflation simply reinforce my own predilection for owning companies that have a strong, durable moat.”
Let me explain. In 2020, we had a very specific problem: we shut down the economy because of the pandemic. But that’s a problem you could reasonably expect to go away as the pandemic eased. As vaccination rates have gone up, our economy is indeed coming out of that shut down the way we would expect. In fact, we’re seeing that there has been a lot of pent-up demand.
Yet the Fed has been buying $150 billion worth of securities every month (admittedly, it may finally be tapering off this policy), which seems inconsistent with the underlying economic progress we're seeing. It's like the Fed has been looking in the rearview mirror and setting its policy that way rather than working through the windshield. Why are they doing that when the economy and the private sector as a whole seems to be recovering nicely?
So, if investors are expecting monetary policy to bail them out of their own personal risk-taking, because that’s what they've come to expect, that could be a problem. In many ways, the risk comes down to how the market is going to react once the Fed pulls back on its overly accommodative stance.
Still, as I said, I don’t know that I have a big bet here. Inflation is still low enough that I'm not sure that anyone at the Fed is losing sleep. Plus, people today don't really have a sense of history. There was a time in the '70s and early '80s when buying a home and financing it at 18 percent was normal!
Plus, there are obviously shortcomings with every economic metric.
For investing purposes, I think questions about inflation simply reinforce my own predilection for owning companies that have a strong, durable moat. In other words, more than ever I’d favor companies that have inherent defenses that competitors and other market forces will struggle to penetrate. So, if prices go up a little bit, a well-positioned company can pass those increases onto the consumers without seeing a huge change in demand. For example, if they business sells something critical, e.g., insulin, they can pass any increases onto the customer. There’s a certain inelasticity that protects the underlying value of the asset from fluctuations like inflation.
For what it’s worth, this market environment offers a great case study of how value investing can perform well when compared to other investing methods.
“Higher inflation expectations have tended to favor value,” writes Bloomberg, which goes on to quote strategists from Barclays: “Cheap, economically sensitive, and an inflation hedge, value seems like the natural place to position a portfolio.”