11 Jan 2018
Business, Economics, Finance, Investing
January 11, 2018 glacierinvest

There sure is a lot of talk about inflation these days. Bonds have been reacting to the news. Commodities have been reacting to the news. Stocks not so much as a little inflation usually isn’t a big deal for them.

While inflation has been dormant for much of the past 10 years, we are starting to see signs of it picking up. In the two charts below (courtesy of John Mauldin at Mauldin Economics and Louis Gave at Gavekal), we can see the New York Federal Reserve’s underlying inflation gauge (UIG) is at its highest level since 2006. Both John Mauldin and Louis Gave shared some very interesting and valuable insights about the current inflation backdrop and what it could mean for investment portfolios. I’m not going to rehash their insightful analysis here though.

Source: Mauldin Economics

The contrarian in me is wondering if all this talk about inflation is much ado about nothing. Yes, we can observe a pick-up in inflation in the data, but does that represent a problem immediately? Is the market overreacting and will the higher inflation scenario take longer to play out? I think if you asked John Mauldin and Louis Gave they would probably suggest it will take a while to play out. Will the recent moves into and out of inflation sensitive assets hold up or will investors bail when the thesis doesn’t play out soon enough for their tastes?

Investing is hard. Identifying trends and understanding the big picture over the next several years is hard to do. Even if you are prescient enough to identify and understand, making the proper asset allocation decisions based on that knowledge and staying the course even when faced with doubts and adversity is really hard.

I personally think inflation will continue to rise. I can’t tell you how long it will take to play out and whether it will ever reach alarming levels, but we will see noticeable increases in the coming years. The deflationary forces that have been present over the past several years are smaller in number as central banks begin to tighten and as the global labor glut levels off. Sure technology will continue to be a deflationary force, but it likely won’t be able to withstand the reversal in trend of the other forces at play.

The implications for investment portfolios are varied based on the path and trajectory of inflation. Rapidly rising or volatile inflation would probably be the worst case as both bonds and stocks would likely suffer. A gradual increase in inflation, which is probably the most likely scenario, would be preferred as stocks would likely do well in that environment although bonds would probably not fare as well.

Regardless, it appears inflation has returned to the party, welcomed or unwelcomed.

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