By David Guttery, Sponsored Content
We have been suggesting for months that we believe inflation will not be transitory in nature, but rather persistent for the foreseeable future. Given the evolution of the data over the past year, it would appear that our view has been validated. Inflation remains stubbornly high, and finding any hint of a decline in the inflation rate is indeed a tough proposition at the present time.
According to the Bureau of Labor, inflation at the producer level was 11.2% from March of last year to March of this year. It was an absolute record. The cost of producing the goods we consume has increased at the manufacturing level at an unprecedented rate
Over the same period, consumer inflation increased by 8.5%. This is the highest rate of consumer price inflation we have seen since 1981.
At a high level, I suppose it would be nice if average income increased by 10% over the same period, so that net after tax, your ability to consume also increased at the rate it fell. However, according to the Bureau of Labor and statistics, this did not happen.
According to the Bureau, all non-farm payrolls have increased by 5.6% over the past twelve months. Net after tax, let’s say you need to keep 4.7% of that increase. Obviously, just looking at this high-level data, we can observe that our ability to consume is shrinking. This is important because gross domestic product represents 70% of consumption. If our ability to consume declines, that only increases the likelihood of seeing a recession, which is simply two negative quarters of gross domestic product.
Think of your income as a finite capacity to consume over a rolling 12-month period. You only have a little money to spend.
Previously, the money you allocated to economically inelastic things, such as food, fuel, health care, and housing, claimed a much smaller percentage of your finite ability to spend than it does today. The more you have to spend on these things, the less you have to spend elsewhere. Typically, when this happens, consumer confidence drops. As this happens, patterns of consumer behavior change. People are much more focused on buying the next gallon of gas and the next roll of toilet paper, more than the next cup of designer coffee.
Since May of 2020, the national average for a gallon of gasoline has increased by 143% according to the Federal Reserve Bank branch in St. Louis.
In my view, food inflation will also likely be higher during this year. The war in Ukraine has considerably disrupted the supply of natural gas. Natural gas is the most important component in the manufacture of fertilizers. If you haven’t noticed, fertilizer is significantly higher over the past 12 months. This has an impact on grain producers around the world. In the region of Ukraine and Russia currently affected by the war, a significant amount of wheat and cereals in the world is normally produced. I have to ask, to what extent could harvests and yields be lower later this year due to war and exacerbated by soaring farming costs?
It wouldn’t surprise me to see a loaf of bread more than double and cost by the end of the year. The moment you harvest what’s been planted and that product is shipped out to make flour, then shipped out to make bread, before it’s shipped to your favorite store, and the fuel hits it four times from further into the process, we could be looking at significantly higher food costs. Also, think about how grains affect livestock feed, and you can get an idea of how this inflationary force at a critical level could become much more worrisome in the months and quarters to come.
There have been suggestions from the mainstream business media that families have healthy levels of cash savings, but I believe there is a lot more to this story than what you hear in the media. If households are swimming in excess reserves due to COVID-related stimulus spending, then someone explain to me why the average household is also swimming in debt right now.
The chart above is from the Federal Reserve Board on April 7, and it clearly shows that the percentage change in total consumer credit is at a higher rate than we’ve measured since March 2002. If the average household swims in cash, so why does it seem like credit cards are maxed out at their limits? It makes no sense to me. Personally, I believe that any excess cash once enjoyed by the average household has long since been usurped by rising costs of economically inelastic things like food and fuel.
I have often said before that confident people spend money. When income is high, inflation is low, taxes are low, the velocity of money is normally higher, and consumer confidence is also normally higher. During times like these, spending on discretionary items is much higher, and that’s usually the hallmark of an expanding economy.
This chart is from the University of Michigan, reflecting the most recent consumer confidence survey. The most recent reading is the third lowest we’ve seen since the Great Recession – Tell me you see optimism in this current trend.
I believe we can also see this manifest in the most recent retail sales data. Retail sales describe our consumption and activity habits in terms of everyday items.
In 13 of the past 15 months, we have seen a decline in the year-over-year change in retail sales. There’s a theme in the general media suggesting that retail sales are positive year over year, and that’s a valid point. Nonetheless, I find it hard to find any comfort in the negative slope of the line produced by linking the last 15 rolling months of retail sales data. We can also see significant shifts in consumption patterns in both ISM readings, Durable Goods, Industrial Production, New Orders, Factory Orders and Retail Sales. This overlaps perfectly with declining consumer confidence and concerns about inflation, at a time when wages don’t seem to be keeping up with the rising cost of living.
So how can investors navigate this period? We have always suggested that it is best to stick to the plan that governs the execution of investment strategies in adverse circumstances. The strategy itself has not changed, but the exposure to sectors of the economy, and by extension the investments within our portfolios, change often. As the economy fluctuates, there is always appropriate exposure at the moment. Today, at a high level, I encourage people to overweight the stocks of companies that make things you will buy anyway. This would include commodities, utilities, pharmaceuticals, precious and industrial metals, and other things that will likely support a period of economic downturn longer than other areas of economic exposure. Clearly this is too simplistic, and obviously the investment direction is individually tailored. Actionable advice can only be rendered after a thorough planning process. But the answer to the question is not to stop investing in achieving a planned goal, but rather to change the nature of those investments as appropriate and when prompted by economic developments. It’s a marathon not a sprint.
David R. Guttery, RFC, RFS, CAM, has been a financial advisor and has been practicing for 30 years, and is the President of Keystone Financial Group in Trussville. David offers products and services under the following trade names: Keystone Financial Group – insurance and financial services | Ameritas Investment Company, LLC (AIC), Member FINRA/SIPC – Securities and Investments | Ameritas Advisory Services – investment advisory services. AIC and AAS are not affiliated with Keystone Financial Group. The information provided comes from sources believed to be reliable; however, we cannot guarantee their accuracy. This information should not be construed as a recommendation to buy or sell a security. Past performance is not an indicator of future results.