There has been a lot of news about inflation as the latest monthly reports are showing big spikes in the cost-of-living indicators and as we consumers see gas and food prices on the rise. I have four topics to discuss as we ponder the implications of rising inflation costs.

The Spike is Likely Temporary

Speaking with a chief economist from Guggenheim this morning, I learned that the spike in inflation numbers has been largely driven by items such as hotels, car rentals, and airlines, and that the other items in cost-of-living index have either remained steady or bumped up just a bit.

This makes sense when you think about it: the items that recently spiked are items that had been largely closed down during the pandemic, so their respective re- openings caused a jump a price. But re-openings are a one-time event, and the expectations are that prices for these items will fall back in line as normalcy returns.

In addition, as I’m sure you noticed, other day-to-day items have been backordered due to supply chain disruptions during the pandemic, causing bumps in price. But these disruptions will get corrected quickly in the marketplace, again returning pricing to more normal levels.

The conclusion of the Guggenheim economist is that the spike in inflation over the past 2-3 months is temporary, soon to return to a more normal 2-3% per year.

How Should We View This Inflation News?

Right now, the media would have you think about inflation as an impending crisis. But remember, if the media didn’t have a crisis to sell us they wouldn’t have anything to sell us. The news is simply too boring without a crisis.

Let’s think about all the crises the past couple of years, as reported by the media:

• Covid-19 Crisis: it has been terrible and tragic, but not at the scale predicted back Feb 2020, and not another Black Plague or Spanish Flu.
• Economic Devastation Crisis: fears of another Great Depression overblown—instead we had a very deep and very quick recession.
• Election Crisis: forecasts of the end of democracy if (fill in the blank) wins. Didn’t happen.
• Overvaluation Crisis: stock market destined to crash either because of the pandemic or because of the rise after the pandemic. Hasn’t happened.
• Gamestop Crisis: market expected to crumble after Reddit users figured out how to drive out short sellers. Didn’t happen.

The Lesson? Inflation is not a crisis. More likely it is a temporary trend, and in a few weeks my bet is that the media will be focused on some other new crisis.

How Does Inflation Impact Interest Rates?

Interest rates tend to rise as inflation rises. This is because bondholders know that when their bonds mature and they receive their principal back (let’s say in 10 years) the dollars they receive back won’t buy the same level of goods and services as when they loaned the money 10 years earlier. So, bondholders require some level of interest payments to offset the loss of purchasing power of their principal. Thus, as inflation rises (or even the perception that inflation will rise) so will interest rates.

How Does Inflation Impact the Stock Market?

It has been my experience that inflation is the stock market’s friend. Why? Because as prices rise throughout the land, including the costs of producing goods for sale, well-run companies will raise their prices accordingly and be able to maintain their profit margins. Companies that can maintain their profit margins typically are rewarded with higher and higher market valuations, continuing the stock market along its normal growth patterns.

In addition, of course, companies do not sit still in the face of obstacles, and this is true if inflation is the obstacle. Companies find a workaround, or they adapt some new innovation, or they cut other costs, again to maintain their profit margins.

Nick Murray recently made this comment about inflation and the stock market, and I will end with his message:

“The larger truth [is] that inflation—the long, slow, inexorable grinding down of purchasing power—is precisely why we’re equity investors. Inflation isn’t the signal to flee equities; it’s the very reason we own them in the first place. Because over the long term, mainstream equities have been the most efficient hedge against inflation ever crafted by the hand of man.”