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Retirement, investments, financial planning for every stage of life—learn about it all here at Invested,
a blog from your Wealth Management Advisors at Kirtland Financial Services.

Inflation and Its Impact on Markets and Portfolios

By Kirtland Financial Services

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In the ever-evolving world of finance, staying abreast of economic indicators is crucial for investors looking to make informed decisions. One such key indicator is inflation, which recently made headlines with the release of data in early January 2024.

According to the report from the U.S. Bureau of Labor Statistics, the Consumer Price Index (CPI) showed a 0.3% month-over-month increase in December 2023, following a 0.1% uptick in November. Additionally, Core CPI, which excludes food and energy, rose by 0.3% month-over-month and showed a year-over-year increase of 3.9%. These rises have significant implications for stock and bond markets, as well as the portfolios of investors.

How is Inflation Calculated?

Fortunately for us, we don’t have to calculate inflation – it’s done for us. Every month, the U.S. Bureau of Labor Statistics calculates indexes that measure inflation:

Consumer Price Index: A measure of price changes in consumer goods and services such as gasoline, food, clothing and automobiles. The CPI measures price change from the perspective of the purchaser.

Producer Price Indexes: A family of indexes that measure the average change over time in selling prices by domestic producers of goods and services. PPIs measure price change from the perspective of the seller.

Inflation Impacts Your Retirement

How? Well, the answer is simple: inflation decreases the purchasing power of your money in the future. Consider this: at 3% inflation, $100 today will be worth $67.30 in 20 years – a loss of 1/3 its value. Said another way, that same $100 will only buy you $67.30 worth of goods and services in 20 years. And in 35 years? Well your $100 will be reduced to just $34.44.

Understanding the Recent CPI Surge

Again, the Consumer Price Index reflects changes in the prices paid by consumers for goods and services over time. The 0.3% month-over-month increase in December is noteworthy, especially considering the preceding 0.1% rise in November. A key driver of this surge was the shelter index, which witnessed a 0.5% increase and accounted for over half of the total monthly CPI increase.

The uptick in the shelter index raises questions about the housing market’s role in inflation. As shelter costs continue to rise, investors may find opportunities in real estate investments, such as Real Estate Investment Trusts (REITs). However, caution is warranted, as an overheated housing market can have broader implications for the economy and financial markets.

Core CPI and Its Implications

Core CPI, which excludes volatile elements like food and energy, also rose by 0.3% month-over-month.

The more stable Core CPI also provides nuanced insights into underlying inflation trends, and its year-over-year increase of 3.9% is a cautionary flag, if not a cause for concern. This figure indicates persistent inflationary pressures that may have broader consequences for investors.

Investors should carefully reassess their portfolios in light of rising Core CPI figures. Historically, inflation erodes the real value of fixed-income investments like bonds. How? Well as the cost of living increases, fixed interest payments become less valuable. As such, investors may consider diversifying their bond portfolios to include inflation-protected securities or assets that have historically performed well during inflationary periods.

PPI: A Different Perspective

While consumer-facing inflation measures provide valuable insights, it’s crucial to consider the Producer Price Index (PPI) for a more comprehensive understanding. In December, the PPI for final demand declined by 0.1% month-over-month, primarily driven by a 0.4% drop in prices for final demand goods. On a year-over-year basis, the PPI for final demand was up just 1.0%, and the index for final demand less food and energy increased by 1.8%.

The relatively modest increase in the PPI suggests that inflationary pressures may not be uniform across all sectors. Investors should carefully analyze industry-specific data to identify sectors that might be more resilient to inflation or, conversely, those that could face greater challenges.

Implications for Investors' Portfolios

In light of the latest inflation data, investors should adopt a proactive approach to portfolio management. Here are some key considerations:

Equity Investments: Historically, stocks have been considered a hedge against inflation. Companies with pricing power and the ability to pass on increased costs to consumers may outperform those that cannot.

Sectors such as technology, healthcare, and energy often exhibit resilience during inflationary periods.

Fixed-Income Investments: With rising inflation, traditional fixed-income investments may face challenges and investors may want to explore inflation-protected securities, Treasury Inflation-Protected Securities (TIPS), and other assets that offer a hedge against rising prices.

Real Estate: As shelter costs contribute significantly to inflation, real estate investments, particularly in the residential sectors, may present opportunities. However, a cautious approach is advised, as the sustainability of the residential housing market should be closely monitored.

Planning with Data and Purpose

The latest inflation data provides valuable insights for investors navigating the current economic landscape. With rising consumer prices and persistent inflationary pressures, a well-informed and adaptable investment strategy is crucial.

At the very least, it is imperative that your long-term retirement strategies account for inflation and
that you prepare for a decrease in the purchasing power of your dollar over time. You should strongly consider assuming that inflation will be more than 3% – its historical average. If you’re wrong and you find that the inflation rate for the next 25 years turns out to be 2%, then the purchasing power of your retirement savings will be more, not less.

As always, maintaining a diversified portfolio and staying vigilant to evolving economic indicators are key principles for confident long-term investing.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.

Investing in Real Estate Investment Trusts (REITs) involves special risks such as potential illiquidity and may not be suitable for all investors. There is no assurance that the investment objectives of this program will be attained.

Because of their narrow focus, investments concentrated in certain sectors or industries will be subject to greater volatility and specific risks compared with investing more broadly across many sectors, industries, and companies.

Treasury Inflation-Protected Securities, or TIPS, are subject to market risk and significant interest rate risk as their longer duration makes them more sensitive to price declines associated with higher interest rates.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

This article was prepared by  FMeX.

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