When it comes to investing, uncertainty is the only certainty. There is always a headline to worry about - wars, viruses, debt-ceilings, Brexit, bubbles, elections, and on and on. Today's worry-inducing headlines are about inflation. Let's talk about it.
What is Inflation?
Inflation is the rate at which the price of goods increases. When the prices of things you buy increase, your money can buy less than it could before. Historically, inflation has averaged about 3% per year. However, since the Great Financial Crisis in 2008-2009, inflation has been less than 2% per year.
Since we have had low inflation for such a long period of time, the headline of most newspapers on January 12th highlighted the sharp increase we've seen. The year 2021 saw inflation of 7%, which is the most significant increase in a single year since 1982. Trillions of dollars were pumped into the pandemic economy to relieve businesses and individuals, coupled with significant supply chain issues that have led to the sharp increase. There has been strong demand from American consumers, armed with cash, while a virus took out much of the supply chain workforce. It turns out this was a recipe for an inflation spike. Who knew? Many are wondering, should we be worried?
(Some) Inflation is a good thing
Some degree of inflation is necessary for an economy to grow. As the Oracle of Omaha, Warren Buffet, once said, "Over my lifetime, the US dollar has lost over ninety percent of its purchasing power. Yet even after adjusting for that inflation, the net output of our economy has grown by over twenty times – over 2000%."
Inflation is harmful to people who hold a lot of cash or have an income source that does not keep up with inflation.
Hyperinflation is the real threat
Since we need moderate inflation for our economy to grow, why is everyone freaking out? Many people fear the harmful effects of hyperinflation, which is defined as inflation that increases at a rate of at least 50% per month. That means one month you could buy bananas for $2 and the following month they are $3, and so on across many goods and services.
After WWII, when the Germans signed the Treaty of Versailles, the German economy was in rough shape. Hyperinflation ensued, and workers were often paid twice per day because prices rose so fast their wages were virtually worthless by lunchtime.
However, hyperinflation is a rare event for a developed economy. If you look at the circumstances that caused hyperinflation at various points around the globe, they always fall into these categories: times of war, economic turmoil, or government collapse.
Fortunately, the US and the US dollar are not there. Inflation has been lower than average for an extended period, and we've now had one year where it was higher than average. Perhaps we are just seeing inflation on its winding path to the long-term average.
Stocks protect against inflation
If you are a Quarry Hill client, you own a bunch of equities (stocks) that have historically outpaced inflation by a wide margin. Over time, inflation will indeed erode your purchasing power. However, we believe equities are the best way to outfox inflation by growing at a pace that not only keeps up but increases your purchasing power. We know that stocks are the most efficient vehicle to accumulate wealth. Many investors will make the mistake of interrupting the wealth accumulation process out of headline-induced fear. Because we know that neither the economy nor inflation can be consistently forecasted and that the stock market cannot be timed, the only way to capture the compounded return of stocks is to ride out their frequent declines.
The game of building and preserving wealth is simple but not easy. The game of forecasting the economy or inflation is neither simple nor easy. Fortunately, we can help you accomplish the first without even attempting the second.