How is Inflation Impacting the Market Today?
''Inflation Isn’t Missing From the U.S. Economy. You Just Need To Know Where to Look for It.
A pair of economic reports released this past week challenge the conventional narrative that inflation is largely missing from the U.S. economy. First, there was the January producer-price index from the Labor Department on Tuesday. The gauge of wholesale-level inflation is often shrugged off by markets. That’s especially true when it’s released after the consumer-price index, as it was this time, because of how it can help predict the pass-through of price changes from wholesalers to consumers. It deserves attention, though, at a time when it is running hotter than expected, despite strong macro factors that should be keeping producer prices contained.
Second came existing-home sale prices from the National Association of Realtors. The median price for all housing types in January rose 7% from the level a year earlier, as housing inventory fell to its lowest point since 1999. Prices have risen for 95 straight months. “If I were just landing from the moon, I’d ask what am I missing. Every pundit says there’s no inflation, and I’m just not there,” said Lisa Shalett, chief investment officer at Morgan Stanley’s wealth-management unit. Inflation is evident in the services part of the U.S. economy, she said, and it’s particularly acute in rent and health care.
Total PPI rose 2.1% last month, up sharply and unexpectedly from December and at the fastest pace since April. Economists surveyed by Bloomberg expected a 1.6% increase. Shalett says a quicker pace of producer inflation is worth heeding; it undercuts the idea that overall inflation is cool because the prices of goods are sluggish and thereby are offsetting rising prices elsewhere in the economy. We should be seeing inflation surprises to the downside, Shalett said, given how strong the U.S. dollar is, relative to other currencies and with the price of oil dropping on coronavirus worries. Instead, inflation numbers are rising.
What worries Shalett most right now is a potential jump in prices once the coronavirus scare subsides. There’s a reasonable scenario where a burst of pent-up demand prompts sellers to raise prices, she said. A spike in goods prices alongside clearly rising services inflation would come at the same time the Federal Reserve is leaning into an easy-money policy. That combination could trigger an inflation boom, she warned, potentially undermining investment returns even if the Fed does what markets expect and lets inflation surpass its longstanding 2% target.
Personal Consumption Expenditures
The way housing is weighted largely explains the discrepancy. CPI estimates that one-third of household spending goes to shelter, while PCE’s estimate is low and implies a household with $75,000 of income would spend just $1,000 a month on rent, said Oren Cass, in a paper published last week by the conservative think tank the Manhattan Institute.
Many economists share the Fed’s view that inflation is benign. That interpretation is the basis for rising expectations by market participants that the Fed will cut interest rates this year as growth slows and the coronavirus hurts American companies operating in China. Take longtime bear David Rosenberg, who in an interview with Barron’s this past week warned that deflation—or falling prices—is possible within the next year or two.
Investors concerned that inflation isn’t as lethargic as it may seem can do a few things to protect their portfolio. The best protection against inflation is real assets, Shalett said, which she defines as investments grounded in cash flows. She recommends investors consider adding real estate, as well as Treasury Inflation-Protected Securities, or TIPS, precious metals including gold, and oil pipelines. Real assets should comprise 10% to 15% of a portfolio, she said, double the share she advised a year ago.''