Gill Capital Partners May 2021 Inflation Update

“Inflation is when you pay fifteen dollars for the ten dollar haircut you used to get for five dollars back when you had hair.” ~ Sam Ewing

Typically we send out updates a couple of times per month, and while we do not want to overwhelm your inbox, we do want to keep you informed as new information becomes available. We have been talking a lot about inflation in recent commentaries and inflation headlines are all over the news. We received new data on inflation this week, so we wanted to provide a quick update on what is happening, and, of course, our view.

Inflation Update

In our update last week, we reviewed the recent spikes in individual commodity and input prices that are being caused both by pandemic related supply issues and increasing demand. This week we got the official read on inflation from April, which showed the sharpest year-over-year increase in prices since 2008. The Consumer Price Index (CPI), which measures a basket of goods, as well as energy and housing costs, rose 4.2% from a year earlier. Based on surveys, the market was anticipating an increase closer to 3.5%. Furthermore, the month-to-month gain was 0.8% against the expected 0.2%. Major contributors were energy prices, which jumped 25% from a year earlier, and used car prices, which saw an increase of 21%.

Our view – Yes, inflation is here, but we believe perspective is very important, so lets first look at the data and what it is being compared against. The year-over-year inflation numbers are being compared to April of last year, when we were in the worst of the pandemic, experiencing massive deflationary pressures, and heading into a historic global recession. The inflation we are seeing is no surprise and no accident. The Federal Reserve and the U.S. Treasury took extraordinary measures to fight the recession and mitigate unemployment. Inflation is the expected and natural consequence of these actions. Three important questions are 1) How long will this last? 2) Will prices come back down once producers bring supply back online and demand normalizes? 3) Is this a more permanent inflation issue that will lead the Federal Reserve to take actions to cool the economy? Our Investment Committee has been meeting on this topic frequently and reviewing independent research, and for now, our conclusion is that this is likely and largely a transitory issue. This is in line with what the Federal Reserve has stated publicly. Following the CPI release, Fed Vice Chairman Richard Clarida said that he was “surprised by the reading but unmoved from a policy perspective. This is one data point, but over time, we’ll be taking signal from this data and it’s going to be very important that any pressures to inflation that arise be transitory.”

Remember, the Fed has dual mandates: price stability and maximum employment. The Federal Reserve has previously stated that they will let inflation run a little hotter than normal to further achieve their employment mandate. It is our belief for now (subject to change if the data justifies), that this inflation spike is largely temporary, a biproduct of present circumstances, and will work itself out over time. Furthermore, we think the Federal Reserve will not see much significance in inflation data until later this year and is inclined to look through the near-term inflation data. The inflation data and story seem to be the perfect catalyst for a market pullback (which may be long overdue, anyway). However, assuming high inflation readings are temporary, we believe a pullback may be short-lived as the economy is continuing to gather strength.

What, if anything, do we need to do now? We have reviewed our portfolio allocations and do not believe we have significant changes to make at this time. We do not own long-dated bonds that could struggle in a rising interest rate environment, and we believe our diverse equity holdings will prove to be a good hedge against inflation. We will continue to keep you updated as the data and our views evolve. If you would like to discuss this topic in more detail, please do not hesitate to reach out.