The markets are settling down now as price data for January, mostly in, shows that fears of rapid inflation were largely overblown. Price increases, both at the consumer level and the producer level show, while rising, are not so out of control to warrant the two trillion dollar decline just witnessed in stock prices.
This past Wednesday, the government reported that consumer inflation was up 0.5%, while core inflation (more volatile food and energy removed) confirmed the strength, up 0.3%. Producer prices also rose in January by 0.4%. Today’s Import and Export prices reinforced the growing trend with a higher-than-expected 1% and 0.8% rise in import and export prices, respectively.
Glass Half Empty – Half Full
Unchecked inflation is clearly a destructive force in any economy. It thwarts investment as interest rates rise, it plays havoc with the capital markets as investors lose confidence in intangible assets like stocks and bonds favoring instead tangible assets like gold, real estate, and commodities. But these gains prove short-lived, if the economy falters.
The ‘half-full’ perspective may be the better way to view current inflation. Inflation, like rising blood pressure when we get up from a rest, might simply be the sign of an economy waking from a prolonged nap – a ten-year nap.
Some inflation is a good thing. Rising prices, within limits just like blood pressure, indicate a healthy growing economy. The Federal Reserve’s target for inflation is 2%, yet the US economy has struggled for the past decade, as demonstrated by the WSJ chart below, to maintain 2% core inflation.
In fact, according to the WSJ, US inflation hasn’t hit the Fed’s target of 2% in 66 of the past 68 months. That’s about to change. How far prices will rise is a question on many investors’ minds. But with January’s numbers in, calm for now, has replaced the panic we saw earlier.
Another huge question on investors’ minds is what corporations will do with their windfall profits thanks in large part to last year’s tax cuts. Will they invest the money in plant, equipment, technology, and people, or will they pay larger dividends and bonuses at the top?
The numbers so far, according to Birynyi Associates, overwhelmingly favor stockholders rather than workers. Some $171 billion in stock buybacks have occurred already in this new year compared to the $76 billion at the same point last year. Workers, on the other hand, have received about $6 billion in pay raises.
Stock buybacks and dividends are the low-hanging fruit, easy ways for CEOs to boost their share prices. We will have to wait and see if they take the bigger gambles to actually invest in growth and productivity to meet rising global challenges. My bet is they are already doing so. Time will tell.
It is reasonable to expect inflation to rise from here. It is also reasonable to expect the Federal Reserve will continue their program of tightening the money supply by raising interest rates to stem the strength of inflation. The concern is that they raise them too fast, choking off the recent signs of growth. We will follow this unfolding story for you.
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