While U.S. inflation remains at historic lows, it has ticked up recently, leaving many investors fearing that it’s time to prepare portfolios for rising prices.
Some fears are primal. For investors, particularly those old enough to remember “The Great Inflation” of the 1970s and early 1980s, inflation is one of them. This fear is reinforced by the widespread perception among market watchers that six years of extraordinary monetary stimulus will inevitably lead to inflation.
As I’ve expressed in the past, given the United States’ unresolved fiscal issues, still excessive non-financial debt, and uncertain path toward monetary normalization, fearing inflation isn’t irrational. However, as of today, it may still be premature.
Recent readings have shown that inflation has stabilized, which is a good thing, but signs of an imminent acceleration in inflation are still scant. In other words, it’s probably too early to restructure a portfolio around a big shift in the inflation outlook. Consider these four facts.
Consumer inflation is still historically low. While it’s true that inflation has risen from last year’s lows – the consumer price index (CPI) has doubled over the past 7 months – the rise needs to be placed in context. Both the CPI and producer price index (PPI) have only reverted back to their three-year average.
Other measures of inflation look more benign. Core PPI is at 1.8%, its post-recession average. More importantly, the core personal consumption expenditure (core PCE), the Fed’s preferred measure of inflation, is at 1.5%, still well below the Fed’s target of 2%.
Inflation expectations remain stable. Both the University of Michigan’s 1- and 5-year measures of inflation expectations are at, or below, the middle of their respective 3-year range. Ten-year inflation expectations from the Treasury Inflation-Protected Securities (TIPS) market remain stable at roughly 2.25%.
Wage inflation remains subdued. Much of the recent anxiety about inflation has focused on two areas: housing and the labor market. On the former, there is some evidence of housing inflation. The Owner Equivalent Rent (the Labor Department’s measure of housing inflation) is at 2.6%, the highest level since the summer of 2008. I believe this reflects a rebound in housing and a growing willingness to rent. However, evidence of wage inflation is more difficult to come by. While most measures of wages have accelerated from last year’s lows, they remain subdued. Hourly wages are rising at 2% year-over-year, consistent with the subdued pace we’ve witnessed since the recession ended. A more complete measure of wages – the Employment Cost Index (ECI) – is growing at 1.8% year-over-year, right in the middle of its post-recession range.
Without more tangible evidence of a pickup in wages, I’d avoid restructuring a portfolio around expectations of imminent inflation. That said, over the long term, investors should be concerned about preserving purchasing power. Unfortunately, some of the traditional inflation hedges are expensive, despite the dearth of imminent inflation signs.
For example, TIPS are barely providing a positive real yield, even before taking taxes into account. And as I recently discussed, while gold and silver both have a place in a portfolio, the potential for rising real-rates calls into question whether now is the right time to add to precious metal positions.
Instead, I’d look to equities to provide a long-term hedge against an eventual pickup in inflation. In particular, I continue to like energy stocks. Despite outperforming year-to-date, the energy sector is one of the few segments of the market that still appears inexpensive. Finally, the sector has an additional benefit: In the past, energy stocks have been one of the better performers when inflation is rising.
Sources: BlackRock, Bloomberg, Citi Investment Research
Carefully consider the Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses or, if available, the summary prospectuses which may be obtained by visiting the iShares ETF prospectus page. Read the prospectus carefully before investing.
Investing involves risk, including possible loss of principal.
Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments.
An investment in iShares Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency and its return and yield will fluctuate with market conditions.
The Funds are distributed by BlackRock Investments, LLC (together with its affiliates, “BlackRock”).
©2014 BlackRock. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock. All other marks are the property of their respective owners.
Investopedia and BlackRock have or may have had an advertising relationship, either directly or indirectly. This post is not paid for or sponsored by BlackRock, and is separate from any advertising partnership that may exist between the companies. The views reflected within are solely those of BlackRock and their Authors.
MarketsWhile U.S. growth remains relatively resilient, global growth continues to slip.
MarketsGeneral economic theory consensus rules that deflation is bad for the economy. But the Swiss economy, which is growing despite a drop in prices for the last four years, is proving otherwise. ...
EconomicsThe Taylor Rule suggests how the central bank should change interest rates to account for inflation and other economic conditions.
InvestingOne reason the Fed has delayed its first rate hike: U.S. inflation has been persistently running below the stated 2 % level the central bank seeks to target.
EconomicsWhen the Fed will raises rates is still the unknown, but if it happens investors can benefit. Financials, consumer and growth stocks should do well.
ForexThe Consumer Price Index is a broad measure of inflation, and inflation can have a dramatic impact on a currency's value against rival currencies.
EconomicsFind out which American cities are hit hardest by inflation, and why California residents find themselves in a bigger pinch than anyone else.
EconomicsLearn about the 10 countries with lower interest rates than the United States and how interest rates indicate a country's economic outlook.
InvestingHow the Petrobas scandal has shaken the Brazilian economy.
RetirementLearn how retirees use various strategies, including immediate annuities and traditional portfolio investing, to make $1 million last throughout retirement.
The Canada Pension Plan protects pension holdings against inflation and adjusts its annual rates for inflation. The Canada ... Read Full Answer >>
Investment timing decisions are among the most challenging faced by investors as they have a significant impact on ultimate ... Read Full Answer >>
One of the most significant challenges faced by 401(k) account owners is the creation of an investment plan that can withstand ... Read Full Answer >>
Social Security benefits are inflation-protected. Social Security was created in 1935, and taxes were collected for the first ... Read Full Answer >>
A cost-of-living adjustment, or COLA, is a purchasing power protection mechanism provided to all monthly Social Security ... Read Full Answer >>
Like all securities, mutual funds are subject to market, or systematic, risk. This is because there is no way to predict ... Read Full Answer >>