Earlier this month, the annual inflation rate—as measured by consumer prices nationwide—was recorded at 5%, which marks its highest reading in almost 13 years.
We weren’t surprised, given that the prices of all types of commodities have been increasing over the last year. Last year, we added Inflation Protected Treasuries to portfolios with tax-deferred accounts to help cushion the blow of rising inflation rates. We also added exposure to a small cap value ETF that has more exposure to energy and materials than the overall market.
Here are three reasons why we believe increased inflation will only stick around for less than a year:
- The Math – The annual inflation rate compares prices today to prices from the prior year. One year ago, the economy was in the depths of the COVID-19 fueled recession, hence exaggerating the comparison. As time goes on, the comparison will leave out some of the extremely low readings we saw last year.
- Supply vs. Demand – Thanks to government-issued stimulus checks, the demand for goods and services bounced back quicker than businesses’ supply. Higher prices for goods in turn provide a powerful incentive for firms to increase their supply. We expect the imbalance between supply and demand to stabilize as businesses increase their supply to meet the increased consumer market demand.
- Technology – Technology is a constant deflationary force, as it allows businesses to produce goods and services at scale more efficiently. As new technologies emerge, the not-as-new technologies become cheaper. A great example of this is your smartphone: The first smartphone ever released couldn’t do half of what current smartphones can do. This disparity in technical capabilities reduces the value of older models, hence why a first-generation smartphone is dirt cheap these days. To put it simply, technological innovations allows the economy to meet demand more quickly than it ever could before.
In anticipation of inflation rates simmering down, we’ve already reduced the amount in the small cap value ETF. In the future, we will be looking to exit our holdings in Inflation Protected Treasuries as well. As always, we will wait for the market to confirm our views.