We continue to see evidence that decades of benign inflation is giving way to a new reality of higher inflation. Not necessarily runaway inflation, but higher than it's been. This is evidenced by higher commodity prices, crude oil, wages and costs overall.
This is typical late-stage economic recovery behavior, but juicing the economy with a tax cut so late in the business cycle may exacerbate this condition, overheating the economy and providing a further boost in inflation. This may cause the Federal Reserve to become more aggressive in raising rates than the market expects.
How Higher Inflation Could Impact You
Economic: Business operating costs will probably increase, reducing corporate margins and returns on capital. As a result, corporate earnings may be negatively affected, reducing economic growth and perhaps stock market valuations.
Living Costs: Your living costs may increase faster than expected, impacting our financial planning projections. Presently, for our financial planning models, we are estimating inflation at 3.2%, though this may have to be increased at some point. Higher inflation may make it more difficult to make your money last.
Investing: Citing these trends, last year we re-configured your portfolio to begin reflecting this new economic reality. Fearing higher inflation, we sharply reduced the interest rate sensitivity of our bond portfolio. Earlier this year, we added commodity-oriented positions, which benefit from higher inflation. These changes have had a positive impact on your returns.
In summary: While there is no reason to expect runaway inflation, it is important to recognize the probability of higher costs going forward and to be prepared for its many impacts. We believe our portfolios are well-positioned for this new reality.