Inflation is here – it’s just not evenly distributed.
In other words, inflation means different things to different people.
The Fed says there is no inflation. That’s fine if you’re the government and want to keep social security increases low. But what if you live in an expensive city and noticed your healthcare, education and housing costs are soaring?
And what about financial assets? While investments don't factor into the CPI inflation calculation, the vast majority of assets are clearly ‘inflated’. This is – in part – a function of the Fed’s aggressive money creation.
Yet, all this stimulus hasn’t resulted in CPI inflation. What gives? Well, the velocity of money today is glacial. As it turns out, it’s a lot easier to save money when everything’s closed. But what happens after more helicopter cash, vaccinations and the floodgates of commerce re-open?
President Biden is proposing another round of stimulus ($1.9 Trillion), which includes:
Increased unemployment benefits through September
A doubling of the Federal minimum wage to $15 / hour
Another direct $1,400 check to every American
Extreme times call for extreme actions. However, we would not be surprised if even more rounds of checks and quantitative easing are forthcoming. How many trillions can we create from thin air without long term consequences?
It appears we’re going to find out.
Free Money Is A Slippery Slope
More concerning is the moral hazard the Fed created by printing and buying everything is sight (including corporate bonds for the first time in history). Passing large tax increases might prove difficult over the short-term. Most Americans now realize the government can just add zeros to its balance sheet to pay bills. Don’t get too excited, taxes are still likely to go a bit higher. We simply assume politicians will have a hard time turning off the cash spicket.
This is not to say we suspect inflation to run rampant. There are deflationary counterbalances. Technology advances and offshoring labor are deflationary. The question is: will deflationary trends be enough to dampen unprecedented money printing?
Your guess is as good as ours.
Evergreen doesn’t rely on macro predictions. We’ll leave that to the economists, who are so numerous that if you stacked them end to end into outer space…that wouldn’t be a bad thing.
We do think deeply about risk and probabilities though. Consequently, we believe the risk of meaningful inflation this decade hasn’t been this high since the 1970s.
Your Personal Inflation Rate
Perhaps a better way to think about inflation is through your own personal spending lens.
Take a mental inventory of your major expenses. If your unique basket of products, services, necessities and future assets (investments you’d like to make) are skyrocketing in price, then today’s zero CPI rate isn’t your reality.
In that case, it makes sense to prepare for the possible degradation of your cash holdings. Or as hedge fund manager Ray Dalio said more succinctly: “Cash is trash”.
Given the circumstances, investor portfolios should overweight hard assets. While commodities have worked as inflation hedges, we prefer cash-flowing real estate with pricing power. As CPI increases, so does net operating income stemming from rent increases. This is true both of private and public real estate (REITs).
Real estate and REITs provide natural protection against inflation. Rents and values tend to increase with consumer prices. This supports REIT dividend growth and provides a reliable stream of income during inflationary periods. REITs also have attractive, fixed rate debt. Inflation is a boon to borrowers as you get to pay the lender back with “cheaper” cash.
America had a four-decade run of disinflation since 1980. Given the circumstances, the risk of broadly higher inflation is – while not a given – on the table. The Fed wants above average CPI numbers to inflate away our unsustainable debt.
Don’t fight the Fed, plan accordingly.