4 must-know facts about rising inflation and your portfolio

Market Realist

Protecting your portfolio: Is it time to prepare for inflation? (Part 2 of 3)

(Continued from Part 1)

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.

Market Realist – The chart below shows that the CPI and PPI indices aren’t high and have only reverted to their three-year average levels. So, though you should exercise caution, now isn’t the time for undue concern.

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 (TIP) 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 (or ECI)– is growing at 1.8% year-over-year, right in the middle of its post-recession range.

Market Realist – Despite a drop in the jobless rate, wage inflation fell to 2.0% year-over-year from 2.1% year-over-year in May. This shows that wage growth remains restrained and might be cause for concern. Janet Yellen, Chair of the Federal Reserve, has stated that only when she sees wage inflation rise to between 3% and 4% will she be satisfied with labor market performance.

Investors often look to TIPS, gold (GLD), and silver (SLV) as inflation protection measures. But TIPS have their shortfalls in the form of lower yields. There are other options, like energy (XLE) and technology (XLK) equities, which seem to be more lucrative.

Read the next part of this series to find out what the road ahead looks like in the current context.

Continue to Part 3

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