Inflation accelerated to 8.6% in May. 😬
Why is inflation getting worse? And how should retirement investors respond?
In this episode, I’m answering those questions + sharing key takeaways from the May inflation (CPI) report.
I’m also discussing:
- What “shadow inflation” is (and why you should ignore it)
- Why inflation is high
- What retirement investors can do in response
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How to Listen to Today’s Episode
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- Stay Wealthy Inflation Series:
- Inflation Part 1 (2/9/22)
- Inflation Part 2 (2/22/22)
- Why I Was Wrong About Inflation (3/15/22)
- Shadow Inflation:
- Debunking Shadow Inflation [Full Stack Econ]
- Shadowstats Response to Errors [Econbrowser]
- Current CPI Report [U.S. Bureau of Labor Statistics]
- Federal Reserve Bank of San Francisco on Pandemic Relief and Inflation [BBC]
- How Not to Panic [Of Dollars and Data]
- Rising Interest Rates Don’t Mean Bonds Lose Money [Stay Wealthy]
- Why Are TIPS Losing Money [Stay Wealthy]
S&P 500 Total Return (1/1/20 – 6/13/22)
3 Key Takeaways on Inflation from the May CPI Report
Taylor Schulte: Welcome to the Stay Wealthy podcast! I’m your host Taylor Schulte and today I’m sharing key takeaways from the May inflation report.
In addition to providing a short summary, I’m also sharing what shadow inflation is and why you should ignore it, why inflation is high, and what retirement investors can do in response.
For all the links and resources mentioned today, head over to youstaywealthy.com/155.
Before we dive into the May CPI report, which I know everyone is really excited about, I want to clarify and expand on something important from last week's episode on TIPS that may have not been clear.
I had shared that TIPS (and let's actually be a little more specific here and say intermediate-term TIPS), I had shared that intermediate-term TIPS were losing money because the current economic environment has been in line with market expectations. I also – and possibly too quickly – stated that TIPS are impacted by changes in interest rates and actions taken by the federal reserve.
To avoid any confusion and expand on these comments, let’s keep it simple and say that there are two ways you can evaluate the performance of TIPS.
One is to compare the performance of TIPS to nominal bonds, your plain vanilla US treasuries. While I advocated for not trying to predict the future and shared that, if you’re going to add TIPS to your portfolio, you might consider Swensen’s philosophy of splitting your TIPS and nominal bond allocations 50/50, some investors, including myself, are interested in understanding when it was better to own TIPS vs nominal bonds.
So that’s one lens in which we can evaluate performance. Are TIPS outperforming or underperforming compared to nominal US treasury bonds? In other words, has inflation been above or below future market expectations? Most students of the market would likely find that data interesting, and in some cases, helpful to their investing decisions.
The second way you might evaluate the performance of TIPS are on their own, in isolation, just like you might evaluate the performance of the S&P 500. Are TIPS in positive or negative territory as an asset class over a specific time frame?
I bring this up because, as I quickly glossed over last week, TIPS are impacted by changes in interest rates, just like your conventional nominal bonds. That inverse relationship between interest rates and bond prices we’re all familiar with does exist with TIPS. When interest rates rise, the value of a Treasury Inflation-Protected Security – or a TIPS fund – is likely to fall.
Of course, as noted last week, if you hold the bond to maturity (or hold your TIPS fund for the stated duration or time horizon) you will receive either the inflation-adjusted principal amount or the original principal, whichever amount is greater.
The relationship between interest rates and TIPS does get slightly more nuanced, but at a very high level, just like nominal us treasury bonds, the recent spike in interest rates has contributed to the short-term losses in TIPS and does add to the explanation for why TIPS are losing money. And I say short-term losses because, as I’ve dispelled in previous episodes, rising interest rates – even an extended period of rising interest rates – doesn’t mean you will lose money in bonds.
If you missed that episode or want a refresh I’ll link to it in today's show notes which can be found by going to youstaywealthy.com/155.
To recap, TIPS can help protect investors from rising inflation expectations, but not from inflation itself. And like nominal bonds, TIPS are not immune to interest rate risk and can experience short-term losses if real yields rise like we’ve seen over the past 24 months or so.
Ok, hopefully that helps. Let’s now move into today’s main topic, the May CPI report.
By now, everyone is likely aware of the disappointing news that came out last Friday when the Bureau of Labor Statistics announced that prices accelerated further last month, sending the 12-month inflation number to 8.6%, surpassing the 40-year high that was recorded earlier this year in March.
While I stated last week that I hadn’t seen any intelligent forecasts, I think it’s safe to say that most people were expecting inflation to tick down. The stock market certainly expected it – shortly after the announcement, US stocks plummeted 3%.
Before we talk about what all of this means for retirement savers and the rest of 2022, let’s first dig into some of the highlights of the May CPI report.
To start, the Consumer Price Index (CPI) – the index that measures the overall change in consumer prices each month – increased by 1% in May. In other words, prices (or inflation) jumped 1% last month. As a reminder, and for some context, CPI increased 0.3% in April, so this is a big jump month over month. That said, we did see CPI increase by 1.2% in March, so this type of increase isn’t necessarily something new we are experiencing here.
So what contributed to this 1% jump in prices? Well, pretty much everything across the board.
Broad energy prices jumped 3.9% in May, bringing the annual increase to 34.6%. Within the energy category, fuel oil jumped 17% last month, and is now up 107% over the past year.
Rising fuel prices + consumer demand, not so surprisingly, caused airfare to jump as well, with airline fares up close to 13% month over month, and up almost 40% over the last 12 months.
And, as we are all too familiar with at the moment, gas prices continue to rise, with the gasoline index rising 4.1% in May, contributing to an almost 49% spike in gas prices over the last 12 months, from May of 2021 to May of 2022.
Lastly, food prices climbed as well, with the food at home index spiking up 1.4% last month, the fifth consecutive increase of 1% or more. Even worse, the index for dairy and related products rose 2.9 percent, its largest monthly increase since July 2007,
It’s hard to find anything positive in this report, but if you had to pick out something it would be that core inflation (which represents all items except food and energy) has slowed for the second consecutive month, falling to 6% year over year. It’s also the lowest reading in four months, but these readings and reports are in our rearview mirror, and where we go from here continues to be a coin toss.
One thing I’d like to address and get out of the way before we move on is this increasingly popular conspiracy that the true rate of inflation is much higher than the government is reporting. This QUOTE/UNQUOTE true rate of inflation is commonly referred to as shadow inflation. And look, I’m all for maintaining a dose of skepticism and questioning information and not blindly accepting everything at face value, but it doesn’t take very much to figure out that this shadow inflation theory isn’t reliable.
In short, the theory claims that, in the 1980s, the bureau of labor statistics made changes to how inflation was being measured, and these changes caused the true rate of inflation to be understated from that point going forward.
Shadow inflation believers claim that if you use the “old methodology” from the 80s, the true inflation rate has been upwards of 8% higher than the official stats have indicated over the last 40 years. So, instead of 8.6% inflation, shadow inflation would suggest we’re actually facing 17% inflation.
However, the founder of Shadowstats and the measure for calculating the Shadow Inflation Rate, John Williams, publicly admitted that he doesn’t actually use the old methodology to arrive at this TRUE rate of inflation or shadow inflation. He takes what most would argue is a more concerning approach – he takes the official inflation number from the bureau of labor and then adds his own personal estimate for how much he thinks inflation has been understated.
Look, making educated and informed assumptions in the world of finance and economics is not uncommon, but many trusted economists and finance experts have long highlighted some very basic mathematical errors that he’s making with his calculations.
For example, in 2021, Williams publicly claimed that the TRUE annual inflation rate had averaged about 9% per year over the last 21 years. In other words, he claimed that, based on his Shadowstat methodology, prices had risen 600% from 2000 to 2021.
Well, it’s not that hard to rewind back to the year 2000 to find out how much things cost, many of us could probably make some reasonable estimates from memory. But to spare you the brain energy, in the year 2000, the average price per gallon of gas was $1.53. If we compare that to the average price of $3.47 in 2021 and crunch some numbers, we would determine that prices increased by 126%, not even close to the 600% Williams claimed.
Heck, even if you used current gas prices here in 2022 which just crossed $5/gallon, we’re still only talking about a 226% increase since 2021, a fraction of what Williams had suggested. As another example, the author of an article I’ll link to in the show notes shared that, in 2000, a chicken burrito at Chipotle was around $5. If that price has inflated at 9% annually over the last 21 years, or 600% because that 9% is compounded, we’d be staring at a $35 burrito today.
The mathematical errors don’t stop there and Williams continues to provide odd explanations that just don’t add up. Again, if you want to read more, I’ll link to a great summary in the show notes. And sure, perhaps inflation is potentially understated, but I’d urge you to be skeptical of the Shadow Inflation methodology given the basic errors found in the calculations, and at the very least, dig into the math yourself before trusting any headlines you see around the internet.
Ok, back to reality. While inflation may not be the 17% number that shadowstat believers are suggesting at the moment, we’re still faced with the highest reported inflation since 1981 and the question marks continue to pile on. Before we talk about where we might go from here and what to do about it, let’s touch on the “why.” Why are prices increasing? Why is inflation hitting 40-year highs?
There are three main causes, and most are linked to the pandemic in some shape or firm.
1.) The first cause, as touched on during my very first episode on inflation earlier this year, is high consumer demand. And this demand is unique because it’s a result of Americans being trapped at home for an extended period of time coupled with massive government stimulus programs.
In fact, a recent study by the Federal Reserve Bank of San Francisco concluded that pandemic relief packages probably contributed to about 3 percentage points of the rise in inflation until the end of 2021. And this data point certainly helps to explain why US inflation outpaced the rest of the world.
To be very clear here, I’m not turning this into a political podcast and pointing any fingers. There are a lot of moving parts and a lot of people involved in making policy decisions. Plus, one could argue that the policy response to covid, while it might be contributing to the pain at the moment, one could argue it was the right move at the time given the information we had in front of us.
This is not the podcast to debate that, but what we can all hopefully agree on is that the covid policy response has contributed to the rise in prices, it cushioned our balance sheets, and enabled people to continue buying. In fact, according to the Wall Street Journal, households still have about $2.3 trillion of excess savings to help them weather the storm right now.
2.) The second contributor, which goes hand in hand with the first, is the low supply of goods – partly as a result of the spike in consumer demand and businesses not being able to keep up, but also factory shutdowns, and shipping backlogs, and reduced production. The spike in consumer demand outpaced the supply of goods, which has enabled companies to raise prices without losing customers, so far, at least. On top of it all, we have the war in Ukraine and recent China shutdowns magnifying the issues we were already faced with.
3.) Lastly, we can point to the Fed, we can point to their responsibility to control inflation and their slow response. We’ve been in a low-interest rate environment for some time, and those low-interest rates make it cheaper for consumers to borrow money, which in turn makes it easier for consumers to spend, especially spend on big items. Now the Fed is trying to play catch up which is shocking the system here in the short term.
On that note, it appears more and more likely that the Fed will raise rates by ¾ of a point or 0.75%, possibly today, the day this episode gets released. And the likelihood of that happening is a big reason why the markets are acting the way they are right now… the markets are anticipating this rate hike (and future rate hikes this year) and stock and bond prices are responding accordingly.
What can be done?
So those are the three primary contributors to the inflationary environment we’re experiencing today. Naturally, the next question is, “what can be done” about it?
Well, the first obvious answer, is the Fed. One of the Fed’s responsibilities is to control inflation, and while they were maybe late to the party here, the upcoming interest rate hikes is their effort to get inflation back under control.
As Jayson Lusk, a professor and the head of agricultural economics at Purdue University stated,
“People have money, and they're wanting to spend it. And despite higher prices, if you ask how people are responding to inflation, they're saying, 'I’m not really changing, I’m just paying more, not cutting back.' That suggests they're not acting like it’s a recessionary environment yet."
So, the upcoming rate hikes, theoretically, will make it more expensive to borrow money which in turn curbs consumer spending and also discourages businesses from expanding. The reduction in consumer spending and business expansion will slow down the economy and, as talked about here on the show, possibly even push us into a recession…which some think we might be in already.
In addition to the Fed’s response, we might also see continued price hikes by corporations in an attempt to keep pace with wage growth. While annual wage growth is running at its fastest pace in 20 years, inflation continues to outpace earnings for most workers, cutting into their spending power. This, of course, often leads to employees asking for higher wages from their employers which then causes this inflationary cycle of wage-price increases.
In the end, there are only so many levers that can be pulled, and we’ll likely need to experience some continued pain as an economy as we work through this current challenge.
As I shared last week, where we go from here feels like a coin toss. Things like the Ukraine war, china shutting down, and surging commodity prices could cause higher inflation.
On the other hand, rising interest rates, a cooling off in the housing market, fiscal tightening, commodities crashing, and a recession could push inflation lower.
Given all of this uncertainty, what should investors and retirement savers do?
One idea is to get curious. My marriage therapist - who after seeing her for over 10 years now has become more of a life therapist – constantly reminds me that curiosity is the antidote to anxiety. That, by consciously deciding to get curious, we can lessen our sense of anxiety. We can get curious by learning new things, asking thoughtful, sometimes uncomfortable questions, and, her favorite, studying history.
And I believe we can apply this same concept to our investments, the financial and economic landscape, and the constant state of uncertainty. In fact, Nick Maggiulli, who I recently had on the show, wrote a great article last month titled “How Not to Panic.”
And in the article he wrote:
“A friend recently asked me how I was able to stay calm during a market crash. I told him that its because I’ve spent a good amount of time studying history. And, in doing so, I’ve come to realize that a lot of what we experience isn’t as unique as we think it is.”
Publishing this podcast is part of my conscious effort to get curious. And while listening to it might also be a version of you getting curious, if anxiety is heightened at the moment, it may be worth getting even more curious. You can dig deeper into the history of the markets and inflation, ask questions, and even publish your own thoughts and comments – even something as simple as a short summary on social media or an email to your family might help calm some nerves and prove to be an antidote to any worry you be me experiencing at the moment.
As Deepak Chopra said,
“The best use of imagination is creativity. The worst use of imagination is anxiety.”
Another response to this uncertainty is to ensure you’re properly diversified, and possibly even over-diversified. For example, if you’re overweight U.S. stocks, perhaps you consider maintaining meaningful diversification overseas. If you own individual stocks, you might consider consolidating your investments into broad-based index funds. If you only own corporate bonds, you might consider adding U.S. Treasury bonds and TIPS.
By reducing risk and over-diversifying, you will also be accepting a lower rate of return when things turn around. But that diversification might also help you sleep better at night if the volatility and uncertainty continue.
One quick note, I’ve had a few people contact me recently who want to improve their diversification and make some meaningful changes to their investments, but feel like their hands are now tied because the market has dropped so much. It feels like they would be selling things while they are down and realizing those losses, so they have expressed that they might just have to wait it out.
Waiting it out and weathering the storm is certainly one option. As the late John Bogle said, “don’t do something, just stand there.” In most areas of our life, if we want to achieve something, we take action. For example, if you want to run a marathon, you train. But with investing, the opposite is often true and sticking with your financial plan – assuming it was the right plan to begin with – is often the right choice.
However, for those that don’t feel like they have the right plan in place and feel like their hands are now tied because of recent drops in the market, it’s important to highlight that the U.S. stock market would have to drop another 30-ish% or so to reach the lows we experienced in March of 2020.
Also, as I shared in a previous episode, if you invested in the S&P 500 on January 1st of 2020, reinvested your dividends, and woke up today to look at your portfolio, your approximate total return would be around a positive 20%. A 20% return over the course of 30 months. So, yes, we’ve given back some of the recent gains, but you’re still buying at a higher price today than 18 or 19 months ago.
Sometimes – or most of the time – it helps to zoom out and look at things through a slightly longer-term lens. In the case of making some changes, sure maybe you realize some near-term losses in the process, but you’re likely still well ahead of where you were at the start of 2020.
To be clear, any changes you make should be permanent changes. I.e., we’re not timing the market in this example here. This is a situation where we’ve realized that we’re invested incorrectly and we want to fix that. And I’m just highlighting that just because we’ve given back some recent gains, it doesn’t mean you can’t move forward with making those appropriate changes. Because, what if you don’t make those changes? What if the market continues to fall? What if we are in a prolonged recession?
As I’ve said many times on this podcast, the best investment portfolio is the one you can stick with.
I have so many more sub-topics I’d like to explore here around the topic of inflation and the current environment, like the housing market, debt deflation, stagflation, and the labor markets, but maybe like you, I’m feeling like I need to set this to the side, take some more time to digest it all, and watch some things play out over the next few weeks before digging in further.
So, I’m going to stop here for today, but if you want to get curious with me, if you have any thoughts of your own or unanswered questions, or you just want to say hi, send me an email at firstname.lastname@example.org.
Once again, the show notes for today's episode can be found by going to youstaywealthy.com/155.
Thank you, as always, for listening and I will see you back here next week.
Episode Disclaimer: This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services.