“Abnormally good or abnormally bad
conditions do not last forever”
(Benjamin Graham


Following is a continuation of our  5-Part series on inflation. For your convenience, if you would like to reference the previous reports you may click the links below or search for them among many other interesting articles in our blog at mgfs.net/category/blog/

Inflation Report — Introduction
Inflation Report 1—What is Inflation
Inflation Report 2—What can you do to protect yourself?
Inflation Report 3—What is the government’s role with inflation?
Inflation Report 4—What Can We Learn From the Past?

Inflation Report – Part 5

Living in or through an inflationary environment requires that we pay attention to a variety of factors – The Fed, microeconomics and the concept of elasticity, an understanding of the environment today, and, often, professional guidance. 

The Fed

Remember the quote by the late Marty Zweig “Don’t fight the Fed”? As it relates to
inflation, the Fed has unlimited resources to use for manipulating the money
supply and interest rates. They have the power to inflate or deflate the money
supply. They move markets quickly when action is either explicit, anticipated,
or implied. Therefore, it is prudent to be in tune with their policies: accommodative
monetary policies generally help elevate asset prices while tightening monetary
policies do not. The Fed has an outsized amount of influence and leverage over
the direction of the economy, interest rates, stock prices, and the level of
inflation. While their messaging is often subtle or in the background, reactions
to them are at the center.

Ironically, inflation is directly caused by the Fed due to excessive money printing generated over a long period of time. Fiscal policy indirectly compounds the impact of Fed monetary policy through government regulations, taxes, and spending. The excessive money in the economy sends mixed signals. In the shorter-term, it provides for wealth creation which leads to excessive consumption and growing stock prices, increasing the level of liquidity in the market repeatedly. In the longer-term, the picture darkens. When consumption exceeds production with excess liquidity, the difference is inflation. As inflation widens, there is a negative longer-term effect on purchasing power. It becomes harder to buy what is needed and wanted.  In essence, the real value of goods and services become distorted by the ability to pay more for them.  When reality sets in, the Fed combats inflation by raising interest rates and regulating its member banks.  This can leave significant collateral damage for the economy, felt by individuals, small and large businesses, and government.

So, when it comes to inflation, you must adapt to the environment. Inflation is always around but now elevated throughout the global economy. Thinking rationally, assessing your own behavior to maintain personal financial security, and potentially influencing those around us is critical and thematic not only as it relates to what the Fed does but for the additional areas of consideration below.

A Microeconomic Lesson- Elasticity and Inelasticity

An important microeconomic concept that applies in many areas of economics, including inflation is elasticity. This is the measure of demand for a good or service in relation to price movements.

Elastic demand suggests that changing prices impact consumer demand for certain goods. This means that during higher periods of inflation, increasing prices for goods result in different decision and spending patterns for things like clothing, cars, furniture, vacations, and luxury items. As prices go up, consumers buy less or look for less expensive alternatives. The reverse holds true when prices
fall. Elastic goods and services are mainly non-essential or discretionary. Wealthier
households are not as influenced by elasticity and would be less likely to change their spending habits.

Inelastic demand primarily effects essential and non-discretionary goods and services. The demand for such items minimally, if at all, change due to price increases. Examples of this would include gasoline, water, electricity, tolls, waste
collection, prescription drugs, alcohol and tobacco, and goods produced by a
monopoly where there is little competition. No matter the price, people will pay.

While inflation causes prices to increase, there are psychological and financial
effects on consumer behavior. In general, people tend to tighten their wallets,
adjusting their preferences and spending habits, particularly those who are constrained by budgets. Sometimes such decisions are quite difficult and painful for families forced to make them.

Economies are extremely complex as they consist of hundreds of millions of people making hundreds of millions of decisions collectively each day on microeconomic or personal levels that eventually filter into macroeconomic data points such as corporate profits, the labor force, and GDP growth, to name a few. As inflation increases or decreases, consumer demand changes depending upon the product, competitive substitutes, and household income levels. The takeaway is that people do more ‘stop and think’ consumer decision-making during higher inflationary periods. This micro behavior on a mass scale impacts corporate profits which then influences market volatility. However, in every environment, certain market sectors will continue to perform well, and consumers and investors, alike, will react and adjust to these changes and opportunities.

This dynamic ties further into the economic law of supply and demand. Simply stated, the law reflects the willingness of people to buy or sell goods. Expanding on this, while there are many factors that can shape the volume of goods available and the demand for them, the market continually reaches equilibrium where the two intersect and prices are set. Inflation complicates this further. Today, supply
constraints also need to be factored into the availability of goods.

As we bring these themes together, you need to consider whether goods and services are needs or wants, whether you can live with or without them, and their degree of accessibility.

Unprecedented Times

In early 2020, the US experienced a short but deep economic recession due to the lockdowns in response to Covid-19. This was paired with an enormous expansion of government spending through monetary and fiscal policies. This level of government engagement was both phenomenal and unprecedented. The government provided massive financial aid to businesses and consumers and at the same time expanding regulations required businesses to close their doors and adopt different ways of conducting business. This impacted every business and consumer and today we are left with a fractured workforce due in part by The Great Resignation and many people continuing to work remotely or shifting into different industries. While unemployment rates have mostly recovered, it feels and looks like a different economy than prior to Covid-19. The workforce is smaller, yet jobs are available in many industries and geographic areas for both skilled and unskilled labor. At the time this report was written there were 11 million job openings with 5 million people looking for work.

As inflation evolves, businesses continue to focus on strategic planning. They are
estimating demand for their specific goods and services. Projections are dependent on the elasticity or inelasticity of their products. Forecasting is not a
simple task, because it can be easy to over or underestimate consumer demand in
the aftermath of a pandemic and during an inflationary period where government
spending has been “off the charts.” For example, major retailers such as
Walmart, Target, and other big box chain stores performed well during the earlier
lockdown phase of Covid-19. Pandemic aid resulting in money printing and spending contributed to their success. The pace of growth could not last indefinitely. After the government spending ended, sales volume eventually dropped. Inventories then went up and profits went down, as did their stock prices, at least temporarily. It is a conundrum to forecast with this magnitude of change and in such a short period of time.

Statistics are more difficult to analyze due to business lockdowns and injections of stimulus money. Inflation, in this era, distorts many aspects of normal macroeconomics.  Company analysts must discern what is sustainable or temporary data with questionable guidance. The economy usually works like a
freightliner that takes a long time to turn around while the market often works
like a speed boat that can turn on a dime. It is a tough environment for businesses
to commandeer the seas of a rapidly changing economy. Additionally, non-domestic situations like the war in Ukraine impacting natural gas and wheat
supplies and China’s “zero-Covid-19” policy that leaves large cities like Shanghai locked down can detract significantly to the balance. News is constantly emerging making the fog around inflation that much more difficult to navigate.

As markets like more certainty and stability, the Fed has worked to communicate their intentions so markets can anticipate potential outcomes. This leaves room for consumers to do the same.  In the next section as we explore our present reality bear in mind it is normal for the market to be experiencing many potential risks. Think of any decade with a challenging economic environment, and there will be political and social challenges that directly and indirectly stoke concerns and fear. Such moments and sets of circumstances leading to our present have influenced resilience, creativity, and innovation.

Reality Check and Good News

While no one knows with certainty how inflation will play out this time, we have experienced it in the past.  With historic precedence, higher inflation will break at some point and come down. Interest rates will peak and then stabilize. Markets will bottom and recover. Bond markets and investors will experience higher and competitive bond coupon rates for the future. Stock markets relying upon future earnings, the key being the future, will thrive. Negative consumer sentiment will eventually be replaced by positive sentiment. 

In terms of market cycles, bear markets are replaced with bull markets. Since the 1920s, the size and scale of economic expansions generate growth 10 time stronger than contractions seen during a recession and they last 7 times longer (Source – National Bureau of Economic Research). Economic theories change back and forth from Keynesian to Classical depending upon the administration in power. Our economy, goes through periods of economic recessions or depressions where everything looks hopeless, followed by even longer periods of recoveries and stronger economic growth. Businesses and individuals are pre-destined to survive and flourish and do what is necessary to overcome and accomplish. What remains uncertain is the severity of inflation and the timeline. Proper government
policy decisions can assist to lower and shorten inflationary pain. Poor ones can
exacerbate and prolong it.

Through all this chaos, improving technology, innovation, and entrepreneurial leadership will help guide us forward. New ideas and companies will emerge. Out from the 70’s came Microsoft! Well-managed companies with lower debt and solid cash flow get through rough patches and thrive. Their stock prices trend upward. Companies are built to prosper.  There will always be opportunities for companies in different parts of the markets to profit and for investors to reap rewards.

It is very easy to become emotional and absorb news from outlets that speak in general terms with less relevance over your lifestyle. Inflation is as formidable an
adversary as Covid-19 when trying to subdue its impact. As well, inflationary
cycles are persistent. We encourage you to stay positive and focus on lifestyle
changes under your control today and that may affect your future.  This advice has a very measurable impact on your objectives and will help you live your life to the fullest.

As advisors, we help you manage through uncertain times. Financial planning is always important and more difficult in periods of higher inflation. Our process is customized based upon your needs, tolerance and capacity for risk, sources of income, and intended use of your assets over time. As we reviewed in previous reports and writings, there are strategies designed to mitigate your specific risks. Of the many different types of investing or planning risks that we highlight in our
book “Guided Retirement Income Planning,” inflation risk is perhaps the most difficult for any long-term plan and can be very damaging, if left unchecked.

Our economy is resilient. We remain optimistic. While the short-term is mostly opaque from an investment standpoint, the long-term outlook is promising. 

All our best,
Your Partners from MGFS