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Why is inflation rising and what does it mean for my investments?

December 27, 2021

The Bridgewater Advisors Team

Don’t panic.

Yes, inflation is on the rise, and it is biting. It’s also tough to stay calm when the media is hyping rising prices as a serious economic threat, particularly for those of us who remember the dark days of double-digit inflation in the 70s with a shudder. In this piece we explain why it’s premature to rethink your investment strategy.

Why is there inflation now?

Inflation has been driven upward by several factors. COVID-related lockdowns that forced people to stay at home while also spending their stimulus checks resulted in a huge spending spree on goods. Demand shifted away from services, such as restaurants and travel, to items you could touch and see.

That wouldn’t normally have mattered too much. But the halt, then slowdown, in manufacturing of goods in China and other major producers hit by the pandemic, combined with well-publicized snarls in the international supply chain, put a crimp in the supply of goods just when demand for them was spiking. That resulted in an epic supply-demand imbalance that drove prices up.

Initially, higher inflation was confined to a few sectors, such as used cars, energy, appliances and construction materials—things we spent money on when we couldn’t go out. But now, we’re seeing inflation spread into other areas such as food, and the price increases are lasting longer than the Federal Reserve and others had expected. Painful as this is, it’s still mostly related to the pandemic, which has gone on long enough to create a tight labor market, which has pushed up wages and, therefore, the cost of everything.

Is it out of control?

We’re a long way from pushing wheel-barrows full of cash to the grocery store. First off, the Federal Reserve has plenty of leeway to counter the “heat” of inflation, because interest rates are at historic lows. Raising interest rates makes borrowing money more costly, encouraging businesses and individuals to postpone projects that involve financing, and also to save money to earn higher interest payments. This reduces the supply of money in circulation, which cools the economy down, and lowers inflation.

Another way the Fed is fighting inflation is by ending their stimulus program of monthly bond purchases. These actions by the Fed are designed to send powerful signals to the market and ultimately calm things down. They are coming for sure (the “tapering” or pullback in bond purchases has already started), sooner rather than later, and will help the demand side of the problem, but not the supply side. Thankfully, supply chain constraints are in the process of correcting themselves, and experts suspect they will be largely alleviated by the middle of next year. Painful as it may be for now, the best strategy is to keep calm and let the Fed lead the way.

But wasn’t this all caused by the government printing too much money?

Between the CARES Act, the American Rescue Plan Act, and other programs, our government has spent $4-5 trillion in the past two years. Isn’t all this spending to blame for the surge in inflation?

We think the answer is no, for a variety of reasons, but this is the most compelling one: we’re seeing elevated inflation in many other developed nations, including countries that didn’t have large government rescue packages.

And here’s the good news. The stimulus money did what it was supposed to—stimulate the economy, which is now growing at a healthy clip. Wages have been stagnant for decades; now they’re rising. For many, including workers in the lowest-paying jobs, compensation is now growing faster than inflation. Corporate earnings have also grown significantly, breaking records this past quarter, and stock markets have reached new highs.

Should I restructure my investment portfolio?

Most likely not. The upcoming months will settle some of the uncertainties that remain, including how long elevated inflation will persist and whether it will become entrenched, and also whether rising wages will start to pinch corporate profits. At present, no one can answer these questions with certainty.

What we do know, looking over many decades of market history, is that stocks have earned on average 6 to 7 percentage points above inflation annually. Stocks certainly don’t outpace inflation every year, and on occasion they fail to outpace it over a decade’s time (for example, from 2000 through 2009), but they do most of the heavy lifting to grow a portfolio’s purchasing power. Global stocks have earned more than 19% over the past year, providing investors with a generous cushion against rising prices.

All the same, at Bridgewater, we remain focused on our clients’ long-term results by constructing all-weather portfolios designed to perform well in different market environments. This includes strategies that are much different from—but complementary to—stocks, such as convertible bonds, floating rate notes, and real estate.

Our message remains the same as always: stay diversified. That means keeping traditional bonds in your portfolio, too. They have important advantages over other investments with more attractive returns, including preserving capital and providing the ability to draw funds quickly if you need them.

This, too, shall pass

Of course, you should be aware of economic sea-changes (or let us take care of that for you). But calmly and consciously riding these ups and downs is all part of being a long-term investor. Normal life will resume, through a combination of immunity and improved treatments, along with appropriate monetary and fiscal policies. Most likely, inflation will right itself in 2022.

At the root, inflation is scary because it’s different from what we’ve seen in a good long while.

– This is not a solicitation, or an offer to buy or sell any security or investment product, nor does it consider individual investment objectives or financial situations.
– Information in this material is not intended to constitute legal, tax or investment advice. You should consult your legal, tax and financial advisors before making any financial decisions.
– IRS Circular 230 Disclosure: Pursuant to IRS Regulations, neither the information, nor any advice contained in this communication (including any attachments) is intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax related penalties or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.