3 Reasons to Expect Stuckflation

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Regardless of near-term outcomes, U.S. inflation will have a difficult time breaking loose longer-term

There has been no shortage recently of alarmist headlines about U.S. inflation. Investors are concerned that after a long period of low inflation and strong market performance, rising prices could surprise investors and erode returns.

While inflation data and comments made following corporate earnings results have indeed pointed to higher prices, the magnitude and time horizon of this pattern are important to keep in mind.

In summary, the magnitude has been modest, and the timing is likely cyclical rather than secular. In fact, longer-term, several significant trends suggest persistently low inflation, or “stuckflation,” poses the greater challenge ahead. They include the following:

Reasons to Expect Stuckflation

  1. Technological advances: The increasing use of technology by both consumers and companies will likely continue to have a significant impact on inflation. On the consumer side, technology offers shoppers more options and transparency when searching for goods and services, allowing them to more efficiently find what they want at lower prices. This in turn forces companies to price more competitively. And this too is being enabled by technological advances, including automation and digitally-streamlined, global supply chains.

  2. An aging population: Globally, people are living longer and reproducing less. In the U.S., life expectancy has risen from 70.8 in 1970 to 78.8 today,1 while the fertility rate has fallen from 2.48 to 1.8.2 While the full economic impact of this trend is uncertain, we do know that older people in the U.S. tend to spend less3 as they exit the labor force and conserve for longer lifespans. This too will likely act as an inflation headwind by holding down overall demand for goods and services.

    U.S. Economic Dependency Ratio, 1996, 2006, 2016 and Projected for 2026 (Per hundred in the labor force)4

    Chart: U.S. ECONOMIC DEPENDENCY RATIO, 1996, 2006, 2016 AND PROJECTED FOR 2026 (PER HUNDRED IN THE LABOR FORCE) Chart: U.S. ECONOMIC DEPENDENCY RATIO, 1996, 2006, 2016 AND PROJECTED FOR 2026 (PER HUNDRED IN THE LABOR FORCE) Chart: U.S. ECONOMIC DEPENDENCY RATIO, 1996, 2006, 2016 AND PROJECTED FOR 2026 (PER HUNDRED IN THE LABOR FORCE)

  3. High U.S. Government Debt: U.S. government debt has risen substantially over the last 10 years and is expected to rise much further over the next 10 years. This trajectory was largely fueled by the 2007-2008 financial crisis and exacerbated by the 2017 Tax Cuts and Jobs Act, which significantly reduced government revenue and increased spending. As it stands, this trend could also dampen demand for goods and services over the long run, as more of the federal budget is allocated to paying and servicing debt rather than spending.

According to the Congressional Budget Office, federal debt held by the public has doubled over the past decade and is expected to reach nearly 100% of GDP by 2028, at which point it will be higher than in any year since just after World War II.5

While long-term inflation headwinds are strong, knowing how to prepare may be less apparent, particularly at a time when some experts are stressing the dangers of inflation.

Here are some guiding principles to help:

  • Don’t Fear the Fed:

    Inflation concerns are often raised in the context of monetary policy. The assumption is that higher inflation will lead the U.S. Federal Reserve (the Fed) to raise the Fed funds rate, which in turn will lead to higher interest rates and negative bonds returns. Keep in mind, however, that changes in the Fed funds rate have historically had a low correlation with bond returns6. This is not to say that bonds won’t experience losses in an inflationary environment, but worrying too much about the Fed’s next move is unproductive.

  • Don’t Fear Fixed Income:

    Regardless of inflation outcomes, bonds play an important role in portfolios by dampening the volatility and downside risk of stocks and other higher-risk assets. Further, while a cyclical uptick in inflation and interest rates could cause unrealized bond losses, portfolios would likely benefit longer-term as coupons and maturities are invested at higher yields.

  • Don’t Abandon Your Plan:

    The best defense against cyclical changes in the economic and market environment is a carefully crafted asset allocation aligned with your long-term goals. For many investors, this includes inflation-dampening investments, such as Treasury Inflation-Protected Securities (TIPS) and real assets (e.g. natural resources and real estate) to protect against both expected and unexpected inflation.

So let the pundits debate the near-term outlook for inflation. Most investors are better served by focusing on the long run, and protecting against – rather than reacting to – varying inflation outcomes.

  1. U.S. Department of Health and Human Services, Centers for Disease Control and Prevention. Health, United States, 2016. Life expectancy at birth. As of year-end 2015, the most recent data available.
  2. The World Bank. Fertility rate, total (births per woman) as of 2016, the most recent data available.
  3. https://www.bls.gov/opub/btn/volume-5/spending-patterns-of-older-americans.htm
  4. Employment Projections program, U.S. Bureau of Labor Statistics.
  5. https://www.cbo.gov/publication/53651
  6. For more information, see our Portfolio Research paper, The Enigma of Fed Policy and Bond Market Returns.
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This information is not intended to be and should not be treated as legal advice, investment advice or tax advice and is for informational purposes only. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal or tax advice from their own counsel. All information discussed herein is current only as of the date appearing in this material and is subject to change at any time without notice.