As inflation gets real, advisers ponder strategies

While the Fed continues to call inflation transitory and temporary, financial advisers are bracing for the reality of higher prices and lower yields.

As the consumer price index and producer price index data continue topping consensus expectations, the inflation debate endures, producing distinct sides on if or how financial advisers should be preparing clients.

“Inflation is definitely running very hot; to levels we haven’t seen since August 2008 and back to 1991,” said Paul Schatz, president of Heritage Capital.

“This is huge; however, the markets are not reacting intuitively to the white-hot inflation numbers,” he added.

The fact the S&P 500 Index is up more than 17% so far this year, including a 2.6% gain over the past 30 days, suggests that the financial markets are still following the lead of the federal government’s fiscal and monetary policy leaders, who insist the current inflation is “transitory” and is likely to level off later this year.

“For investors, the inflation trade began last summer and accelerated significantly after Halloween,” said Schatz. “Right now, the market is trading the other way. So, if somebody was looking to hedge or to hide you would look at all the things that are not currently working, like commodities, energy, industrials, and materials.”

Zachary Bachner, a financial adviser at Summit Financial, said those in or near retirement are typically focused on the threat of inflation, but that inflation is a “bigger concern than normal right now” due to the sudden spike.

“Keeping money at the bank and earning a very low interest rate is one of the worst ways to devalue your savings, because your savings will not keep up with inflation,” he said. “The best way to outpace or keep up with inflation is to take on risk by investing in the stock market. Equities tend to have higher returns, which should outpace inflation, but they also carry increased risks.”

While advisers ponder the best course for the kind of inflationary cycle this country hasn’t seen in decades, the economists and market watchers are trying to read the tea leaves coming out of the Federal Reserve Board of Governors.

Speaking before the Senate Banking Committee Thursday, Fed chairman Jerome Powell described the spiking inflation data as “bigger than many expected, certainly bigger than I expected, and we’re trying to understand whether it’s something that will pass through fairly quickly, or whether in fact we need to act.”

Peter Yi, head of duration at Northern Trust Asset Management, is generally in line with the Fed’s argument that the current levels of rising prices are temporary, even if they are already triggering some wage increases.

Yi cites the impact of the economic shutdowns, stimulus spending and various emergency monetary rescue efforts during the pandemic as “distortions” of the data that are now being measured against less disruptive periods.

“It will take some time for these distortions to work out of the system, and the Fed wants to run hotter for longer once the data smooths out,” he said. “All of these temporary bursts of inflation will fade, and the supply chains will catch up.”

The Northern Trust stance is the current inflation spike is just a blip in an outlook they have been describing as “stuckflation” for the past five years.

“The Fed has had a difficult time trying to get to 2% for over a decade,” Yi said. “When all the pent-up demand and distortions go away, our view is we will go back to somewhat of a moderate growth stage, with inflation under the 2% threshold.”

In such an unprecedented scenario the analysts and market watchers, along with the Fed, are basically hoping for the best while trying to apply traditional models to an untested environment.

Mohamed El-Erian, chief economic adviser at Allianz SE, said the rising inflation index data suggests “realized inflation is being accompanied by additional inflation in the pipeline.”

El-Erian also challenged the logic of the federal government maintaining “ultra-stimulative policies notwithstanding the repeated underestimation of both growth and inflation.”

“The longer this configuration persists, the greater the risk of a monetary policy mistake,” he added.