May 2021 – Inflation, should we be concerned?

In preparation for this month’s note, I reread our May 2020 note emailed out to clients on May 8th, 2020, exactly a year and five days ago.

I will quote my opening paragraph, “This morning, the April Non-farm payroll report showed 20.5 million Americans lost their job last month. The U.S. unemployment rate is 14.7% which is now higher than the 10% unemployed at the height of the great recession”. The S&P 500 and the Dow Indices closed that Friday evening of May 8th at 2,929.80 and 24,331.32.

Today, the April 2021 unemployment rate is 6.1% and tonight’s closing index levels on the S&P 500 and Dow Indices were 4,173.85 and 34,382.13. It is remarkable how far we have come and a testament to human perseverance, patients, and innovation.

The economic recovery has firmly taken hold and is accelerating quickly. While the last year has provided for a relatively easy investing environment off the market lows, the remainder of the year will prove to be more challenging for both equities and fixed income. We still maintain our lower end S&P 500 year-end target of 4300 as our base case but recent signs of inflation could crash the markets party.

Earlier this week, the U.S. Bureau of Labor Statistics released its monthly report on inflation revealing that the headline Consumer Price Index (CPI) rose 0.8% month over month and 4.2% year over year. The Core CPI, which strips out food and energy, rose 0.9% month over month -it’s highest reading since the early 1980’s and 3.0% year over year. While economist expected a modest increase in inflation, these numbers came in a lot hotter than expected and caused the market sell off we experienced on Wednesday.

What is the Consumer Price Index (CPI) and how does it affect stocks and bonds you may ask? The CPI Index is a measure of the change in the prices paid by the average Joe for a basket of consumer goods and services.

It is normal for the cost of goods and services to increase over time at a steady rate, however, if cost for these goods and services spike and continue to increase rapidly due to excess demand and lack of supply, purchasing power is eroded and a whole host of other problems arise. Regarding stock prices, higher costs for commodities and services eat into company profit margins, reduce overall revenue and in turn warrant lower stock prices. Bond prices drop as interest rates creep up to keep pace with the market, creating a vicious cycle that can be difficult to rein in.

Is April’s inflation surge a cause for concern? As it stands right now, we don’t think so. April’s surge in the CPI Index was mainly due to used car and truck prices surging 10% in April, their largest gain ever and representing the largest contributor to the overall rise, while other components included lodging away from home and airfare experienced large jumps month over month.

This spike in demand is to be expected as the economy opens back up, traveling and hotel occupancy is quickly coming back online, and this behavior is considered a “one off” when compared to April 2020 when the economy was completely shut down. Over the next couple months, we believe the demand/supply equation will come back into balance as individuals get back to work.

The market, given time to digest Wednesday’s CPI data, apparently agrees which led to Thursday and today’s market rallies. It’s important to note that the easy money has been made and the path to higher returns will be littered with unexpected challenges that are unique to an economy that is opening up quickly from a once in a lifetime pandemic.

Given the gains our portfolios have experienced, if you foresee yourself needing a substantial withdrawal over the next 2-3 months, we encourage you to reach out to us. Taking a little bit off the table now for a future expense is prudent.

We wish you a great Friday evening, an enjoyable weekend.

As always, please reach out to us with any questions or comments you may have regarding your specific situation.

Jaran Day, Chief Investment Officer

Griffin Dalrymple, CFP®, Chief Strategy Officer