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June 8, 2021

Inflation Part 2: The Bark That’s Worse Than the Bite

Please read important disclosures HERE.

Last May, my colleague Aaron Waxman wrote a timely blog post entitled “Inflation: The Dog That Hasn’t Barked,” outlining the absence of inflation during the start of the COVID-19 pandemic. Fast forward a year later, much has changed: the total U.S population is approximately 40% fully vaccinated, businesses are reopening, and the economy is expected to grow 5.1% in 2021 after contracting 3.4% in 2020.1 With a relatively sharp recovery underway, inflation is again in the headlines after April’s core personal consumption expenditures (PCE) index surged 3.1%, its highest increase since 1992.2 In the article below, we provide an updated perspective on 1) what’s driving inflation, 2) whether we should be concerned about inflation, and 3) key wealth planning action items for inflation longer term.

Word "Inflation" in wooden block on US Dollar bills

What’s driving the inflation narrative?

  • Supply chain issues: Due to transportation bottlenecks, supply chain issues have made it more costly to buy and ship goods. Factory shutdowns and capacity constraints have created shortages in items such as lumber and semiconductors, causing higher prices for homes, electronic components, and autos.
  • Labor shortages: Labor shortages lower output and lead to higher input prices for components needed to make and finalize goods. Combined with higher wage costs, labor related issues are also adding to inflationary pressures in the system.
  • Rise in demand for goods: With consumer spending of $15.5 trillion3 exceeding pre-pandemic levels, consumers are spending more on items such as home appliances and furniture. Rising demand alongside the supply side issues noted above is creating ripe conditions for an elevated price environment.
  • Government stimulus: With over $5 trillion dollars4 of stimulus passed by the U.S government since the start of the pandemic, higher debt levels and expanded money supply can create an environment of more dollars chasing too few goods.

Should we be worried about inflation?

Near term, there is fear that higher inflation will drive up interest rates, which could pose a headwind to market returns. However, there are signs that show the current spike in inflation may be transitory: 1) with close to 10 million still unemployed, there is considerable amount of slack left in the economy, and as businesses and schools re-open, labor related shortages should unwind, 2) supply chain issues should subside and lead to lower commodity prices (as highlighted by this recent Wall Street Journal article, and 3) with a fourth round of stimulus checks unlikely for now, along with enhanced unemployment benefits phasing out in the second half of 2021, there is potential for consumer spending to smooth out over time.

Investors should also consider how optics in the data may be painting a more dire picture than reality. The graph below compares actual core personal consumption expenditures (PCE, or the Fed’s preferred price index) vs. if prices had maintained a 2 percent growth rate, mirroring the Fed’s target on the dotted line. It shows that prices today are just catching up to the levels expected had the pandemic never occurred.

With year-over-year comparisons becoming tougher as we move past the spring, there is potential that headline risks abate as well. Moreover, given the Fed is targeting an average inflation rate of 2 percent, then there’s reason to believe some overshooting will be tolerated.

Chart - Inflation Part 2 The Bark Thats Worse Than the Bite

Source: U.S. Bureau of Economic Analysis (May 2021)

Wealth Planning for Inflation

While it is impossible to predict where inflation will ultimately land, we at B|O|S believe in taking a long-term approach to constructing portfolios that can withstand different market environments over multiple business cycles. We outline important steps investors can take to better insulate against inflation pressures on their financial objectives:

  • Allocate towards inflation resilient assets: If inflation runs hotter than expected, real assets, value stocks, and Treasury inflation-protected securities (TIPS) should hold up better than other investments such as growth stocks and long-term nominal bonds. Rents tend to correlate with inflation, while value stocks are generally less sensitive to interest rate changes- an important consideration for investors with concentrated exposures in the tech sector. For investors looking for a more direct offset, the principal value of TIPS increases (or decreases) with changes in the Consumer Price Index (CPI), with interest payments applied to this adjusted principal.
  • Be mindful of cash balances. With savings rates higher versus pre-pandemic levels, holding too much cash over time leads to performance drag and loses purchasing power long term. Aside for emergency or upcoming expenses, evaluate whether holding additional cash is warranted in the context of your overall financial plan.
  • Assess liabilities with variable rates: Look for ways to pay off or refinance adjustable-rate debt such as a non-fixed rate mortgage, auto loan, or credit card balance.
  • Optimize your fixed income portfolio. Along with allocating a portion of your fixed income portfolio to TIPS, you can further moderate the impact of rising inflation by targeting shorter-maturity bonds. Further, investors with sufficient risk tolerance can consider adding diversified credit risk to generate higher yields vs. Treasury-only portfolios.
  • Plan for high inflation expenses. Investors should budget for high inflation line items to ensure investments are aligned to meet objectives. For example, the cost of attending a traditional four-year university rose 2x the pace of inflation.5 Medical expenses ran 33% higher than historical average inflation,6 which also contributed to higher insurance premiums. Utilizing 529 and HSA plans can help by investing assets to meet these expenses in a tax advantaged manner.
  • Review retirement plans: Review annuities, pensions, and retirement plans to see if they have cost of living adjustments (COLA) built in. While social security adjusts for inflation, retirees depending on plans without COLA are at risk of reduced purchasing power and benefits over time. Overall, creating a robust retirement plan should incorporate sufficient levels of expected real (after inflation) portfolio growth to ensure assets can meet ongoing lifestyle needs.

If you are interested in our comprehensive wealth management services, please click here to reach out to a member of our team.


1 International Monetary Fund: World Economic Outlook Update (January 2021)

2 U.S. Bureau of Economic Analysis, Personal Consumption Expenditures [PCE] Price Index (May 2021)

3 U.S. Bureau of Economic Analysis, Personal Consumption Expenditures [PCE] (May 2021)

4 Here’s Everything The Federal Government Has Done To Respond To The Coronavirus So Far (March 2021). Peter G. Peterson Foundation

5 College Tuition Is Rising at Twice the Inflation Rate—While Students Learn At Home (April 2020). Forbes

6 U.S. Bureau of Labor Statistics. Comparison of annual average of CPI-U versus CPI-U Medical Care between 1936-2020

Filed under: Wealth Management

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