‘Everything Screams Inflation:’ Interpreting Headlines

KEY TAKEAWAYS

  • After last year’s many surprising shocks, sharp rebounds in prices this year should be no surprise.
  • Potential inflation is one among many factors to account for when setting a price at which to trade.
  • Looking at headlines from the past 50 years shows that reliably timing markets around inflation expectations is difficult, and sticking to a long-term planning strategy may be best.

How quickly things change.

Two years ago, the New York Times reported, “Federal Reserve officials are increasingly worried that inflation is too low and could leave the central bank with less room to maneuver in an economic downturn.”1 Recently, a Wall Street Journal article presented a sharply different view, with a headline that likely touched many raw nerves: “Everything Screams Inflation.” The author, a veteran financial columnist, observed, “We could be at a generational turning point for finance. Politics, economics, international relations, demography and labor are all shifting to supporting inflation.”2

Is inflation headed higher? In the short term, it has moved that way. With many firms currently reporting very strong demand for goods and services following last year’s abrupt collapse in business activity, prices are rising—sometimes substantially. Is this a negative? It depends where you sit in the economic food chain. Airlines once again enjoy fully booked flights, and many restaurants struggle to hire cooks and waiters. We should not be surprised that airfares and steak dinners cost more than they did a year ago, and that stock prices for JetBlue Airways and The Cheesecake Factory correspondingly surged over 150% from their lows in the spring of 2020.3

Do price increases like those signal a coming wave of broad and persistent inflation or just a temporary snapback following 2020’s unusually sharp downturn? We don’t know. But we know that future inflation is only one of many factors impacting prices. The market’s job is to take positive information, such as exciting new products, substantial sales gains, and dividend increases, and balance it against negative information, like falling profits, shortages, riots, and natural disasters, to arrive at daily prices that buyers and sellers mutually deem fair.

Let us assume for the moment that rising inflation persists. Some investors might choose to hedge against even higher inflation, while others might see it as a market timing signal and change their investments. But for traders to profitably time consistently, they need a trading rule that directs exactly when and how to revise their portfolios — “I’ll know it when I see it” is not a strategy. A trading rule based simply on some bureau’s inflation estimates is just a market-timing strategy dressed up differently. Successful timing requires that two predictions must be correct: when to change the portfolio and then when to change it back.

Having a negative outlook for stocks or bonds due to disconcerting information regarding inflation (or other conditions) is not enough. Current prices already reflect such concerns. Prices don’t change blindly. To justify switching a portfolio, you must be even more negative than the average investor. And then you must outsmart computer algorithms once again when the time appears right to switch back. And then repeat, over and over.

Documented evidence in of success pursuing stock timing strategies — by individuals and professionals alike — is conspicuous by its absence. Mutual funds and internet advice sellers advertise their winners and are silent about their losers.

Let’s illustrate the challenge: Imagine it’s New Year’s Day 1979. The overall US stock market4 produced a positive return in 1978 but failed to keep pace with that year’s 9% inflation for the second year in a row. Your crystal ball inerrantly foresees two years of back-to-back double-digit inflation for the first time since World War I.

What would you do? You painfully remember the losses of 1974, when the inflation-adjusted total return for US stocks was –35%, among the five worst annual returns since 1926.

We suspect many investors would begin to panic and sell stocks in anticipation of significantly lower security prices for the next two years. The result? Those who would have sold in fear likely failed to capture very high returns from both the equity and size dimensions of the U.S. stock market, as shown in Exhibit 1.5

Exhibit1: Looking Up

Cumulative Return, January 1979-December 1980

Chart: US Stock Market Cumulative Return, January 1979-December 1980

Past performance is no guarantee of future results. Indices are not available for direct investment. Source: Dimensional Fund Advisors Matrix Book 2021: Historical Returns Data — U.S. Dollars

Much recent inflation concern is linked to substantial increases in government spending and record levels of U.S. debt. Determining the appropriate levels is a contentious public policy issue, and its enormous importance should not be discounted. But the news items in Exhibit 2 suggest inflation concerns are not new. We believe the expected consequences of these issues are likely already reflected in prices of stocks and interest rates of bonds in publicly traded markets.

The future is never certain. But as economist Frank Knight observed 100 years ago, willingness to bear uncertainty is the primary reason investors have a profit opportunity.6 Investors will always worry about something. The possibility of unwelcome or unexpected events should be addressed by the structure of your portfolio’s design rather than by a hasty reaction to stressful headlines when they appear. As recent research highlights,8 staying invested with a dimensionally informed global strategy of a well-designed portfolio right for you is the most likely way to stay ahead of inflation, avoid costly mistakes and protect your lifestyle.

Exhibit2: Fears Through the Years

"Fears Through the Years" chart

FOOTNOTES

1Jeanna Smialek, “Fed Officials Sound Alarm Over Stubbornly Weak Inflation,” New York Times, May 17, 2019.

2James Mackintosh, “Everything Screams Inflation,” Wall Street Journal, May 5, 2021.

3Sourced using Bloomberg security returns. Low for Cheesecake Factory was April 2, 2020, and low for JetBlue was March 23, 2020.

4As measured by the CRSP 1-10 index.

5S&P data © S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.

6Frank H. Knight, Risk, Uncertainty and Profit (Boston and New York: Houghton Mifflin Co., 1921).

7Headlines are sourced from various publicly available news outlets and are provided for context, not to explain the market’s behavior. This material is in relation to the U.S. market and contains analysis specific to the U.S.

8Dai, Wei and Medhat, Mamdouh, U.S. Inflation and Global Asset Returns (July 13, 2021). Available at SSRN: https://ssrn.com/abstract=3882899