The Crisis Du Jour - How Worried Should I Be?

Believe it or not, there are lots of reasons to be positive right now.  The vaccine is working, and most major countries are doing a pretty good job at getting people to take it.  COVID cases in the US are down 95% from their high and hospitalisation rates are falling every day.  It’s a similar story in the UK.

Certainly in the US life is getting back to normal.  People have their jobs back (the unemployment rate is at its lowest level since the start of the pandemic) and they have money in their pocket.  Personal incomes in the US were 29% higher in March than a year ago – according to Charlie Bilello, that’s the highest rate of increase ever recorded.

With the unemployed back in work and people richer than they have ever been, everyone has got busy spending.  This is great news for businesses – the earnings of the biggest 500 companies in the US hit a new high in the first quarter of this year.  And their share prices have followed, as they always do.  As I write, the S&P 500 is a whisker off its all-time high.

But, of course, the media don’t report on any of that.  What they report on is the next crisis du jour.  We are never free to sit back and relax, we always have to be worrying about something.

That something today is inflation. 

Inflation is caused by too much money chasing too few goods.  A bit of it is good, too much of it is bad because we end up like Zimbabwe or Venezuela (we are not going to end up like Zimbabwe or Venezuela).

So the question is, how worried should we be about inflation?  What does it mean for savers and investors?

Here is what you need to understand about inflation.

Inflation is a savers’ biggest risk.  Inflation eats away at your purchasing power.  Let’s say today you have one million one dollar notes.  That is, you have $1m in cash in the bank.  And let’s say in twenty years you still have one million one dollar notes.  That is, you still have $1m in cash in the bank.

You might think that you have kept your money.

But what you have kept is the number of units of currency that you own.  You have not kept your money.

Let’s say, conservatively, that the cost of living increased at 3% each year over that 20-year period.  You might not feel that year-on-year, but it translates into prices practically doubling.

So, where you needed $5 to buy a box of cheerios, you now need $10.

However, you still only have one million one dollar notes.  So now you can only buy half as many cheerios. 

What we say is that your purchasing power halved. 

3% inflation over a twenty year period and your purchasing power almost halves.

This is how you have to think about money – as purchasing power.  It’s not about the number of units of currency that you own.  It’s about what you can buy with that currency.

Inflation is the biggest risk to that.

Money sitting in the bank over the long-run, earning zero, is pretty risky when we think about it that way.  There is a guaranteed loss of purchasing power.

That’s why we invest in companies (equities) – we invest to protect our purchasing power and to ensure we don’t go slowly backwards each year.

Over the long-run equities have been a remarkable hedge against inflation.  Since 1928 the US stock market has compounded at just under 10% per annum.  Inflation has averaged roughly 3% per annum.  Stocks have therefore returned 7% more than the rate of inflation. 

Nothing else has protected your purchasing power like equities.

They have done this because stocks are businesses – when you own a stock (or share or equity – all the same thing), you own a little bit of a business.  As costs increase, strong businesses pass those increases onto the consumer.  It might not happen immediately, but it does happen.  And then the business gets busy innovating and figuring out how to become more productive, which further boosts profits and therefore the share price over time. 

So why are equity investors suddenly so worried about inflation?  Bond investors should be worried because when you invest in bonds you receive a fixed income stream.  A fixed income stream when prices are rising is not good. But us long-term, goal-focused equity investors, what do we have to worry about?

I am not sure really. 

There might be a short-term impact on the stock market but the data on this is mixed and we are dealing with highly complex adaptive systems (the economy and the stock market) so even if we did know what the inflation rate is any date from now we still wouldn’t know what interest rates would be and we definitely wouldn’t have any idea how the stock market would have reacted to all of it.

So here’s my advice.

If you are a Liberty Wealth client and therefore a long-term disciplined, patient and goal-focused investor take inflation off your list of things to worry about.  Your beautifully diversified global portfolio of companies will protect you from it over the long-run.

If you are not a client and your advisor is recommending positioning your portfolio to ‘protect against inflation’, I would question that advice.

And finally, if you are sitting on large cash balances earning zero and being eroded by inflation, how about dropping me a line and starting the conversation?

 Georgie

georgie@libertywealth.ky