Today, the US Bureau of Labor Statistics released its monthly inflation report for April, which highlighted that prices paid by urban consumers for a basket of goods and services increased by 4.2% relative to the same month last year. Even when looking at US core inflation, which strips out volatile food and energy prices, price levels climbed by 3.0%, the highest annual pace since 1996. While we believe investors should be mindful of the risks associated with inflation, investors should also be mindful of the unusual factors that influenced these figures prior to making any portfolio changes.
First, April’s inflation levels are being compared to the same period last year, which is when economic activity collapsed as the reality of the pandemic became clear. Google mobility data in April 2020 indicate that retail, grocery store, transit, and workplace foot traffic dropped more than 30% compared to a baseline of pre-pandemic activity. That reality put downward pressure on price levels then, which makes today’s comparison seem high. But, if we compare today’s inflation to April 2019, headline inflation and core inflation climbed by more reasonable 2.2% annual rates.
Second, the magnitude of recent economic activity changes influenced today’s inflation readings. While it is not unusual to have high inflation readings following economic turmoil—headline inflation jumped to 3.8% in 2011—the extent of last year’s economic decline and this year’s potential expansion makes annual comparisons even more problematic. Consider that US real GDP in second quarter 2020 declined by a staggering 9.0%, which was the worst quarterly change in the post–World War II era. Also, with the lifting of pandemic-related restrictions, economic activity is expected to expand this year at a generationally high pace.
Last, it’s important to examine what drove changes in inflation this past year. While prices were up for nearly all items that determine the core inflation rate, annual price increases in used cars and trucks (21.0%) and airline fares (9.6%) were the largest two major line items. But, these price level changes are almost certainly due to temporary cyclical factors linked to the pandemic, not structural long-term factors that will likely force price levels higher for years to come.
While we expect US inflation will be high for the next couple of months, we are doubtful that US core inflation will stay elevated above 3.0% this year and next. However, predicting future levels of inflation is notoriously difficult. Just ask any economist! So, the best way to protect against different macro-economic outcomes is to maintain a well-constructed portfolio, one that is rooted in data and theory and stress tested to understand potential vulnerabilities.