Morgan Stanley
  • Wealth Management
  • May 18, 2021

Rising Inflation: More Than Just Transitory?

Why investors shouldn’t dismiss recent upside surprises in U.S. inflation as a temporary phenomenon and how they can recalibrate their strategy.

Investors who braced for a sharp rise in April’s U.S. inflation readings from last year’s muted levels early in the pandemic were still surprised by the 4.2% year-over-year surge in the consumer price index (CPI)—double the highest projection in a Bloomberg survey of economists, even after hints in March of a coming uptick.

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The CPI data released last week weren’t the only concerning indicators of inflation’s resurgence. The producer price index, which tracks wholesale and manufacturing costs, increased by 6.2% year-over-year in April—the highest reading since the U.S. Bureau of Labor Statistics started tracking the data in 2010—after rising 4.2% year-over-year in March. Perhaps most concerning, these moves came with strong gains in the “core” readings, which strip out volatile commodity-related drivers, such as food and energy prices.

While many, including the Federal Reserve, see the jump in prices as “transitory,” we believe it’s much more than just a blip. To be sure, some short-term inflation drivers, such as supply-chain bottlenecks, are likely to subside. However, we believe this post-pandemic business cycle has ushered in a new period of sustained higher fiscal spending, higher inflation and rising long-term interest rates. In particular, we see five secular shifts that could contribute to this dynamic, each of which can be summed up using terms that begin with the letter D:

  • Deglobalization: In the past decade, globally optimized supply chains helped to check price inflation. Now, the COVID-19 pandemic has likely sped up a shift toward deglobalization that could return supply chains to the U.S., which could contribute to consumer price inflation.
  • Deficits: Federal debt and deficits are exploding in the wake of unprecedented amounts of stimulus meant to counter pandemic disruptions. With the Fed essentially buying new government debt, dramatic growth in the money supply could be inflationary.
  • Dollar debasement: More stimulus to keep long- and short-term rates low would likely drive inflation through further declines in the value of the dollar against other major currencies.
  • Demographics: More Baby Boomers are retiring, and the hiring of Millennials and Gen Z has accelerated, creating conditions for a wealth transfer to a younger workforce entering its peak spending years.
  • Digitization 2.0: The need for contactless business models arising from the pandemic coincides with a completely different set of maturing technologies that could help drive robust capital spending, including artificial intelligence, robotics and distributed-ledger technology known as blockchain.

Investors should consider positioning their investments for higher interest rates and inflation. Portfolio adjustments shouldn’t be confined to fixed income. With volatility likely to stay high, as rates normalize, we suggest trimming holdings that may have run their course, in terms of high price-to-earnings multiples, in favor of quality value stocks and equities that offer growth at a reasonable price.  

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from May 17, 2021, “Unmoored.” Ask your Financial Advisor for a copy or find an advisor. Listen to the audiocast based on this report.

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