The Cost of a Malibu in California

By Chris Cassidy, CEO

Every year I travel to California for a family reunion that occurs the last week in July. It is one of my favorite weeks of the year because it’s usually the only time that I get to see my mother’s side of the family. Sunny weather, palm trees and beach sand are not too bad either!

Everyone in the world has been impacted by COVID-19 in many ways. One way that I was impacted was that last summer the family reunion was cancelled for the first time in twenty-five years due to coronavirus restrictions. When making travels plans for this year I was shocked at the price of rental cars. $100 a day for a Chevy Malibu?!

I am not the only person impacted by price increases in certain areas of the economy. According to the Bureau of Labor Statistics, inflation, as measured by the Consumer Price Index (CPI), increased 5% over the past 12 months. This was the largest 12-month increase since a 5.4% increase for the 12-month period ending August 2008. Certain sectors of the economy, such as used cars and trucks, saw particularly sharp increases in May.

In addition to impacting travel planning, this recent data has resulted in several questions from investors. Why is inflation rising? How long will it last? How does it impact my investment portfolio? These are common questions that investment officers are asked when meeting with clients. In simple terms, inflation is a general increase in the price of the goods and services that we consume. Prices are currently rising in our economy for three main reasons: an increase in consumer demand, supply chain disruptions and an increase in the supply of money.

I am a perfect example of the recent increase in consumer demand. I have not been on an airplane since before the pandemic, but have recently made plans to travel. Apparently, I am not alone. In June, daily U.S. air travelers exceeded two million for the first time since the pandemic began, according to the Transportation Security Administration. When demand increases sharply, and outstrips available supply, prices rise, a phenomena economists refer to as demand-pull inflation. There are too many dollars chasing too few goods and services.

In addition to an increase in consumer demand, there are also supply chain disruptions that further exacerbate inf lationary pressures. The rental car industry is a perfect example. In March of 2020 travel came to a grinding halt. To survive, rental car companies sold a large portion of their inventory to reduce interest expenses and raise cash. In fact, the industry sold more than half a million cars, or roughly one third of their entire fleet. Unfortunately, rebuilding fleets this year has been difficult due to auto plant closures and a shortage of semiconductor chips. The average car contains 50 to 150 different chips. I could complain about $100 a day for a Chevy Malibu, but travelers to Florida during spring break were paying $300 a day for a Kia Rio.

Supply chain disruptions can lead to increases in the cost of materials. We have seen this occur with lumber, copper, plastics, and many other materials. When material costs increase, the price of finished goods often increase as businesses need to charge consumers more just to earn the same profit margin. This is referred to by economists as costpush inflation. Currently, the global economy is dealing with both demand-pull and cost-push inflationary pressures at the same time. Further adding to inflationary pressures, the Federal Reserve has been putting more money into the economy in response the economic slowdown caused by the pandemic. When the Federal Reserve prints money to stimulate the economy, the money in the economy loses some of its value and consumers need more of it to buy the same goods and services. The Fed is pumping about $120 billion per month into the financial system through its purchase of Treasury Bonds and Mortgage-Backed Securities from financial institutions. This is what economist refer to as expansionary monetary policy, which stimulates the economy, but can lead to inflation.

The question of how long this increase in inflation will last cannot be known because nobody has a crystal ball. However, policy makers, and most analysts, believe that it will not last very long. Fed Chair Jerome Powell has characterized the current spike in inflation as “transitory” and has stated that the price increases should be temporary and not result in long-term accelerated inflation. The majority of Wall Street Analysts, such as Goldman Sachs and JP Morgan, agree with the Fed that inflationary pressures will be short-lived. Those that hold this view note that supply disruptions and bottlenecks are not usually a long-term problem, and that the reopening of schools and the expiration of enhanced unemployment benefits will help to ease wage pressures. Automation and technology also keep inflationary pressures in check.

However, Deutsche Bank contends that there is a potential risk of 1970s style inflation. In the 1970s, inflation, as measured by the CPI, averaged over 7% per year. For the past ten years, inflation has been consistently running at about 1-2% per year. In fact, the United States has not experienced a single calendar year with annual inflation above 4% since 1991.

Given the uncertainties surrounding inflation, what should investors be doing with their portfolios? If the recent spike in inflation proves transitory, then no major adjustments are needed. Historically, over long periods of time, stocks have provided investors with protection from inflation because many businesses can raise prices on their goods and services. Over the 95-year period from 1926 to 2020, large cap stocks returned roughly 10% compared to inflation, which averaged roughly 3%.

During the 1970s, the S&P 500 saw total annual returns of just under 6%. While this number is lower than the rate of inflation during that decade, it is not far off. On the fixed income side, Series I Bonds and Treasury Inflation Protected Securities (TIPS) contain a built-in inflation adjustment. These bonds are designed to provide investors protection from significant increases in inflation. Another option for investors is owning “hard assets” such as real estate or physical commodities. As far as real estate is concerned, home prices have seen the largest year over year gain since 2005.

I am looking forward to seeing family in California at the end of July. Hopefully, last year’s cancellation was transitory and will not happen again for many decades. Maybe next year when I make my travel plans a Chevy Malibu will cost less than $100 a day.