Inflation Rears Its Head – Dividend Power Week In Review

Inflation Rears Its Head

Inflations Rears Its Head. The stock market just finished a volatile week. Certainly, it was not as volatile as the end of January 2021, June 2020, or even mid-March 2020 when the CBOE VIX spiked to over 80 and COVID-19 seemed to bring the world to a halt. Still, there is a let of news and talk in social media about inflation. Stock prices are more volatile and stock prices of go-go tech stocks and valuation metrics have dropped, but not enough to make them inexpensive. Most everyone’s favorite electric vehicle stock, Tesla (TSLA), is down -23.5% in the past month and is trading at ~$675 per share after establishing a high of ~$900 per share earlier this year. Other tech stocks and broader stock market indices are down too. Certainly investing in stocks is humbling, one month you are up and a few weeks later you are down. The bubble is not popped but it seems to be deflating. What gives?

Inflation Rears Its Head

Inflation Rears Its Head

Stocks and Inflation

Stocks are down because inflation leads to rising costs for many companies and consumers. Both the price of goods and services rise. Businesses have to spend more for their inputs as the prices of commodities, electricity, natural gas, and so on rise. Inflation can lead to higher salaries and labor costs for companies that in turn slows hiring. Consumers, like you and me, can buy less for the same dollar. Consequently, revenue and margins are adversely affected and profits decline…at least in the short-term until businesses adjust.  

In theory companies should be able to raise prices at the same rate as inflation. If the cost of beef goes up 3% then McDonald’s should be able to raise the price of its burgers by 3%. But there is a caveat, if a company faces intense competition not every company will behave rationally. Some companies will absorb the cost of inflation accepting lower margins. Other companies may even operate at a loss at least for a short time expecting inflation pressures to ease. This will limit the ability to raise prices.

Is Inflation Really Rearing Its Head?

How do I know that inflation is rearing its head? On a personal basis, I went grocery shopping this past week and the cost of milk, half-half, eggs, beef, pork, and chicken were up from the week before. The organic milk that my kids drink is now $4.29 compared to $3.99 last week, a 7.5% increase. The big box of waffles that my kids like went up to $6.39 from $5.99. The price of organic eggs went up too. The price of gas is up from a year ago as well. You get the idea; the costs of basic necessities are rising.

From an investor’s perspective, the breakeven inflation rate is heading up after plummeting during COVID-19. The breakeven inflation rate represents a measure of expected inflation derived from the 10-year and 5-year U.S. Treasuries, respectively. The breakeven inflation rate was expected to rise but the values for both the 10-year and 5-year breakeven inflation rate are higher than before the pandemic and also higher than the U.S. Federal Reserve’s target of 2%.

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Source: Federal Reserve Bank of St. Louis

Is this a problem? Maybe not if it is short-term. Fed chairman Powell doesn’t think that the surge in inflation will be sustained. Increasing vaccine distribution should put the U.S. and global economy back on track reducing supply chain disruptions. The yield curve is steepening after being inverted and flat during much of 2020 indicating that bond investors are expecting economic growth. Furthermore, unemployment and underemployment are still relatively high and business bankruptcy rates are rising keeping a lid on demand. But what if he is wrong?

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Disclaimer: Dividend Power is not a licensed or registered investment adviser or broker/dealer. We are not providing you with individual investment advice on this site. Please consult with ...

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