Still in the Middle of the Desert
It may be difficult to find a movie with characters as cool and slick as those in the 2001 version of Ocean’s Eleven. The movie is fun to watch, not just for the cast of characters but also for the sharp visual aspects and snappy dialogue. In the early part of the movie, Danny (played by George Clooney) and Rusty (played by Brad Pitt) are recruiting members to join their gang to rob a marquee Las Vegas casino, the Bellagio. One such target is Reuben (played by Elliott Gould), who happens to be a former casino mogul and could provide the funding for their scheme. After Danny and Rusty explain their plan, Reuben shows skepticism by telling them he has full confidence they can rob the casino but then offers a reminder that once they are outside the casino they are still in the middle of the desert, therefore making a getaway difficult. In similar fashion, markets celebrated lower than expected inflation readings last week, but we need to not lose sight of the fact we are still experiencing the highest levels of inflation in 40 years.
The Consumer Price Index rose by 8.5% year-over-year, which was lower than the 8.7% expected and 9.1% reported the previous months. Similarly, the Producer Price Index increased by 9.8% compared to a year ago, less than expectations of 10.4% and last month’s reading of 11.3%. Month to month, the CPI was flat and did not show a gain while the PPI showed a decrease in prices of 0.5%. These numbers were greeted with enthusiasm from the markets, leading the S&P 500 to a gain of over 3% for the week. Year over year inflation remains high but appears to be slowing, especially given there was not an increase from a month ago. But does this mean we have reached peak inflation?
The month-to-month numbers can be volatile, so it remains to be seen if this is the beginning of a trend lower or a single month anomaly. Back in April, inflation was reported as being lower than March, just to reverse course and increase in subsequent months. Energy prices are leading the way lower and are very much attributable to the lower inflation readings. We are nearing the end of the summer driving season and have already seen a reduction in energy demand but short supplies remain and we would expect energy prices, especially natural gas, to rise over the cold winter months. There have been encouraging reports regarding the situation in Ukraine, but even if we were to see a pullout of the Russian troops the damage that has been done, not only to Ukraine’s infrastructure but also with Russia’s standing in the world and trade partners. This could take many years, if not decades to mend. In the meantime, food and energy prices are expected to remain high.
You Need a Dozen Guys
Every person has their own rate of inflation based upon how they spend their money and there are many different components, so while energy is a major factor we also need to consider all that contribute to overall inflation. On a macro-scale, supply chain issues seem to be improving and energy prices are moderating, if not slowly easing, but inflationary pressures remain, especially with food and housing. Housing costs, which in CPI is measured by the cost to rent and not home prices, remain elevated and tend to be sticky so it is doubtful they will fall. However, they seem to be stabilizing as the real estate market cools off. Our expectation is that inflation, more specifically year-over-year price increases, will moderate and we will continue to see lower readings than what we’ve seen over the past several months. But we also expect inflation to remain at levels higher than what we’ve experienced over the past two decades. Even if inflation were to drop to the 5-6% range over the next year, it would continue to have a profound effect on retirement savings and future purchasing power.
Despite lower readings last week and because inflation remains elevated, the Fed is expected to continue raising interest rates. Their next meeting is in September and current expectations are for either a half point or three-quarter point increase with additional increases at their November and December meetings. The Fed remains somewhat behind the curve since inflation remains stubbornly high but with softening inflation numbers, the odds of a soft landing seem to be increasing. This is reflected in the stock market as the S&P 500 has rallied nearly 18% since it’s low in mid-June. If we look back at history, after inflation peaked in 1974 and 1980, stock markets rallied and presented very robust returns over following years.
Even if pricing pressures are diminishing and inflation is rolling over, it remains elevated and continues to eat away at the purchasing power of consumers. Fortunately, there has been a recent reprieve for investors and savers in the form of better market returns and higher interest rates. We expect inflation to remain above average for at least the next couple of years so while we welcome a better outlook with open arms, it is premature to declare victory. The last few weeks of August tend to be relatively quiet in terms of the markets. There are still some companies to report earnings and economic releases will be closely watching, including updates to GDP and Personal Consumption Expenditures (PCE) in a couple of weeks.
Most people think that a market downturn is the greatest risk when preparing for retirement, but there are many other things to consider such as taxes and inflation. For the first time in several decades, the latter continues to take center stage. And while recent reports are encouraging, we need to remember that inflation has not yet been tamed. When preparing for retirement, it is vital to have a sound financial plan which includes multiple sources of income and assets to overcome inflation so you can maintain your lifestyle. This is a long game, so don’t declare victory early just to find yourself stuck in the desert later in life.
Have a wonderful week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
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