Weekly Market Recap This week was relatively slow for economic news given the Thanksgiving holiday. According to the Bureau of Economic Analysis, US economic growth in the third quarter was revised up to 2.1%. We want to focus on the recent trends in US inflation and what it could mean for your portfolio.
Inflation is the rate at which prices change. High inflation means prices are, on average, rising quickly. Currently, there is significant focus on how low inflation is in the US. For example, the year-on-year US inflation rate is currently 0.2% according to the Bureau of Labor Statistics. However, this is not the full picture, because energy prices have fallen 17.1% over the last 12 months to October 2015. We believe this move in energy prices is a large enough move in a single category to materially reduce the inflation index, which can make inflation appear a little more subdued than the underlying rate may actually be.
Furthermore, inflation measures the change in a price, so unless energy prices change further, then after 12 months the drag on inflation from energy prices will, all else being equal, stop because the price will no longer be changing when compared to a year ago.
So headline inflation is currently 0.2%. However, when the historically volatile food and energy components are excluded from the inflation calculation, the resulting figure is often described as core inflation. Core inflation is running at 1.9%. This is just below the US Federal Reserve's 2% goal for inflation. So, we believe the impact of falling energy prices, which could be temporary, is what is creating such a low rate of inflation currently.
Increasing inflation has historically not been favorable for savers or investors and remains a compelling reason why the Federal Reserve is likely to eventually raise interest rates. From this context, you can see how a Fed rate hike is actually a move to protect the domestic economy and the savers and investors in America. This is also another reason why we view Treasury Inflation Protected Securities (TIPS) and Real Estate Investment Trusts (REITs) as an important component of a diversified investment portfolio. TIPS can compensate investors directly for changes in the rate of inflation. REITs derive their value from property, which is an asset that we believe is relatively well protected from the effects of inflation when compared with other asset classes because rents and property values can rise in line with broader price trends.
So remember, though inflation appeared subdued on some measures, on an underlying view it is higher than it first appears due to the impact of energy prices currently bringing inflation down in a manner that may not be sustainable. Should inflation rise unexpectedly, we believe REITs and TIPS in an investor's portfolio can offer a degree of protection.
Notes
http://www.bls.gov/news.release/pdf/cpi.pdf
https://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm Disclaimer:
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