The Bureau of Labor just reported that the CPI rose 6.4% over the past 12 months. According to data assembled by Golden Eagle Strategies, we believe inflation is now running at an annual rate between 12% to 15% in the United States.
Despite the government stance that inflation is transitory, we believe that we are in the midst of the most destructive inflationary environment in U.S. history based on real returns. Fixed income investors are being eaten alive, watching their pricing power decline by at least 10% over the past year. The proof: T-bills are yielding 0.2% and T-bonds 1.6% in an inflationary environment of 12% to 15%, according to our calculations. Never before have fixed income investors been thrust into such a hostile inflationary environment in real terms.
Here’s our take on why we think that the rate of inflation is being underreported. We view the just reported rise of 6.4% in the CPI as a questionable number. CPI food inflation in the US was reported to be up 5% over the past 12 months. The United Nations recently reported that worldwide food inflation is galloping along at a 31% annual clip. Furthermore, the UN has stated that high food prices will kill more people than COVID-19 in the next year. The UK reported a 3.2% spike in inflation in August alone, which translates into a 38% annual rate. Moreover, the Food and Beverage Federation in the UK stated that food and beverage inflation in their economy is running at a “frightening” 14% to 18% annual rate.
In the US, Tyson Foods raised prices on beef 30%, pork 38%, and chicken 19% in the past quarter. The Department of Labor reported last month that meat, poultry, eggs and fish increased 10.5% over the past 12 months. Clearly, there is a disconnect between Labor and the real world. Although random, the price of small Pepsi cans have risen from $2.50 a six-pack during the summer to $3.79 now – a 52% price spike. At the same time, a 16 oz. Pepsi sold by gas stations has, in general, gone up in price from $1.25 to $1.69 representing a 35% increase. Moreover, Pepsi has announced that it will raise prices again next year.
In looking at the Labor report on energy prices, gasoline is up 50% and heating oil up 59%, which seems reasonable. However, Labor shows that natural gas prices were up just 28% over the past 12 months, whereas the Henry Hub Natural Gas Spot Price Index has more than doubled, jumping 130% since January 1st. Equal weighting these three energy categories shows skyrocketing energy inflation of 80% over the past year which is a far cry from the reported 30% for this sector.
What does high inflation mean for the stock market? Why are the talking heads saying that high inflation is bad for growth stocks? First, American businessmen and businesswomen are the best in the world and don’t command enough credit in making adjustments to all types of business conditions. They have managed businesses in periods of high inflation, low inflation, high interest rates, low interest rates, high oil prices, low oil prices, strong dollar, weak dollar, and so forth. The pricing cycle in any inflationary environment starts out with hesitancy by businesses to raise prices due to push back by government and consumers. When pushed to the wall as pressures on profit margins start to erode profits, they are forced to respond by instituting price increases. We are now in this phase of the inflation cycle.
In turning to the stock market, conventional views hold that inflation is bad for the stock market, and particularly bad for growth stocks. Let’s look at another period of high inflation. From 1972 through 1980, the rate of inflation soared from 3.4% to 12.4%. Treasury bond yields during this period moved largely in tandem with escalating inflation. The average 10-year T-bond yield in 1980 was 11.2%, hitting a high of 15.8% in 1981 before inflation started to decline, after the Fed started to take action by squeezing the money supply and forcing interest rates higher.
Despite runaway inflation during the 1970s, corporate profits rose 82% and the S&P 500 returned 65% over 8-years. Stock indexes measuring our own investment style, dating back to 1958, show that aggressive growth funds, which focus on companies with very rapid profits growth, provided a cumulative return of 130% over the same period – far more than the rise in inflation.
Given the foregoing, we think that investors will be better protected by being in stocks, as opposed to bonds, at this juncture. Unlike bonds which carry fixed payments for years, stocks provide a growing income stream from increasing dividend payments which helps to protect capital in periods of high inflation. Stocks have always been viewed as a hedge against inflation and this time should be no different from the past.