With inflation soaring to as high as 7% in the United States and 3.2% in Singapore last year, I wanted to find out more about inflation because that's the reason why we all invest, right? To ensure that the value of our net worth keeps abreast of the rise in the cost of living.
What is inflation?
Inflation basically refers to the loss of your purchasing power over time. Your money will empower you to buy X amount of goods and services right now; however, this amount of goods and services you can purchase in the future will be less than X. I'm sure you have heard about the Consumer Price Index (CPI), which measures the cost of a basket of consumer goods and services people pay out of their pockets, including foods and electrical appliances. However, there is also the personal consumption expenditures index or PCE, which measures things people consume, including things they do not pay for directly like healthcare expenses.
What caused the surge in inflation in 2021?
You guessed it. A lot of this increase in inflation can be attributed to the Covid-19 pandemic. Firstly, the pandemic has forced many countries to implement social distancing and quarantine measures, all of which drastically hindered the capacity of factories to meet their usual production targets. Some factories which were unable to pivot effectively were even compelled to shut down for good. This supply chain disruption also extended to the shipping and logistical industries as transportation of goods came to a standstill due to the reduction in air flights and shipping. Thus, prices of consumer products escalated simply due to supply not meeting demand.
Secondly, in 2020, many countries around the world imposed stringent lockdowns, which helped consumers save up tremendously. In 2021, as countries gradually opened up their economies, consumers who were practically dying to spend unleashed their purchasing power in full force. This phenomenon was so prevalent that it was given the name of 'revenge spending'.
Will this increased inflation continue in 2022?
More and more countries are adopting strategies that exhort their citizens to live with Covid-19 instead of implementing quarantine measures. In fact, since the start of 2021, employees in Singapore were allowed to go back to the office to work for a certain number of days per week. This hybrid work model is surely not peculiar to my country. Thus, supply chain disruptions are expected to ease this year. Coupled with how people have exhausted their funds on revenge spending last year, it seems likely that inflation will be more manageable this year.
But keep a lookout for the Federal Reserve
It appears that the Federal Reserve will be employing a more hawkish approach in response to inflation. In fact, Goldman Sachs predicts that the Federal Reserve will raise interest rates four times this year, which will put the Fed Funds Rate at 0.75-1.00%. This consistent increase in interest rates will likely lead to a scenario in which future profits are worth less today. Since growth stocks usually have higher valuations based on growth trajectory of future profits, the Federal Reserve's aggressive stance could consequently impact growth stock prices negatively. Hence, you may wish to rebalance your portfolio such that you have a greater weightage of value stocks (as opposed to growth stocks).
How are you reacting to inflation? Let me know in the comments below.