- Inflation has fallen from pandemic highs, but one economist does not expect a return to 2%.
- Rate cuts and other changes in the economy point to 3%+ long-term inflation, says Steven Blitz.
- Blitz shares three trades for investors to prepare for a high inflation environment.
For the past decade or so, the Federal Reserve’s magic number for inflation has been 2%.
The central bank has aimed to keep the long-term inflation rate at this level to maintain stable prices and a healthy economy.
And after the runaway prices of the pandemic era, it looks like the Fed is moving closer to its 2% target: the inflation rate was 2.4% for the 12-month period ending in September.
Don’t count on a return to the 2% era, though, said Steven Blitz, chief economist at business intelligence firm GlobalData. Blitz believes the economy is on track for long-term inflation, not lower.
“I think inflation will settle around 3%, 3.5%,” Blitz told Business Insider in an interview. “There is a higher core inflation rate now than it was before COVID for a number of reasons.”
In Blitz’s view, the Fed’s rate-cutting campaign is undoubtedly a contributing factor to future inflation. In the past, brisk inflation has returned to 2% only after the Fed projected a tough tapering that slowed consumer spending and wage growth, Blitz said. Financial historian Mark Higgins points out that when the Fed cut rates too quickly in the 1960s, inflation rose and contributed to stagflation in the 1970s.
But there are other factors contributing to the rise in the long-term rate of inflation, many of which Blitz tracked even before the pandemic.
Debt levels are rising, generating an inflationary effect by increasing demand and prices for goods. In terms of consumer and business debt, after the Great Financial Crisis, households and businesses focused on reducing their balance sheets, but that trend began to reverse after the passage of the Tax Cuts and Jobs Act of 2018, Blitz said. Reduced taxes stimulated spending and also increased the national debt. A higher national debt balance could erode confidence in the dollar, further increasing inflation.
Demographic changes in the workplace are also driving higher debt and higher long-term inflation, according to Blitz.
The workforce is getting younger as Gen Z workers enter the workforce and baby boomers and Gen X workers retire, resulting in increased Gen Z spending power.
As millennials age and earn more income, they are entering their prime home buying years.
“They’re at that part of their lives where they normally use their balance sheets to get physical assets,” Blitz said. And as more millennials start families and have children, their spending will only continue to rise. These demographic changes will drive consumer demand and, subsequently, inflation.
And finally, inflation is rising thanks to changes in international trade, Blitz said. Import penetration, or the amount of foreign goods flowing into the US, is reaching a plateau. Importing cheap goods from abroad has a disinflationary effect by lowering the prices paid by consumers.
Blitz believes that US import penetration is near or has already reached peak levels, meaning that the deflationary impacts of international trade will be muted going forward. With trends such as rapprochement and restructuring companies pushing to move their operations closer to domestic markets, import penetration is sure to decline.
In Blitz’s view, all these factors add up to an inflation rate exceeding 2% going forward.
Investing for higher inflation
According to Blitz, investors may start to see continued inflation within the next year. According to him, the September jobs report is already an early sign of rising inflation, especially wage inflation.
There are several ways investors can prepare their portfolios.
In a high interest rate environment, bonds are less attractiveBlitz said. Bonds suffer from inflation risk because inflation feeds into interest rate payments, reducing their real yield. Higher inflation also raises yields as investors demand higher compensation, reducing the value of assets.
Instead, look to the stock market, he said. While rising inflation could hurt the stock market overall, there are some pockets of stocks that will benefit. Technology AND value shares typically perform well in the wake of higher inflation, according to Blitz.
In a high inflation environment, companies look to invest their capital in more stable investments as the dollar depreciates. Blitz believes the chip industry in particular is a resilient pick against inflation because they supply critical assets for many supply chains.
High inflation can be a boon to valuing stocks because it increases business margins.
“In a lower-inflation environment, it’s harder to raise incomes from the nominal growth of the economy,” Blitz said. This results in strong performance from growth stocks, which investors predict will grow earnings at a significantly higher rate than the rest of the market.
In an inflation environment of 3% to 3.5%, there is more opportunity for overlooked value stocks to appreciate. High-quality value stocks with solid margins will actually get a boost from rising prices, especially if they have good cost management, Blitz said.
Those looking to increase their exposure to these areas of the stock market can do so through funds such as iShares Semiconductor ETF (SOXX) and Vanguard Value Index ETF Fund (VTV).