Written by Keith Wirtz, Chief Investment Officer, Union Savings Bank
While we’re officially well into 2021, there’s still much uncertainty business owners may be facing as we slowly recover from the pandemic. The good news is that experts believe we’re about to enter a period of economic growth and expansion as more people get vaccinated and are expected to spend after a year spent at home.
Looking back over the past twelve months, the U.S. economy has yo-yoed from a deep contraction to a new expansion phase, one that many believe will be the most robust since the early 1980s. However, violent moves like this could have caused a problem. At a macro level, demand and production activities are out-of-sync with their potential. Think about it. People have remained active in their purchasing of groceries and other basic needs. Housing demand has jumped based on this new consumer priority. Conversely, COVID issues disrupted supply-chain structures and production in general. The result? Demand-supply imbalances.
At USB, we are expecting to see signs of relatively strong price inflation this year. In fact, these signs are surfacing now in areas like agriculture, lumber, energy, and semi-conductors. This may sound alarming to some business owners; however, we also expect this current inflation condition to moderate as the year concludes and our economy fully opens. In the words of the Federal Reserve, “these one-time increases in prices are likely to only have transitory effects on inflation.” This is one time that we agree with the Fed.
So, the important two questions may be, “how high will inflation climb to and will it persist for years to come?” People are talking about it and the fear of inflation is obvious. So, here’s what else you need to know about inflation, how it impacts your business, and what you can expect over the next couple of years.
What is Inflation, Anyway?
To understand how changes in inflation might impact your business, first consider what it is. Price inflation is the term economists use to characterize the increase in the price of goods and services over time, and the rate of inflation is the increase in prices during a specific period. For example, if inflation is at 3% annually, something that costs $100 this year will cost $103 the following year. For businesses, this price increase has affected the purchasing power that they possess.
While many economic factors can influence inflation, there are generally two major types to consider: demand-pull and cost-push.
- Demand-pull happens when an increase in the demand for goods and services leads producers to raise prices to maximize profits.
- Cost-push occurs when producers raise prices because their costs have gone up.
Inflation seems to have a natural momentum over a business cycle. As such, we would encourage business owners to pay attention to this trend and consider the implications to their company.
Lastly, there is one condition that is a concern for all—stagflation. This rare condition was last observed in the U.S. during the 1970s and is one that most people will never forget. Stagflation is an environment where inflation is present during an economic slowdown or recession. In other words, prices are rising but there is little-to-negative growth being experienced in the economy. To the point, stagflation is probably the worst-case scenario for business owners.
How Inflation Impacts Business
As you can imagine, business decisions are easier to make when prices are stable. Why? A stable pricing condition facilitates the planning process and raises the owner’s confidence level when faced with capital spending decisions. In fact, this logic helps to explain a core mission of the Federal Reserve—price stability in our economy.
On the other hand, rising inflation can significantly affect small and medium-sized businesses, mainly because they are often financed by their owners’ personal savings, which leads to greater financial risk. A period of rising inflation can lead to a variety of issues:
- Reduced purchasing power
- Reduced ability to hire more staff
- Less ability to expand your business
- Lowered inventory levels due to higher costs
- Increased importance on Inventory Management
- Higher borrowing costs
What to Expect in 2021 & 2022
As of March, 2021, there have been clear signs of price inflation. But as we look out to the rest of 2021, we expect the inflation experience to average no worse than about 2.5%. Clearly, this kind of pace is higher than what the economy has experienced over the last five years. But as mentioned earlier, this is due to demand picking up more quickly than production activity. Supply-demand pressures should move to a better balance over the next year as we enter a “post-pandemic” environment.
Further into the year 2022, we believe inflation will drift down to 2% or less. There are some powerful forces in play that will contribute to this improvement. Technology advancement, demographics, and productivity gains will be the drivers. No surprise, the U.S. dollar has also remained strong, and gold prices have not jumped to significant new levels. All are signs of better inflation conditions ahead.
How Current Trends Affect Investors
What is the most important thing investors should keep in mind? Bond investments will suffer during periods of high inflation. Why? High inflation and the expectations for higher inflation will surely lead to higher interest rates. And higher interest rates mean lower bond values. That is how bond math works. In fact, history can act as a guide. The two asset classes that stood out as good hedges against inflation risk during past episodes—the 1970s for example– have been the stock market and the real estate market. Commodities, like gold, can work as a hedge too but these assets have exhibited some degree of volatility as well.
Again, for 2021 we’re expecting a spike in inflation as the economy moves toward full capacity. Moreover, we’re expecting things to level out as we head into 2022. This is something business owners should take note of and prepare as the next several months unfold.
Keith and our team of USB financial advisors bring worldly expertise and local knowledge, and service to the table for every discussion. Call us today and set yourself, your business, and your employees up for success in 2021 and beyond – 866.872.1866 or visit unionsavings.com.
Notice: This is a general communication being provided for informational purposes only. It is not designed to be a recommendation for any specific investment product, strategy, plan feature, or other purposes. By receiving this communication, you agree with the intended purpose described above. Union Savings Bank and its’ representatives are not suggesting that the recipient or any other person take a specific course of action or any action at all. Prior to making any investment or financial decisions, an investor should seek individualized advice from personal financial, legal, tax, and other professionals that take into account all of the particular facts and circumstances of an investor’s own situation.
Opinions and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable but should not be assumed to be accurate or complete. The views and strategies described may not be appropriate for all investors.