Investing and the return of inflation

Dr. David Kelly, Chief Global Strategist – J.P. Morgan Asset Management

Man taking notes with notebook and laptop

A strong economic recovery from the pandemic could lead to higher inflation, in our view. It is important for investors to be prepared for this possibility. 


Driving factors

We believe the current economic growth is fueled by huge fiscal stimulus and reduced business restrictions as more people become vaccinated.   

Additionally, the Federal Reserve has committed to keeping short-term interest rates at very low levels until inflation is on track to exceed 2% for some time. This patience, given the lags in when monetary policy impacts the economy, increases the possibility that inflation will increase. In fact, we believe inflation will reverse a long-term trend and go well above 2% in the months ahead — and perhaps accelerate into 2022.


Potential market implications

Although it sets short-term interest rates, the Federal Reserve does not have complete control over longer-term interest rates. As a result, we believe investors should consider several possibilities across the financial landscape:

  • Rising yields on U.S. Treasury and corporate bonds could inflict losses on fixed-income portfolios.
  • Traditional inflation hedges, such as real estate and commodities, should fare better.
  • Stocks face a more nuanced situation. Rising inflation, particularly if caused by a booming economy, could help companies grow earnings if they can increase prices to account for higher input costs.

However, the fundamental value of stocks depends on a discounted stream of earnings stretching years into the future. Higher long-term interest rates would make the discounted value of those future cash flows worth less today. Consequently, stock prices may see selling pressure. In this scenario, the most vulnerable stocks are generally those with the highest price-to-earnings (P/E) ratios, as their value depends to a greater extent on earnings that are likely to be realized years into the future.


Not a repeat of 1970s inflation

In the 1970s, the U.S. economy was beset by high inflation, as the chart below illustrates. As measured by the consumer price index, inflation soared to over 12% in 1974, retreated for a period and then surged to almost 15% year-over-year in 1980.

Headline Consumer Price Index (CPI) and core CPI

Chart sources: U.S. Bureau of Labor Statistics, FactSet and J.P. Morgan Asset Management


Throughout the 1980s, however, inflation fell sharply and has trended down ever since. Some declines in inflation were the predictable after-effects of recessions. For example, soft consumer demand slowed inflation for goods/services, and high unemployment restrained wage growth. 

Several long-term forces also contributed to lower inflation, including:

  • Less unionization
  • Increased globalization
  • More competitive markets from information technology
  • A higher rate of savings


In summary

While we believe a strong economic recovery could lead to higher inflation, it is also not inevitable. For example, a relapse in the pandemic recovery would quickly douse inflation fears — as might a reversal of current policies toward very strong fiscal stimulus. 

We believe regular portfolio reviews are important for investors. Now may be a good time to consult with your Ameriprise financial advisor to confirm your portfolio is well positioned to thrive in an environment of rising inflation.