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Thank you.
Welcome to the Stay Wealthy Podcast. I'm your host, Taylor Schulte, and today I'm addressing the May CPI inflation report. And in addition to providing a short summary, I'm also sharing what shadow inflation is and why you should probably ignore it, why inflation is so high, and what investors can do in response. For all the links and resources mentioned today, just head over to youstaywealthy.com forward slash 155.
Okay, before we dive into the May CPI report, which I know everyone is really excited to talk about, I want to clarify and expand on something important from last week's episode on tips that I may have not made very clear. I'd shared that tips and let's actually be a little more specific here and say intermediate term tips. I had shared that intermediate term tips were losing money because the current economic environment has been in line with market expectations.
I also, and possibly too quickly, stated that tips are impacted by changes in interest rates and action taken by the Federal Reserve. To avoid any confusion here and expand on these comments a little bit, let's just keep it simple. And let's say that there are two ways that you can evaluate the performance of tips.
One is to compare the performance of tips to nominal bonds, your plain vanilla U.S. treasuries. While I had advocated for not trying to predict the future and shared that if you're going to add tips to your portfolio, you might consider Swenson's philosophy of maybe splitting your tips and your nominal bond allocations just right down the middle at 50-50. While I advocated for that type of approach.
some investors, including myself, are still interested in understanding when it was better to own tips versus nominal bonds.
So that's one lens in which we can evaluate performance. Are tips outperforming or underperforming compared to nominal U.S. Treasury bonds? In other words, has inflation been above or below future market expectations? Most students of the market would likely find that data interesting or in some cases even helpful to their investing decisions.
The second way that you might evaluate the performance of tips are just on their own in isolation, just like you might evaluate the performance of the S&P 500. Are tips in positive or negative territory as an asset class over a specified period of time? I bring this up because as I quickly glossed over last week, tips are impacted by changes in interest rates, just like your conventional nominal bonds.
That inverse relationship between interest rates and bond prices that we're all familiar with does exist with treasury inflation protected securities. When interest rates rise, the value of a treasury inflation protected security or a TIPS fund or ETF is likely to fall.
Of course, as noted last week, if you hold the bond to maturity or you hold your tips fund or ETF for the stated duration or time horizon, if you hold it to maturity or the stated time horizon, you'll receive either the inflation adjusted principal amount or the original principal, whichever amount is greater.
The relationship between interest rates and tips does get slightly more nuanced, but at a very high level, just like nominal U.S. Treasury bonds, the recent spike in interest rates has contributed to the short-term losses in tips and does add to the explanation for why tips are losing money. And I say short-term losses because as I've dispelled in previous episodes, rising interest rates, even an extended period of rising interest rates, doesn't mean that you'll lose money in bonds.
If you missed that episode or you want to refresh, I'll link to it in today's show notes, which can be found again by going to youstaywealthy.com forward slash 155. So to recap, tips, treasury inflation protected securities can help protect investors from rising inflation expectations and
not from inflation itself. And just like nominal bonds, tips are not immune to interest rate risk, and they can experience short-term losses if real yields rise like we've seen over the past couple of years.
Okay, hopefully that helps. Let's now move into today's topic, the May CPI report. By now, everyone is likely aware of the disappointing news that came out last Friday when the Bureau of Labor Statistics announced that prices accelerated further last month, sending the 12-month inflation number to 8.6%. This surpassed the 40-year high that we saw earlier this year in March.
While I had stated last week that I had not seen any intelligent forecast kind of predicting what the May CPI report would look like, I think it's safe to say that most people were expecting inflation to come down a little bit. The stock market certainly expected it because shortly after the announcement, U.S. stocks plummeted by about 3%.
Before we talk about what all this means for retirement savers and the rest of 2022, let's first dig into some of the highlights of the May CPI report. To start, the Consumer Price Index, or CPI, the index that measures the overall change in consumer prices each month, CPI increased 1% in May. In other words, prices or inflation jumped 1% last month.
As a reminder, and for some context here, CPI increased 0.3% in April. So this is certainly a big jump month over month here. That being said, we did see CPI increase by 1.2% in March. So this type of increase month over month isn't necessarily something new that we're experiencing here.
But what contributed to this 1% jump in prices last month? Well, if you read the report, pretty much everything across the board contributed to this spike. Broad energy prices jumped almost 4% last month, bringing the annual 12-month increase to almost 35%. Within the energy category, fuel oil jumped 17% last month and is now up 107% over the past year.
These rising fuel prices plus consumer demand, not so surprisingly, has caused airfare to jump as well, with airline fares up close to 13% month over month and up almost 40% over the last 12 months.
And as we're all too familiar with at the moment, gas prices continue to rise with the gasoline index rising just over 4% last month, contributing to an almost 50% spike in gas prices over the last 12 months from May of 2021 to May of 2022.
Lastly, food prices climbed as well with the food at home index spiking about one and a half percent last month. This is the fifth consecutive increase of one percent or more. Even worse, the index for dairy and related products rose just below three percent. And this was its largest monthly increase since July of 2007.
It's hard to find anything positive in this report, but if you had to pick out something, it would be that core inflation. Remember, core inflation represents all items except for food and energy, which are certainly important. But core inflation is something that people pay attention to. Core inflation has slowed for the second consecutive month, falling to 6% year over year.
It's also the lowest reading in four months. But as we all know, these readings and these reports are behind us. They're backwards looking. And where we go from here continues to be a coin toss.
One thing that I'd like to address and get out of the way here before we move on is this increasingly popular conspiracy that the true rate of inflation is much higher than the government is reporting. This quote, true rate of inflation is commonly referred to as shadow inflation. And look here, I'll
I'm all for maintaining a dose of skepticism and questioning information and not blindly accepting everything at face value. But it doesn't take very much to figure out that this shadow inflation theory isn't very reliable. So in short here, the theory claims that in the 1980s, the Bureau of Labor Statistics made changes to how inflation was being measured.
And these changes caused the true rate of inflation to be understated from that point going forward.
Shadow inflation believers claim that if you use this old methodology from the 80s, the true rate of inflation has been upwards of 8% higher than the official reports have indicated over the last 40 years. So instead of 8.6% inflation, shadow inflation would suggest that we're actually facing 17% inflation.
However, the founder of shadow stats and the measure for calculating the shadow inflation rate, his name is John Williams. John publicly admitted that he doesn't actually use the old methodology to arrive at this quote true rate of inflation or shadow inflation.
He takes what most would argue is maybe a more concerning approach. He takes the official inflation number from the Bureau of Labor Statistics, and then he adds his own personal estimate for how much he thinks inflation has been understated. And look, making educated and informed assumptions in the world of finance and economics is not uncommon, right?
But many trusted economists and finance experts have long highlighted some very, very basic mathematical errors that John might be making or is making with his calculations. For example, in 2021, Williams publicly claimed that the true annual rate of inflation had averaged about 9% per year over the last 21 years.
In other words, he claimed that based on his shadow stat methodology, prices had risen 600% from 2000 to 2021 over that 21 year time period.
Well, it's not that hard to rewind back to the year 2000 to find out how much things cost. Many of us could probably do it from memory. We could probably make some reasonable estimates from memory. But I'll spare you the brain energy here, and I'll tell you that in the year 2000, the average price per gallon of gasoline was $1.53.
If we compare that to the average price of $3.47 in 2021, and we crunch some numbers, we would determine that prices increased by about 126%, not even close to the 600% that was claimed. Heck, even if you used current gas prices here in 2022, which just crossed $5 per gallon on average...
We're still only talking about a 226% increase since 2021, a fraction of what Williams had suggested.
Another example that the author of an article I'll link to in the show notes shared, he shared that in the year 2000, a chicken burrito at Chipotle was around $5. If that price had inflated at 9% annually over the last 21 years or 600% because that 9% is compounded, if that actually had happened, we'd be staring at a $35 burrito today.
The mathematical errors don't stop there. And Williams continues to provide odd explanations that just don't add up. Again, if you want to read more, you want to dig in, I'll link to a great summary in the show notes. And again, sure, perhaps inflation is understated, but
I'd urge you to be skeptical of this shadow inflation methodology in particular, just given that the basic errors that have been found in the calculations and just at the very least dig into the math yourself before trusting any headlines that you see flying around the internet. Okay. Back to reality. Well, inflation may not be the 17% number that shadow stat believers are suggesting at the moment.
We're still faced with the highest reported inflation since 1981, and the question marks continue to pile on. Before we talk about where we might go from here and what to do about it, let's just touch on the why. Why are prices increasing? Why is inflation hitting 40-year highs? Well, there are three main causes, and most of them are linked to the pandemic in some shape or form.
The first cause, as I've touched on during my very first episode on inflation earlier this year, is high consumer demand. And this demand is unique because it's a result of Americans being trapped at home for an extended period of time, coupled with massive government stimulus programs. In fact, a recent study by the Federal Reserve Bank of San Francisco concluded that
that pandemic relief packages probably contributed to about three percentage points of the rise in inflation until the end of 2021. And this data point certainly helps to explain why U.S. inflation outpaced the rest of the world.
And to be very, very clear here, I am not turning this into a political podcast and I'm not pointing any fingers. There are a lot of moving parts and a lot of people involved in making policy decisions. Plus, one could argue that the policy response to COVID, while it might be contributing to pain at the moment, one could argue that it was the right move at the time, given the information that we had in front of us.
This is not the podcast to debate that, but what we can hopefully all agree on is that the COVID policy response has contributed to the rise in prices. It cushioned our balance sheets and it enabled people to continue buying. In fact, according to the Wall Street Journal, households still have about $2.3 trillion of excess savings to help them weather the storm right now.
The second contributor to the rise in prices and inflation that we're seeing right now, which goes hand in hand with the first one, is the low supply of goods, partly as a result of this spike in consumer demand and businesses not being able to keep up with this demand, but also, as we know, factory shutdowns and shipping backlogs and also reduced production.
The spike in consumer demand outpaced the supply of goods, and this has enabled companies and kind of forced companies to raise prices without losing customers, at least so far. And then on top of it all, we have the war in Ukraine and recent China shutdowns that are magnifying the issues that we're already faced with.
And then three, lastly, we can point to the Fed. We can point to their responsibility to control inflation and their slow response. We've been in a low interest rate environment for a long time now, and those low interest rates make it cheaper for consumers to borrow money, which in turn makes it easier for consumers to spend, especially spend on big items.
Now the Fed is trying to play catch up here, which is shocking the system here in the short term. On that note, actually, it appears more and more likely that the Fed will raise rates by three quarters of a point or 0.75% possibly today, the day this episode gets released and published.
And the likelihood of that happening is a big reason why the markets are acting the way they are right now. The markets are anticipating this rate hike and future rate hikes this year, and stock and bond prices are responding accordingly. So those are the three primary contributors to the inflationary environment that we're experiencing today. And naturally, the next question becomes, well, what can be done? What do we do about it?
Well, the first obvious answer is the Fed, which we kind of just touched on. One of the Fed's responsibilities is to control inflation. And while they were maybe late to the party here, the upcoming interest rate hikes is their effort to get inflation back under control.
As Jason Lusk, a professor and the head of agricultural economics at Purdue, as Jason Lusk stated, people have money and they're wanting to spend it. And despite higher prices, if you ask how people are responding to inflation, a lot of them are saying, I'm not really changing. I'm just paying more. I'm not cutting back. That suggests that they're not acting like it's a recessionary environment yet.
So the upcoming rate hikes theoretically will make it more expensive to borrow money, which in turn curbs consumer spending and also discourages businesses from expanding. This reduction in consumer spending and reduction in business expansion will, of course, slow down the economy and, as we talked about here on the show, possibly even push us into a recession, which some have argued we might be in already.
In addition to the Fed's response, we might also see continued price hikes by corporations in an attempt to keep pace with wage growth. While annual wage growth is running at its fastest pace in 20 years, inflation continues to outpace earnings for most workers, which cuts into their spending power.
This, of course, and maybe you're one of them, often leads to employees asking for higher wages, asking for pay increases from their employers, which then starts to cause this inflationary cycle of wage price increases. In the end, there are only so many levers that can be pulled, and we're likely going to need to experience some continued pain as an economy as we work through this current challenge. As I shared last week,
Where we go from here, it feels like a coin toss. Things like the Ukraine war, China shutting down and surging commodity prices could cause a higher inflation or higher inflation to continue. On the other hand, rising interest rates, a cooling off in the housing market, which we haven't gotten into yet, fiscal tightening, commodities crashing and a recession. All these things could push inflation lower.
Given all of this uncertainty, what should investors and retirement savers do? How should they respond to this current environment? One idea is to get curious. My marriage therapist, who after seeing her for over 10 years now, she's become more of a like a life therapist to me. And she constantly reminds me that curiosity is the antidote to anxiety.
That by consciously deciding to get curious, we can lessen our sense of anxiety. We can get curious by learning new things or asking thoughtful, sometimes uncomfortable questions and her favorite by studying history.
And I believe that we can apply this same concept to our investments or the financial and economic landscape and this constant state of uncertainty that we're experiencing. In fact, Nick Majuli, who I recently had on the show, he wrote a great article last month titled How Not to Panic.
And in the article, he wrote, quote, a friend recently asked me how I was able to stay calm during a market crash. I told him that it's because I've spent a good amount of time studying history. And in doing so, I've come to realize that a lot of what we experience isn't as unique as we think it is.
Publishing this podcast is part of my conscious effort to get curious. And while listening to it might also be a version of you getting curious, if your anxiety is heightened at the moment, it may be worth getting even more curious. You can dig deeper into the history of the markets and inflation. You can ask thoughtful questions and even publish your own thoughts and comments. Even something as simple as a
A short summary on social media or an email to your family might help calm some nerves and prove to be an antidote to any worry that you might be experiencing at the moment. One of my favorite quotes from Deepak Chopra said, the best use of imagination is creativity. The worst use of imagination is anxiety.
Another response to this uncertainty right now, and maybe a solution or something for investors to do is to ensure that you're properly diversified and possibly even over diversified. For example, if you're overweight U S stocks, perhaps you consider maintaining meaningful diversification overseas as well. If you own individual stocks, you might consider consolidating your investments into broad base index funds instead.
If you only own corporate bonds, lower rated bonds, you might consider adding US treasury bonds and or tips. By reducing risk and over diversifying, just know that you'll also be accepting a lower rate of return when things do turn around.
But that diversification might also help you sleep better at night if the volatility and uncertainty continues. And one really quick, important note here. I've had a few people contact me recently who want to improve their diversification and they want to make some meaningful changes to their investments right now, but they feel like their hands are kind of tied because the market has dropped so much.
It feels like they would be selling things while they're down and they would be realizing those losses. So they've expressed that they might just have to wait it out and waiting it out and weathering the storm is certainly one option. As the late John Bogle said, don't do something, just stand there. And in most areas of our life, if we want to achieve something, we usually take action. For example, if you want to run a marathon, you would typically train for it.
But with investing, the opposite is often true, as John Bogle stated. And sticking with your investments and your financial plan, assuming it was the right plan to begin with, is often the right choice.
However, for those that don't feel like they have the right plan in place and they feel like their hands are now maybe tied because of the recent drops in the market, it's important to highlight that the U.S. stock market would have to drop another 30-ish percent or so to reach the lows that we experienced in March of 2020. I'll say that one more time.
the U.S. stock market would have to drop another 30-ish percent or so to reach the lows that we experienced in March of 2020.
Also, as I shared in a previous episode, if you invested in the S&P 500 on January 1st of 2020, you reinvested your dividends and you woke up today to look at your portfolio, your approximate total return would be around a positive 20%, a 20% positive return over the course of 30 months. So yes, we've given back some of the recent gains, but you're still buying at a higher price today than 18 or 19 months ago.
Sometimes, or maybe most of the time, it helps to zoom out and look at things through a slightly longer term lens. In the case of making some changes, sure, maybe you do realize some near-term losses in that process, but you're likely still well ahead of where you were at the start of 2020.
To be clear, any changes that you make right now, these should be permanent changes, i.e. we're not trying to time the market in this example here. This is a situation where you've realized that you're invested incorrectly and you want to fix that. And I'm just highlighting that just because we've given back some recent gains here and we're off to a rocky start this year, it doesn't mean that you can't necessarily move forward with making those appropriate changes because we're
What if you don't make those changes? What if the market does continue to fall? What if we end up in a prolonged recession? As I've said many times on this podcast, the best investment portfolio is the one that you can stick with.
I have so many more subtopics that I'd like to explore here around the topic of inflation and the current environment, like the housing market, debt deflation, stagflation is now showing up in the headlines. The labor markets are super fascinating to me, but maybe like you, I'm just feeling like I need to set all this to the side and take some more time to digest it all and watch some things play out over the next few weeks before digging in any further. So
I'm going to stop here for today, but if you want to get curious with me, if you have any thoughts of your own or any unanswered questions, or you just want to say hi, send me an email at podcast at you stay wealthy.com. Once again, the show notes for today's episode can be found by going to you stay wealthy.com forward slash one five five.
Thank you, as always, for listening, and I'll see you back here next week.
