Just How Bad Can Inflation Get (And For How Long)?

I’m worried, but I feel like everyone is. Worry has become normal given the state of the world.

And while there are hundreds of things we could worry about, I’m going to limit my concerns today to one related to the economy and the stock market.

First is inflation. I’ve mentioned this repeatedly because prices are rising, and the consequences are unavoidable. We have to pay more for gas, for food, and for the other things we absolutely need. Higher prices also means that most of us cut back on the things we don’t need. Instead of going out for pizza, we make fun meals at home.

Looking at the long history of inflation, I believe the problem will get worse.

The chart below shows the Producer Price Index (PPI) for All Commodities, a data series maintained by government economists since 1914. Until about 2010, this was the headline number reported for PPI. That year, the Bureau of Labor Statistics made some changes to better reflect how they believed the current economy functioned.

The original series is still useful to consider, as the chart below shows.

This index is up over 22% compared to a year ago. It’s been this high just three times since 1914. The first time was during World War I. The second time was during World War II. The third time was during the Vietnam War.

Inflation has surged during wartime for hundreds of years. This makes sense because military demand surges and often exceeds the production capacity of a nation’s economy. Since at least the time of Napoleon, victory has depended on an ability to surge economic production almost as much as it has relied on military strength.

While wars are inflationary, the subsequent peace is often disinflationary. Demand for many items declines as wars end. At the same time, supply chains are rebuilt as defeated countries, and even victors, rebuild their industrial base.

What This Means Now

Today, it’s possible to explain the surge in inflation by recognizing that the response to Covid resembled the mobilization for war. But standing where we are now, it’s difficult to see how the inflation subsides.

Consumer demand is surging as pent-up demand forced upon consumers by quarantines and lockdowns is unleashed. Supply chains are stretched to their limits and there are shortages of many goods, limiting the ability of manufacturers to increase supply. Fortunately, there is no rubble to clear and there is no need to rebuild capacity that was destroyed in combat.

While the wartime surge against Covid was necessary, there isn’t a natural release valve for the inflationary pressures. This means inflation is something to worry about and will be for some time.

As investors, we don’t need to worry, for now, about the impact of inflation on companies. Many companies are passing along cost increases to consumers. That’s bad for us consumers as we shop at stores on Main Street, but it’s beneficial for us on Wall Street.

Analysts expect this trend to continue. Earnings expectations for this year, next year, and even 2023 are rising.

Source: Yardeni Research

Closing Thoughts

As long as earnings remain strong, the bull market can continue. In the meantime, the short-term outlook for my indicators are bullish.

If we look at the SPDR S&P 500 ETF (NYSE: SPY), we can see that my Income Trader Volatility (ITV) indicator is on a “buy” signal, with the indicator (red line) below its moving average (blue line) in the chart below.

After approaching its MA, the indicator turned lower, resuming its bullish trend.

My Profit Amplifier Momentum (PAM) indicator warns that the pullback we saw last week could go for a few more days.

PAM is designed as a short-term indicator. Looking at the bottom section of the chart, you can see that momentum (bars) is weakening.

For the short term, based on my indicators, I continue to look for some weakness before the rally resumes.

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As chief investment strategist of Velocity Trader, Jim Fink has devised trading methodologies that reap market-beating gains, regardless of economic cycles or the rate of inflation.

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