A Lesson on Inflation from Shopping for Motorcycle Accessories

One of the best days in a rider’s life is the purchase of a new motorcycle. I was fortunate enough to recently acquire one of my dream bikes. Like any motor vehicle acquisition, half the fun of buying it is accessorizing it to make it your own. This time around, I found that was difficult. I started to look at the P&A (parts & accessories) catalogues online for a set of panniers (i.e., motorcycle jargon for side bags). And I saw something I’ve never seen before next to many of the items I was interested in buying – “SOLD OUT.” It seems the long arm of supply chain disruption was going to make it difficult for me to buy what I needed.

From an investment perspective, the big concern about these disruptions is they could cause much higher inflation when coupled with increasing demand. Inflation is the increase in goods and services prices over time. Too much of it reduces the value of one’s savings and causes investors to demand higher rates of return on their investments. That is, interest rates for bonds and the discount rate on future earnings growth for stocks.

Lessons from the CPI

Wednesday’s issuance of the Consumer Price Index level will be in focus for politicians, pundits and investors alike. Because fiscal and monetary policy remain dominant in the approach investors are taking today, how politicians and the Fed view today’s inflation report will be something to watch. While the Fed uses the Personal Consumption Expenditures index as their official inflation measure, the Consumer Price Index (CPI) provides a more detailed breakdown of where inflation exists and how much.

Before getting into the evaluation of inflation and the impact on those policies, let’s review the numbers from the report.

• CPI increased half a percentage point in July after rising nearly a full percentage point in June. 
• Over the last 12 months, it rose to 5.4%, well above the Fed’s target of 2% inflation.
• However, the Fed has often stated that it believes much of the inflation we’re seeing is temporary, due to the global economy’s pandemic closure and sudden reopening.

As an example, a set of panniers cost around $1,000 for the bike. However, the few brands I’m interested in are sold out, though I can find them on eBay for $1,500—so, 50% inflation. As inventories are rebuilt and supplies come back to manufacturers, I’m told I’ll find them again for $1,000.

Another example is the used car market. The CPI report shows that used car and truck prices rose only 0.2% in July after rising an average of 9.3% in the prior three months. While auto manufacturers are still wrestling with supply chain issues surrounding their technology components, we are seeing the supply of autos pick up enough that prices in the used market seem to have reached their peak in this cycle. New car prices are up 6.4% during the last 12 months while used prices have risen a whopping 41.7%. They are not likely to do that again in the next 12 months.

The chart below provides a picture of the nuances in the CPI. It looks at the 12-month growth rate of inflation for all items, food, energy (i.e., gasoline and natural gas among other things). In red you can see the all-items increase of 5.4%, whereas food is up 3.4% and energy is up 23.8%. Certainly, gasoline is a perfect example of what happens when you reduce demand by more than half and then try to increase it by the same amount across the globe in a short period of time.

Energy companies were selling assets and laying off workers in droves to try to stem the tide of negative cash flow when demand for gasoline and other energy products cratered in 2020. Getting their infrastructure back online and people back to work takes time. In the interim, demand increases (think summer driving season) and you can see why there would be a temporary increase in gas prices.

Of course, the increase in demand has led to more production and just recently the OPEC plus announcement indicated an increase in daily production starting next month. In the U.S. we know that shale producers need a comfortable cushion of oil prices above cost, and the current level of West Texas Intermediate crude of $67 provides that cushion. FYI – the new bike gets around 47 miles to the gallon, saving money at the pump!

Transitory?

The debate over whether inflation is transitory or not has gone on since the beginning of the economic recovery. We are comfortable saying it is and it isn’t. Let me explain. There is some inflation that will be transitory. The 5.4% annual inflation rate just reported in July will not be sustained. How can we be so sure?

We know that the economy will not continue to grow at an annualized rate that is three to four times higher than it was before the pandemic. Why? Two things drive economic growth over the long-term, labor force growth and productivity. The average growth rate for the labor force will settle in the 1-2% range once we get through the pandemic forces on the labor market. We will see an increase in participation as government programs recede. However, we’ll need more work on the skills mismatch if we want to close the gap further.

Productivity will likely continue to improve, although we currently see a 1-2% run rate. Together these numbers show that we can expect the economy to return to a “normal” growth rate of 3%. A third higher than the run rate of the last decade, so good news, but not nearly the 6-8% we may expect this year.

That likely means inflation runs hotter than it had during that decade but not significantly so because of those productivity gains.

Finally, we haven’t left the era of better information and global access to products providing downward pressure on pricing. I found the panniers I wanted at a dealership in Hungary, ordered them for $784 and received them five days later!

ABOUT THE AUTHOR

Brian Andrew

Chief Investment Officer | Johnson Financial Group

As Chief Investment Officer, Brian Andrew leads Johnson Financial Group's investment strategy to provide consistent, actionable investment solutions for our clients.