Monday, December 18, 2017

Inflation happens when you least expect it

By Stewart Taylor
Guest Columnist

Inflation can be tricky to navigate. It can remain low for years before suddenly moving sharply higher. 

During the quiet periods, investors can forget how prior inflationary periods have damaged savings and lifestyles. The period following the Great Recession has left investors particularly vulnerable. Not only have the fears generated by the great inflations of the 1970s become distant memories for Baby Boomers, but the younger Millennial and Gen Xers, having never experienced anything other than steady disinflation, have no frame of reference. 

Perhaps my own experience can provide some perspective. I graduated from high school in June of 1972, still basking in the afterglow of the release of "Led Zeppelin IV." At that time, inflation, after printing as high as 6.2 percent year-over-year in December of 1969, had fallen to 2.7 percent. Unfortunately, a scant 21 months later, year-over-year inflation reached double digits, and nine months later was 12.3 year-over-year (the circles in the figure below show some periods when inflation quickly moved higher). 

The dent in the living standard for someone like me making $2.25 an hour was substantial. Bologna sandwiches became ketchup sandwiches. My yellow VW bug sat unused for days at a time due to lack of gas money. While I didn’t understand it at the time, the downgrade to ketchup sandwiches and the dent in my social life were my first experiences with inflation.   

Fast forward to December 1986. Partly due to the large decline in energy in 1985, year-over-year headline inflation was running a modest 1.1 percent, the lowest inflation in nearly 25 years. Even better, the combination of low inflation and high nominal interest rates created significant returns for bond investors. A scant four months later, the year-over-year headline inflation rate was 3.8 percent and rising, on its way to an ultimate 6.3 percent in late 1990. Meanwhile, 10-year treasury yields also rose swiftly to peak above 9 percent in March 1989.

Once again, the rapid rise blindsided the vast majority of economists and investors. On a more positive personal note, this time around I wasn’t forced to alter my eating habits. However, the small but promising savings that I had been building suffered a significant loss of its purchasing power over the next several years. Not a disaster, particularly as I had many more years in front of me to earn, but still, very unpleasant.   

Now, in 2017, my retirement is much closer. Along with 80 million other baby boomers, I face the challenge of protecting the purchasing power of a lifetime of saving and investing. For many of us, protecting against unexpected inflation shocks may mean the difference between having a comfortable retirement, or not. Knowing that inflation often appears with little or no warning and that it often moves much higher than anyone expects strongly argues that inflation protection, much like insurance, should be pre-positioned prior to its need. 

Bottom line: I continue to believe that the inflation trend changed in early 2015 and that inflation is more likely to rise than fall going forward.   

The views expressed in the article do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Eaton Vance Management or TEXPERS.

About the Author:

Stewart Taylor
Stewart Taylor is a vice president of Eaton Vance Management and a portfolio manager on Eaton Vance’s quantitative strategies team within diversified fixed income. He is also responsible for overseeing residential mortgage trading and inflation protection strategies. He joined Eaton Vance in 2005.

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