May 2018 Market Insight
Which “flation” is it?
Welcome to the beginning of summer! We hope you’re enjoying some summertime activities since the weather has finally turned.
While the kids are getting out of school, we thought we would take you back to the classroom and review some key terms that you may be hearing regarding what’s happening in the market.
Reflation is the act of stimulating the economy in order to achieve a healthy level of inflation. It’s a form of monetary policy that we’ve seen recently as the government has reduced taxes, dropped rates, and spent money in order to increase demand and raise prices. In order to make money more accessible and promote reflation, the Fed dropped rates to an all-time low of 0.25% in 2008 and left them there until December of 2015. Reflation usually coincides with economic recovery as growth is reestablished, employment is up and the entrepreneurial spirit is rekindled. This is all great, but too much of a rise in prices can lead to run-away inflation.
Inflation is the same as reflation as prices for goods and services increase over time but it has a more negative connotation. When inflation rises too quickly or too high, economic growth can be choked off as businesses are forced to pay more for raw materials, profit margins shrink, and consumers are not able to purchase as much. Right now, the Fed is carefully raising interest rates to keep reflation going while making sure inflation doesn’t take off too fast. They also want to watch out for stagflation.
Stagflation occurs when prices continue to increase but demand drops and unemployment increases. Instead of companies making more profit (perhaps due to a healthy level of inflation) and hiring more people to make more products, demand decreases while prices rise which decreases profit and hinders the ability to hire more people. If you see inflation going up at the same time as unemployment, that might be a sign of stagflation.
Deflation is the overall price level decrease. This could be caused by a number of things but let’s take an example where unemployment spikes. This may cause a chain reaction where consumers are less able to purchase goods and demand decreases. When demand decreases, prices will drop and profits will shrink. When businesses make less in profits they are less likely to hire workers, as was the case in 2008-2009.
Now that we know the terms, let’s apply them to the current conditions. The Fed is currently reacting to a reflationary environment as inflation is gradually ticking up toward the Fed’s target of 2%. There have been some brief concerns recently that inflation was accelerating too quickly, which has spooked the market, but a strong earnings season has kept us in a “Goldilocks” zone (not too hot and not too cold).
Going forward there needs to be a very orderly rise in inflation along with a strong economy and continued growth. We expect that the Fed will raise rates again in June but be very cautious to not choke off the economy as it continues to recover.
That’s all for today’s lesson. Should you have any questions or concerns please let us know and we can talk further.
Enjoy some time with your loved ones and soak up the summer!
|S&P 500 Composite (Large Cap)||2.41%||2.02%|
|Russell 2000 (Small Cap)||6.07%||6.90%|
|MSCI World Ex-Us||-1.90%||-1.69%|
|Barclays US Aggregate Bond||0.71%||-1.50%|
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