Wednesday, May 12, 2021

A Look Under the Hood For Inflation

I recently saw a chart from AEI, which broke down inflation into a few components between 1997 and 2017. 

You can see that prices increased on average by 55.60% between 1997 and 2017.


Source: AEI

This picture provides an interesting perspective, because not every item you would buy actually increased at the pace of inflation that is widely quoted. 

Certain items that are more labor intensive, which cannot be easily automated ended up increasing much faster than the pace of inflation. Those include healthcare, education and childcare – all very labor intensive occupations, which require some skill and are difficult to automate well. There are other issues around healthcare and education, notably the persistent demand for these services, as well as the opaque nature of the industry ( eyeing healthcare, and the way it is “broken” in the US essentially).

On the other hand, items like TV have declined in price. That’s because it is easier to automate TV production.

This is a fascinating chart to look at, because it explains to a certain degree why some folks “feel’ that inflation is higher than reported. It is very likely that the composition of your annual expenses will determine whether you experience high inflation or a low inflation. If all you spend money on is TV’s, your cost of living has declined substantially over the past 20 years. However, if you are like one of the millions who need quality healthcare, you have likely seen a large spike in your costs over the past 20 years.

It’s fascinating to think that your personal basket of goods and services will definitely impact your lifestyle cost over time. For example, for most Americans the cost of daycare and college is high, but covers only a few years ( around 4 in each, give or take). There is a clear end in sight to when your child would graduate college for example ( in most cases). It also makes planning for retirement that much more challenging, because it entails forecasting expenses that are not a major component of your inflation basket today. 

Owning productive assets such as equities provided a very good inflation hedge over the past 20 years. I used S&P 500 as a proxy for a diversified dividend growth portfolio, since data on S&P 500 is readily available. 

Year

Earnings Per Share

Dividends Per Share

Price

1995

33.96

13.79

615.93

1996

38.73

14.90

740.74

1997

39.72

15.49

970.43

1998

37.71

16.20

1229.23

1999

48.17

16.69

1469.25

2000

50.00

16.27

1320.28

2001

24.69

15.74

1148.08

2002

27.59

16.08

879.82

2003

48.86

17.39

1111.92

2004

58.50

19.44

1211.92

2005

69.93

22.22

1248.29

2006

81.51

24.88

1418.30

2007

66.18

27.73

1468.36

2008

14.88

28.39

903.25

2009

50.97

22.41

1115.10

2010

77.35

22.73

1257.64

2011

86.95

26.43

1257.60

2012

86.51

31.25

1426.19

2013

100.20

34.99

1848.36

2014

102.40

39.44

2058.90

2015

86.53

43.39

2043.94

2016

94.55

45.70

2238.83

2017

109.88

48.93

2673.61

2018

132.39

53.75

2506.85

2019

139.47

58.24

3230.78

2020

94.13

58.28

3756.07

Dividends did a pretty decent job in providing a good inflation hedge. 

The S&P 500 paid $14.90 in dividends in 1996 and $15.49 in 1997. The annual dividends kept growing to $48.93 in 2017, for an over 228% increase. 

The index earned $38.73 in 1996 and $39.72 in 1997. S&P 500 grew earnings to $109.88 in 2017 for a 183% increase. 

The S&P 500 index closed at 740.74 at the very end of 1996, and went all the way up to 2673 by the end of 2017, for a 260% increase.

I could have used a combination from any of the large cap dividend growth stocks like PepsiCo, Johnson & Johnson, Procter & Gamble etc, and reached similar conclusions that dividends generated from diversified portfolios tend to grow above the rate of inflation over time.

It also looks like dividends have managed to exceed inflation in each decade since 1960. The exception is in the 1970s, when dividends trailed slightly behind inflation. However, stock prices lost a lot more ground to inflation.

Period

S&P 500 Price Growth

Earnings Growth

Dividend Growth

CPI Growth

1960s

58.58%

77.74%

61.11%

31.08%

1970s

47.33%

172.05%

101.88%

112.37%

1980s

143.24%

51.10%

87.73%

58.62%

1990s

299.82%

147.81%

32.92%

31.75%

2000s

-4.74%

49.24%

40.95%

26.66%

2010s

198.66%

64.88%

150.33%

18.66%

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4 comments:

  1. Interesting, as a doctor I can categorically deny that the healthcare system is broken! It works most of the time just fine...what is wrong with our healthcare is the special interests groups, the AMA, the pharmaceutical companies, and the lobbyists. If, we were to model our healthcare administration of the Northern European or Taiwan it would be stupendous! However, the obscenity that is now is over bloated with multi million dollar salaries of healthcare administration that do not see patients and noing to the care of patients, the ridiculous cost of medicine and the MDs and their unions

    ReplyDelete
  2. My personal consumption basket of goods is something I think a lot about. I'm fortunate enough to consume a very modest amount of the goods subject to high inflation, and I live in a rural area where housing inflation is non-existent. As a result the purchasing power of my cash tends not to deteriorate.

    You can't control inflation, but to some extent you can control your demand for goods and services. Be proactive about limiting your current and future demand for healthcare, education, and childcare.

    ReplyDelete
  3. "It’s fascinating to think that your personal basket of goods and services will definitely impact your lifestyle cost over time."

    Excellent point. Most people don't realize this about inflation. The BLS publishes many measures of the inflation. The Fed has their own. The CPI-U is the most used series, and excluded food and energy (because they are volatile!?).

    A further distortion to the numbers are "hedonic" adjustments. The average price of car has doubled in the last 30 years, but the BLS says prices are about the same. That's because they consider all the extra car stuff you get with a car now: ABS, backup cameras, side restraints, etc. You can't buy a car without lots of safety features today, so in fact, the price of a car has doubled.

    Another common source of inflation is product size decreases. Costco just dropped the number of sheets in their paper towel rolls from 160 to 140. Same great price! You got hit with a 14% increase in price/sheet but it is stealth. Ice cream used to come in half gallon containers, now 1.5 pints (25% smaller). Countless examples of this kind of inflation.

    You can get some protection with TIPS and I-bonds, but their interest rates fluctuate based on distorted calculations. Stocks with dividend growth rates higher than inflation are another great bet. Real estate also tends to keep up with inflation over long periods.

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  4. When I see data like this, I remember what my Father taught me - Figures don;t lie but liars can figure. Also the quote attributed to Mark Twain - There are lies, damn lies and statistics

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