Higher Inflation Ahead? Maybe. But Don’t Even Try to Predict It.

by Msnbctv news staff

But, no: The study shows that the bond market is no good at this, either. Again, the research draws finer distinctions. Bond mavens are a little better than economists at predicting short-term inflation, while economists are a smidgen better than bond mavens at looking a few years ahead.

“However,” Mr. Gagnon and Mr. Sarsenbayev wrote, “neither bond markets nor economists have a great track record at forecasting inflation.” So it would be unwise to take comfort from current prices, which suggest that inflation will be no more than 2 percent next year. To the contrary, the two economists wrote, based on the bond market’s well-documented myopia, “more persistent inflation cannot be ruled out.”

The study’s various statistical comparisons relied on data from the University of Michigan Surveys of Consumers, the Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters and the Bureau of Labor Statistics’ Consumer Price Index going back to the 1970s. It delved deep into the weeds, and for those with a passing knowledge of statistics, it’s well worth reading.

For everybody else, I’d suggest that their findings have some important implications.

If you happen to be lucky enough to have some money to invest, relax. You don’t need a crystal ball. Embrace a buy-and-hold strategy, setting up a portfolio with diverse, low-cost index funds, including stocks and bonds, in an appropriate asset allocation.

The much derided, old-fashioned 60-40 allocation — 60 percent stocks and 40 percent bonds — remains a reasonable place to start. Add stocks to the mix if you want to take on more risk. Add bonds, preferably Treasurys, if you want more safety. It’s true that if inflation surges, bond prices could be expected to fall, but not by much: The stock market can lose more in a week than the bond market loses in a bad year.

This is evident if you look at historical stock and bond returns. Vanguard has charts that show the performance from 1926 to 2020 of indexed portfolios with different asset allocations — from those with 100 percent stocks to those that have only bonds. Here are a few highlights:

  • A 100 percent stock portfolio had a 10.3 percent average annual return. It produced losses in 25 of those 95 years, and the worst year was 1931, with a 43.1 percent loss.

  • The old standby, a 60-40 portfolio, had a 9.1 percent average annual return. Twenty-two years produced losses, and the worst year, also 1931, had a 26.6 percent loss. Note that bonds staved off the deeper losses of the pure stock investment.

  • A 100 percent bond portfolio had a 6.1 percent average annual return. Nineteen years produced losses, and the worst year was 1969, with an 8.1 percent loss. Inflation in 1969 soared to 5 percent, yet the loss for bonds was inconsequential compared with those in bad years for stocks.

If, at the moment, inflation is your big worry and you are a homeowner, there is some solace. Real estate often does spectacularly well in inflationary periods.

But the Fed has kept inflation quite low for decades, and has the tools to reduce it should prices spike, Mr. Gagnon said. The central bank is deliberately trying to move the inflation rate just a bit higher — raising its target to 2.5 percent from 2 percent annually — for two main reasons.

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