Inflation in check
With the first quarter spike in oil and gasoline prices, many investors are asking about inflation. Clients often become concerned about inflation when food and energy prices rise. At Russell, we still believe inflation will remain benign into 2013 for a number of reasons.
First, energy and food only make up a portion of the inflation calculation. The table below shows the components of headline inflation as measured by the Consumer Price Index (a measure of the average change in prices over time of goods and services purchased by households) with December 2011 weights.
You’ll note that housing is the largest component, at 41%, of the total calculation. This is a surprise to most. It also helps explain why inflation, at 2.9%, remains well below its 50-yr average of 4.2%.
Most Americans have witnessed first-hand the downward pressure on housing prices since 2007. Over the 12 months ending February 2012, the housing component of headline inflation is up only 1.8%. Even though it is the largest component, its small year-over-year change helped mute overall inflation. It serves as a good reminder that, even though rising oil and gas prices make front-page news, inflation is made up of more than just the volatile food and energy components.
The second reason we believe inflation will remain benign into 2013 is that three key drivers of inflation are not present in the market today.
In order for sustained, higher-than-trend inflation you need:
- General upward pressure on wages. (Not prevalent today.)
- Easy credit. (Ask anyone who has tried to buy a new home recently – credit standards are generally tighter.)
- Industrial production operating at full capacity. (Capacity utilization rates remain below long-term averages.) Total industry capacity utilization rates: average 1972-2011 = 80.3, March 2012 = 78.61
Given that these drivers are not prevalent in today’s economy, our strategist team at Russell continues to believe that inflation will remain benign into 2013.
1Board of Governors of the Federal Reserve System, Industrial production and capacity utilization summary: http://www.federalreserve.gov/Releases/g17/Current/default.htm