A good friend of mine recently left the U.S., which was a very difficult decision for him to make. We were discussing the state of the economy, and when I said, “Well, at least inflation has been contained,” he laughed. Loudly. “Amigo, inflation is rampant. The powers that be just keep hiding it.” I thought this might be approaching tinfoil-hat territory, so I thought I’d look into it.
Turns out he’s right. And that could mean bad things for the economy and the stock market going forward.
The CPI has been running at 3% to 4% over the past year and a half. Backing out food and energy costs, the CPI has been remarkably stable, at around 2.5% for much of the past decade. But there are many problems in this quick and dirty analysis. Even 2.5% annualized inflation is a killer if wages are stagnant, which by many accounts, they are. So every year, an average employee earns the same amount of money, and that money’s buying power is reduced by 2.5%.
The other problem is that the so-called “core CPI’ eliminates food and energy. But do you know anyone who doesn’t buy food or energy? Of course not. You must include those sectors because those stagnant wages are buying less and less food and energy.
Moreover, food price increases outstrip increases in all other products except gasoline. That means that the 46 million people that are now on food stamps are also seeing that entitlement buying less and less food.
My friend also told me to visit my grocery stores and pay careful attention at the container volumes of things I buy every day. Wouldn’t you know it — that 64oz carton of orange juice I thought I was buying is down to 59 oz. That 16oz bag of chips is now 13 oz. How did that slip past me?
The losers here are working- and middle-class Americans. The other loser may be the stock market.
If food stamps don’t buy as much as they used to, then consumer staples revenues will decline. If wages are stagnant and money is worth less, then less revenue will be generated.
If that happens, earnings get affected. Even if companies subsequently decrease the size of their products, while that will reduce costs, it still means less is being consumed. And if gas prices remain high, this inflation will also impact travel.
All this just adds more obstacles to a recovery that’s already weak and nearly jobless.
So how do you play this trend?
For starters, understand that because inflation is in reality higher than reported, if you’re using dividends as an inflation hedge, you’ll need to move into higher-yielding stocks. So instead of 3% yielders, look for 5% or more.
These might include AT&T (NYSE:T), Altria Group (NYSE:MO), pipeline plays such as Kinder Morgan Partners (NYSE:KMP) and preferred stocks, such as the D or E series of Ashford Hospitality Trust (NYSE:AHT), which goes ex-dividend at the end of this month.
You might also think about shorting consumer staples, which can be risky since staples, by definition, are always needed, so do it with Vanguard Consumer Staples ETF (NYSE:VDC).
A safer bet would be to short consumer discretionary, such as Vanguard Consumer Discretionary ETF (NYSE:VCR). I think it’s always a safe bet to short any of the airline stocks, except for Southwest Airlines (NYSE:LUV), which, as a low-cost provider, will be the go-to airline for many people.
Lawrence Meyers is long shares of Ashford Hospitality Trust and its Preferred D series.