Inflation — much like love — is in the eye of the beholder.
People’s views of inflation depend on how they experience it, not necessarily what the data says. These contradicting experiences have forced a lot of confusion — and healthy debate — at the dinner table, the water cooler, and on your social feeds.
But here’s the thing: Inflation feels different in our daily lives than it does in our portfolios. And because of that, our view of inflation could be distorting our opinions about just how healthy the economy is.
In our daily lives
Inflation is still pervasive, no matter how you slice it. Rents and grocery bills continue to climb at a rapid clip. Local businesses are still ratcheting up their prices in the fight over labor. And just a few weeks ago, we were all complaining about egg prices.
But the way most of us experience inflation could be distorting the progress we’ve seen over the past few months. Think about your monthly budget — what do you spend all your money on? If you’re the typical American, you spend about 66% of your disposable income on services: rent, travel, haircuts, medical bills, experiences in general. The rest of your hard-earned cash goes to goods like food, apparel, and TVs. In January, the price of services rose 7.2% year over year, the fastest pace in more than three decades.
Ironically, our biggest expenses are where inflation is still stinging the most. The average American household spends about 30% of their budget on rent or mortgages, 16% on transportation, and 12% on food, according to Bureau of Labor Statistics data.
Well, rent prices climbed 8% year over year. Transportation services — car leases, vehicle registrations, and parking — soared 15% over the same period. Food prices — 12% of our budgets — climbed 10% year over year.
You’re not imagining things. Inflation is still ravaging big swaths of our spending, and it’s weighing on Americans’ confidence in the economy.
In our portfolios
Inflation is still a serious problem. But it may be a bigger problem for our wallets than our portfolios.
And to be clear, people still think inflation is a big issue for their portfolios. In fact, inflation was the biggest risk in investors’ minds for the next 12 months, according to the US segment of our latest Retail Investor Beat survey.
What do I mean? Inflation for everyday goods is still fiery hot, yet other prices are cooling rapidly. Goods and materials inflation has dropped precipitously to about 1% a year. Shipping container prices have slid 80% over the past year. Even labor costs (which amount to about 70% of businesses’ total costs) have stabilized at about 5% year over year. While we’re still feeling strained over inflation, companies — especially goods-focused companies — are finding it a little easier to breathe.
I realize this isn’t the best news, especially because we know corporate America has fared decently well over the past year. But it’s a trend to think about if you’re feeling anxious about the stock market.
Up until now, company profits have slowed more due to rising costs than declining sales. In the last three quarters of 2022, S&P 500 company costs outstripped sales, even though revenue rose at a 14% year-over-year pace.
Businesses have struggled with inflation and cost management, too. But there could be a glimmer of hope ahead, at least for companies. In 2023, analysts expect costs to continue to outpace sales, leading to year-over-year profit declines over the next two quarters. If you believe inflation — and by extension, costs — are coming under control quicker than we think, you may have more of a reason to feel optimistic about the companies you’re invested in.
It’s also important to take a step back and understand what high inflation is telling us about the economy. Despite higher prices, Americans are still comfortably spending money — primarily on services. Remember, consumer spending is 70% of gross domestic product, and it’s helped cushion the economy against recession.
This could be a double-edged sword for the stock market, though. Spending may be keeping the economy afloat, yet services spending tends to benefit local businesses more than publicly traded companies.
Think about it: Who are you paying for your rent, haircuts, and medical bills? The local landlord, the barber shop, and the neighborhood doctor — not a huge corporation. By our count, just 43% of the S&P 500 are services providers. Many of the bigger companies aren’t benefiting as much from this surge in services demand, and you can see it in stock performances this year. The median return among S&P 500 goods stocks is 5.5%, much lower than the 9.3% median return among S&P 500 services stocks.
Still an issue
You’re justified in still feeling annoyed by inflation. Prices are still rising too quickly for both our and the Fed’s tastes, and this could keep rates high and markets on edge.
But if you dig deep enough, you’ll realize that there’s a subset of inflation that is making progress, even if you don’t see it in your grocery bill. And that alone could be a reason to stay invested.
*Data sourced through Bloomberg. Can be made available upon request.
**The Q4 2022 Retail Investor Beat was based on a survey of 10,000 retail investors across 13 countries and 3 continents. The following countries had 1,000 respondents: UK, US, Germany, France, Australia, Italy and Spain. The following countries had 500 respondents: Netherlands, Denmark, Norway, Poland, Romania and the Czech Republic.