The inflation threat: real or exaggerated?

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1 Capital market insights Conversation guide March 2018 The inflation threat: real or exaggerated? Volatility has returned to the stock market, as investors have become increasingly concerned that accelerating economic growth will result in excessive inflation. Indicators show that the overall price level has ticked up, and with steadily improving wage growth, additional pricing pressures should be expected. A higher rate of inflation could cause the Fed to raise interest rates further, potentially bringing the end of the current business cycle closer. The robust global recovery and stimulus resulting from the recent tax cut have also contributed to inflation fears. There is little evidence, however, that the uptick in price pressure in certain areas of the economy is pervasive enough to cause runaway prices (considered greater than 5%). Given the economy s lateexpansion position in the business cycle, a rise in pricing pressures should come as no surprise. Investors would be well-advised, therefore, to be wary of dire headlines about the threat of inflation. Current inflation is fueled by positive drivers and is considered normal at this point in the business cycle. Inflation remains low by historical standards, and rapid increases are not expected. Fundamentals remain healthy, and stocks can likely continue to perform if inflation remains modest.

2 Current inflation is fueled by positive drivers and is considered normal at this point in the business cycle. Almost nine years into the expansion, the U.S. economy is in the late expansion phase of the business cycle, typically characterized by low unemployment, wage increases and rising interest rates (see chart below) Inflationary pressures driven by rising wages should not be viewed negatively, particularly given the modest acceleration we are currently seeing; rising wages improve discretionary spending, which can improve corporate profits Chart 1: Inflation is expected during late expansion Spending EXPANSION Inflation We are here Incomes Rates Jobs GDP Yield curve steepens Rates GDP Jobs Yield curve inverts Yi Inflation Income Spending Source: Nationwide Economics, 1st Quarter 2018 RECESSION Capital market insights 2

3 Inflation remains low by historical standards, and rapid increases are not expected. While inflation is on the rise, it is increasing from an extreme low and remains below the long-term average (see chart 2 below) Looking ahead, Nationwide Economics forecast a modest level of inflation in the coming years, rising to 2.3% by the end of 2018 and 2.6% in 2019; this outlook is partially driven by continued below-average GDP growth expectations Focusing only on the reported inflation figures ignores the secular trends that are driving widely different price adjustments in different areas of the economy (see chart 3 below) 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% -3.0% Chart 2: Inflation remains low by historical standards Consumer Price Inflation Jan Jan 2018 CPI All Items (1-yr Ch) Recessions Average Chart 3: Inflation is not being felt in all sectors Consumer Price Inflation* ( ) Hospital Services 6% College Tuition 5% Child Care 4% Energy 4% Wages** 4% Housing 2% Food & Beverage 2% All Items 2% Vehicles 0% Apparel 0% Toys -6% Computers -10% Televisions -15% Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Source: Bureau of Labor Statistics, Federal Reserve Bank of Atlanta Source: Bureau of Labor Statistics * Represents average over the past 20 years ** Does not represent CPI. Included for illustrative purposes Capital market insights 3

4 Fundamentals remain healthy, and stocks can likely continue to perform if inflation remains modest. If inflation remains under control, as expected, the environment can remain supportive for equities. A modest inflation rate has little effect on equity valuations. The impact is most significant when the rate rises above 4% (see chart below) In an environment of modest inflation, some stocks are expected to perform better than others. For example, quality growth companies and high growth sectors (technology, multinationals, industrials) have more pricing power than others and can adjust their prices upward as necessary Other stocks may be harmed by higher levels of inflation, particularly those in sectors that are more sensitive to higher interest rates, including REITs, utilities and telecommunications Chart 4: Stock valuations historically have been hurt by much higher levels of inflation 20 S&P Average P/E by Inflation range, < 0% 0-2% 2-4% 4-6% 6-8% 8-10% > 10% Year-over-Year Inflation Range Source: Strategas Research Partners Capital market insights 4

5 Key takeaways A rise in inflation is not unusual or unexpected at this stage of the business cycle. Today s inflation is relatively positive, arising from strong economic growth and wage increases. Generally, modest inflation has little impact on stock market valuations, so given today s inflation rate, which remains low by historical standards, investors probably face little threat from rising price levels. Monitor the Fed s interest rate hikes and keep an eye on the inflation rate Consider an allocation to quality growth, technology and multinational stocks Be aware of inflation and its implications, but don t overreact to panicky headlines For more help or information, contact your financial advisor. This material is not a recommendation to buy, sell, hold or roll over any asset, adopt an investment strategy, retain a specific investment manager or use a particular account type. It does not take into account the specific investment objectives, tax and financial condition or particular needs of any specific person. Investors should discuss their specific situation with their financial professional. Except where otherwise indicated, the views and opinions expressed are those of Nationwide as of the date noted, are subject to change at any time and may not come to pass. Market index performance is provided by a third-party source that Nationwide deems to be reliable. Indexes are unmanaged and have been provided for comparison purposes only. No fees or expenses have been reflected. Individuals cannot invest directly in an index. MSCI EAFE Index: An unmanaged, free float-adjusted, market capitalization-weighted index that is designed to measure the performance of large-cap and mid-cap stocks in developed markets as determined by MSCI; excludes the United States and Canada. S&P 500 Index: An unmanaged, market capitalization-weighted index of 500 stocks of leading large-cap U.S. companies in leading industries; gives a broad look at the U.S. equities market and those companies stock price performance. Nationwide Funds are distributed by Nationwide Fund Distributors LLC (NFD), member FINRA, Columbus, Ohio. Nationwide Investment Services Corporation, member FINRA. Nationwide, the Nationwide N and Eagle and Nationwide is on your side are service marks of Nationwide Mutual Insurance Company Nationwide NFM-17291AO (03/18)

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