The experts say inflation is accelerating ... or is it?

I just love it when markets all agree. When some new piece of information comes along, the stock and bond markets should drop into a familiar routine and do what they are supposed to do. We learned all about these routines in our sophomore economics classes, or from boilerplate articles in investment magazines and books.

These are the sorts of “blink” moments that Malcolm Gladwell loves. Why actually stop and think when we can access received knowledge? The experts say it is so, and so it must be.

Except that it’s rarely so. Surely you have heard by now that that the investment world’s scariest boogey man - inflation - is rearing its ugly head. The Bureau of Labor Statistics recently released new and worrisome upticks in its inflation data. On top of this, many academics and analysts make a compelling argument that the Bureau understates inflation due to political and budget-management concerns. The consensus seems to be that inflation is accelerating.

If we stop thinking and observing and merely look up the relevant article in an economics text or magazine, we will find that some things are supposed to happen. Stocks are supposed to fall – and they have. Bonds are supposed to also fall – but they haven’t. Gold is supposed to rally – but it hasn’t. The dollar is supposed to collapse – but it hasn’t. Herein lays the conundrum. What should investors do when the major asset classes do not behave like they are supposed to?

We need to engage our brains in a process of critical thinking, that’s what we need to do. We need to stop taking checklist investment advice from textbooks or from journalists who have never managed a retirement portfolio in their lives. We need to think, not blink. I have called this the Wisdom of Why. We have to think about why something is happening, and drill down into the situation ever more deeply. We might never find the true answer, but the process of exploration will inform us and make us better investors.

In the case of the current conundrum, we can first start by asking whether there is truly high inflation or not. Do we take one month of data from the government at face value and consider it to be the final word? I think not, frankly. If you search out various opinions on the matter, you will find that some signs of inflation are high, and some are quite low. The government’s process of calculating inflation is anything but simple. It reminds me of the old metaphor about watching sausage being made. Some things you just don’t want to see first-hand. I am trained as an economist, and I take inflation figures with a very large chunk of salt.

Assuming inflation is, in fact, on the rise, stocks are supposed to fall because not all companies can pass on cost increases. There is strong evidence that inflation hurts corporate profits in the short run more than it hurts consumers. In addition, it is assumed that the Federal Reserve will raise short-term interest rates. Such increases have historically depressed stock prices. In the past 10 days, the stock market has fallen significantly, so this predicted effect seems to be holding true to form.

However, another outcome of accelerating inflation is that bond yields are supposed to rise. As inflation picks up,