Fed Inflation Numbers Out of Sync with Reality (Market Forecast by Kerry Watkins-Bradley)

The government keeps telling us inflation as measured by the consumer price index has averaged about 3.5 percent over the past four quarters.

Mr. Bernanke tried to calm our concerns recently by reminding us of the double-digit inflation rates from the 1970s, like any of us care.

The Fed has indicated that the rate of inflation is higher than they would like, which in my opinion is a not-so-subtle way of telling us no more rate cuts. As the economy continues to struggle with a strapped consumer, the Fed may have a hard time raising rates to combat rising prices.

To the average Joe like myself, it certainly feels like much more than an incremental 1 percent to 1.5 percent is coming out of my pocket on a daily basis. (The average rate from June 2006 to June 2007 was around 2 percent.)

Just skimming back through my credit card bills and checkbook confirms my suspicions.

It used to cost me about $80 to fill up my gas guzzling SUV, a product of my husband’s choosing, not mine – but I digress – and now the pump cuts me off at $100, leaving me with less than a full tank.

On another note, my daily Route 44 iced tea at Sonic is now costing me $2.10, not the good-old-days price of $1.88, up almost 12 percent.

On the brighter side, that 52-inch television we purchased 3 years ago – again, a product of my husband’s choosing – for $3,000 can now be purchased for less than $1,500.

If everyone was buying flat panel TVs on a daily basis, we would be in heaven!

A concern of everyone here at Garrison and many others like PIMCO’s Bill Gross, is how the inflation numbers are being calculated and reported.

The government has an inherently biased interest in keeping the reported CPI number manageable.

Otherwise the entitlement programs would skyrocket more out of control than they already are due to cost-of-living adjustments.

The U.S. seems to differ from the rest of the world in how it computes its inflation rate in three primary ways. The details will be left for another day, but one example is the adjustment made for improved quality.

We have all witnessed the dramatic price declines in computers and televisions. Computer prices have dropped about 8 percent per year for the last decade. But because the power and memory of the machines have improved, the government-adjusted prices have dropped by 25 percent per year.

No wonder inflation has been so tame. Just about everything I own as compared to a decade ago has improved except for maybe my dental floss, but I can’t think of too many goods that aren’t more expensive than they were in 1998.

The erosion of purchasing power is staggering even at just 3 percent inflation. Over a 15-year period, $100,000 will only buy you $63,325 worth of goods. Those of us still in the workforce can hope to offset this erosion with higher wages, but it can be a real problem for retirees living on their investment savings and social security. This is why asset allocation and a well-thought-out investment strategy is so important.

Although in the short run the stock market tends to react negatively to higher inflation data, over the long-term, equities are actually one of the best asset classes to combat the inflation boogey man.

Even though equity investments are much more volatile than those in fixed income, the growth aspect of stock returns is one of the best ways to protect yourself from rising prices.

In light of current conditions, it may be prudent to review your portfolio to make sure you are doing all you can to prevent a deterioration of your standard of living.

(Kerry Watkins-Bradley, CFA, MBA, is equity portfolio manager at Garrison Financial in Fayetteville. E-mail her at [email protected].)