This Day On The Street
Continue to site
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

The Unpleasant Truth About Inflation

What Makes Inflation So Bad?

The impact of inflation is clearly negative on the broader economy. It hurts the credibility of the Federal Reserve, whose primary goals include price stability; undermines the dollar's buying power and appeal to foreigners (as a debtor nation, we don't want that); and provides yet another disincentive for Americans to save because cash loses its value over time when inflation is ascendant.

Inflation is also a problem because various federal programs (including Social Security, Veterans Benefits, Medicaid) have cost-of-living adjustments built into them. As inflation -- as measured by CPI -- goes higher, the payments increase, putting an increasing burden on the federal deficit.

But inflation's effect on corporate profitability and equities is particularly pernicious.

  • Inflation Raises Corporate Borrowing Costs: As these expenses increase, the extra price paid to borrow comes right off of the bottom line.

  • Inflation Squeezes Margins: As producer prices go up, companies often have the Hobson's choice of either raising prices -- and risk losing sales -- or eating the higher costs. If they cannot pass thru wholesale price increases, margins get squeezed, hurting earnings.
  • Competition for Capital: As rates rise, bonds become increasingly more attractive. Better yields, no-risk, tax-free Treasuries pull money away from the stock market; this is one of the biggest dangers to equity investors. Watch the flow of funds away from equity mutual funds. Ultimately, this can lead to lower prices.
  • Recessions: Inflation causes the Fed to tighten, and often at the same time, rising energy prices crimp consumers. A recent study by Merrill Lynch's David Rosenberg noted that when the Fed tightens and oil prices rise, GDP typically contracts. When all three factors coincide, that does not bode well for the macro economy and equities.
  • Conclusion

    It is crucial for investors to have a realistic understanding of how robust inflation is. Doing so early reveals investment opportunities that those who focus on the core CPI have missed. In particular, oil, commodities and gold have been attractive investments overlooked by the "no inflation" crowd.

    Now, as the Fed rate tightening cycle goes from being accommodative to neutral and beyond, the risk to domestic equity holders increases. I have been advising clients that as we come to the end of 2005, they should be getting increasingly defensive. In addition to owning gold, they should be looking to increase their exposure overseas.

    Those who live in a synthetic reality -- seasonally adjusted, hedonically altered -- will confront the unpleasant reality of the real universe. Ignoring inflationary data in the CPI won't make it go away. All that accomplishes is to shift the focus away from precisely where it should be: on the part of CPI that has been rapidly increasing in price.

    Those who fail to grasp this will pay a heavy price for their self-imposed ignorance.

    RealMoney Barometer Poll

    1 What would best describe your stance heading into the coming week of trading?
    2 Which of these sectors do you think is set to move up in the coming week?
    3 Which of these sectors do you think is set to move down in the coming week?

    View the results without voting
    Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries, and is a member of the board of directors of, a streaming media software company. At the time of publication, Ritholtz had no position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback; click here to send him an email.

    3 of 3

    Check Out Our Best Services for Investors

    Action Alerts PLUS

    Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

    Product Features:
    • $2.5+ million portfolio
    • Large-cap and dividend focus
    • Intraday trade alerts from Cramer
    Quant Ratings

    Access the tool that DOMINATES the Russell 2000 and the S&P 500.

    Product Features:
    • Buy, hold, or sell recommendations for over 4,300 stocks
    • Unlimited research reports on your favorite stocks
    • A custom stock screener
    Stocks Under $10

    David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

    Product Features:
    • Model portfolio
    • Stocks trading below $10
    • Intraday trade alerts
    14-Days Free
    Only $9.95
    14-Days Free
    Dividend Stock Advisor

    David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

    Product Features:
    • Diversified model portfolio of dividend stocks
    • Updates with exact steps to take - BUY, HOLD, SELL
    Trifecta Stocks

    Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

    Product Features:
    • Model Portfolio
    • Intra Day Trade alerts
    • Access to Quant Ratings
    Real Money

    More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

    Product Features:
    • Access to Jim Cramer's daily blog
    • Intraday commentary and news
    • Real-time trading forums
    Only $49.95
    14-Days Free
    14-Days Free
    AAPL $118.03 0.00%
    FB $105.52 0.10%
    GOOG $748.15 0.00%
    TSLA $229.64 0.00%
    YHOO $33.16 0.00%


    Chart of I:DJI
    DOW 17,813.39 +1.20 0.01%
    S&P 500 2,088.87 -0.27 -0.01%
    NASDAQ 5,116.1430 +13.3350 0.26%

    Free Reports

    Top Rated Stocks Top Rated Funds Top Rated ETFs