The Good, The Bad & The Ugly


The Good, The Bad & The Ugly

Inflation sticker shock is so common now that people expect it. That doesn’t mean that anyone likes it. Americans are getting angry, and politicians and central bankers are under the gun to show that they’re doing something about it.

The pressure to act is ratcheting up as inflation becomes a bigger threat to financial well being. Broad-based wages are growing too slowly to keep up with the leap higher in the cost of so many items, from food to gasoline to rent.

Will there be relief this year? Consensus economic forecasts are predicting a pull back in inflation’s rate of growth. But with so many economists and politicians being slow to recognize the problem, suspicions abound that the predictions and proposals could miss the mark.

Lost in the negative publicity blitz over inflation are the potentially good aspects of climbing prices. The wage gains at the low-end of the economic ladder ends years of stagnation and softens some of inflation’s impact. Additionally, inflation is an easier economic scenario to address by the Fed compared to its opposite: deflation.

Horizon Investments’ Q4 Focus explores the good, the bad and the ugly sides of inflation as we seek a more complete picture; one that we hope can help advisors and goals-based investors navigate the unique circumstances in which we find ourselves.


Demand Booms, Supply Lines Snap
2021 was a bucket of cold reality after two decades of tame U.S. inflation readings. The combined forces of fiscal stimulus, swollen savings accounts, working from home, the desire to reconfigure our houses and apartments, and the search for new digs in a new town fueled scorching demand for goods, homes and home renovations. Meanwhile, many supply lines were stretched beyond their breaking points to meet that demand. The spreading virus made it all the more difficult to keep factories and other businesses fully staffed.

Put simply, we experienced high inflation because demand for durables like appliances, cars, and furniture oustripped supply. The same was true in the labor market where hiring demand outpaced the number of people who were available for hire. As we know from our Econ 101 textbooks, the main way a free-market economy rations a constrained supply is through higher prices and wages.

It’s a mismatch that remains as 2022 dawns.

What was extraordinary in 2021 was how far and wide the interruptions were. They affected little things like plastic coffee cup lids to massive items such as steel beams for new buildings.

As is now widely realized, the just-in-time global delivery systems we took for granted were only reliable when all of their parts work together like a well-oiled machine. It’s a situation that’s made worse by factory output that yo-yos up and down around the world in reaction to the spreading virus.

There was some healing of the global supply chain at the end of 2021, but not nearly enough to make a discernible impact on inflation.

But what likely made inflation feel so bad in the closing months of 2021 was the spread of sticker shock to more and more everyday products. A trip to the grocery store may have felt like a choice between must-haves and nice-to-haves as prices jumped in seemingly every aisle.

Constantly Changing Face of Inflation
Financial markets were flummoxed, too. Inflation quickly became difficult to predict as every month saw new drivers emerge, while old drivers faded. That’s something that will likely stick with us in the opening months of the new year.

Gasoline, for example, went from being a large contributor to inflation in the spring, as measured by the Consumer Price Index (CPI), to being a non-factor in the summer. It was back to being the leading inflation driver in the autumn as rebounding production could not keep pace with a surge in demand as adults went back to work, kids returned to school, and traveling picked up.

They’re Predicting a Glide Path to Less Inflation Pain
While the near-term outlook for inflation is that it will remain at today’s painful levels, economists are generally hopeful it will improve during the year. The consensus forecast of economists is for the year on year inflation rate to be below 3% by the end of the year, down from a first quarter CPI projection of 6.3%, according to data compiled by Bloomberg.

Some forecasters are predicting a dramatic plunge over the course of the year. Cornerstone Macro, for example, sees a headline CPI reading of just 1% by December 2022. The firm’s prediction rests on a change in both demand and supply. Consumers, satiated by their spending sprees, may shop less often. Meanwhile, all of those goods on ships waiting to get into America’s ports could refill depleted inventories.1 Such a rebalancing in demand and supply could take the sting out of inflation, which shoppers would notice in the form of flat to falling prices.

Still, a rebalancing is not the only way for inflation to slow as 2022 progresses. If prices simply stop climbing, then, mathematically, the year-on-year change in CPI should be much smaller in the back-half of the year; and therefore the headlines would presumably be less dramatic. Could that happen? At the moment, it seems like a low probability scenario given there are many intertwined problems that are feeding inflation.

We’ll need to see improvement in several areas, not least of which are trucking availability, port throughput, faster-running trains, people re-entering the workforce, more new cars and trucks on dealer lots, and a continued rise in U.S. and global oil output. We are watching all of those areas, but improvement often seems to take two steps forward, and one step back.

As an example of that, consider the drop in the cost of sending a shipping container from Shanghai to Los Angeles. It fell approximately 20% from mid-September to the start of November, from just over $12,400 to about $10,000. It seemed like a sign the snarled international shipping industry was getting back to normal. But it was not to be. There’s been no further drop in the price; it’s still hovering around $10,000, as of December 23, 2021. At that rate, the Shanghai to Los Angeles route is about 150% more expensive than this time last year. The longer it remains stuck there, the greater the incentive for companies to demand higher prices for their goods.

Omicron Adds to the Uncertainty
Omicron’s arrival throws up a potentially significant hurdle to figuring out where inflation is headed. As we write, there’s no clear idea of how disruptive it will be for individual countries or for the global economy, even if the variant causes a less severe form of the disease as early indications suggest. The sheer number of cases, and the quarantines that go with a positive test result, is straining staffing levels across all types of businesses. What progress there was to get supply lines back to normal may be undone by the virus, pushing back the day when more normal conditions prevail.

On the other hand, politicians and health experts are mainly steering away from using broad economic lockdowns to combat omicron’ spread. Instead, they’re putting an emphasis on fostering a continued recovery in their economies by getting people back to work, which could mitigate the effects of supply interruptions. 

The Ugly Inflation Threat from Housing and Rent
Even if omicron passes relatively quickly, there is another threat to be worried about that could scramble economists’ predictions for a glide path to lower inflation pressure.

In 2022, housing and rent costs may be poised to keep CPI uncomfortably high, even if other prices fall.

Housing and rent “have the potential to poke another hole in the narrative that inflation will soon fade as pandemic-induced pressures ease.”

Former Federal Reserve researcher and now Bloomberg economist David Wilcox.2

The threat from housing and rent comes from how CPI is calculated. The rent and housing components of the report, by design, react slowly to the rising prices we see around us today. Government economists slow-walk higher prices into CPI because the increases for the new people moving in take a while to be reflected in what existing residents pay – assuming the price increases stick. Sometimes the hikes don’t last, and so a measured approach tamps down the volatility of the housing components.

The dilemma for the Federal Reserve is that the jump in the cost of renting or buying a home is essentially nationwide and rising by double digits in many areas.

A model built by former Federal Reserve researcher and now Bloomberg economist David Wilcox predicts that over the next 12 months, the CPI component for renters’ costs could be up 7% year-on-year, while the ‘owners’ equivalent rent of residences” component could advance by 6% y/y.2 That would be the biggest increase in both of those items in 30 years.

The housing and rent components have the heft within the CPI report to extend inflation’s hot streak. They account for about one-third of the index, according to the Bureau of Labor Statistics.

Wilcox’s conclusion? “The rent surge will sustain the narrative that overall inflation is high.” And because housing costs affect nearly everyone, he said it might lay “the foundation for a classic wage-price spiral.

Some 2022 Inflation Risks
  • Housing/rent costs rise 
  • Too few workers re-enter workforce
  • Wage-price spiral begins 
  • Energy prices remain high
  • Snarled transportation hurts inventory rebuilding 
  • Meat, grain supplies remain hobbled
  • Covid surge hurts factory output 
  • Computer chip scarcity continues

What’s a Wage-Price Spiral?
wage-price spiral occurs when workers demand higher pay to compensate for the higher cost of living, and that, in turn pushes up the cost of goods and services, which sparks further competitive rounds of pay raises and price hikes. That’s an ugly inflation scenario.

And Wilcox is not the only one flagging such a possibility.

The director of the University of Michigan’s consumer sentiment survey, Richard Curtin, said consumer confidence among low-income households surged in December as they expect even fatter paychecks in the future. That, he said, “suggests an emerging wage-price spiral that could propel inflation higher in the years ahead.”3

The economic risk from a wage-price spiral comes not only from perceptions of where inflation could be headed, but also from the Federal Reserve’s likely response to it. In order to crush such a spiral and retain its inflation-fighting credentials, the Fed may aggressively raise interest rates to a level that’s so high that a recession and high unemployment follow.

To some Fed watchers, that sounds like a replay of the high inflation and deep recession that played out during the 1970’s and 80’s.

The comparison with the 1970s, however, has flaws. For one, the U.S. economy today is digitally-based and technology driven, far different from the mainly analog days of 50 years ago. America today is much less dependent on manufacturing for employment and GDP growth, with services now the dominant sector. Services businesses, and the jobs tied to them, are generally less economically sensitive than those that are tied to factories. Thirdly, the Federal Reserve since the 2001 internet bubble has aimed at so-called “soft landings” for the economy – meaning it wants to rein in excesses without causing a recession, which tends to hurt low-income households more than high-income ones. While there’s debate about the risks and benefits of the Fed’s “soft-landing” approach, the practical result is that the central bank is probably paying more attention to the downside of rate hikes than it did in decades past.

Should the Fed go on a rate-hiking campaign against inflation this year, it will likely try to thread a narrow path of doing just enough to squelch rising prices, but not so much that the recovery we’re experiencing turns into an economic crunch.

Could There Be a Good Side to Inflation?
As with any major theme these days, the dour litany about inflation and the Fed runs the risk of giving a distorted or one-sided view of the issue. That might lead to regrettable investment decisions.

Among the mental tools goals-based investors should possess is a balanced perspective of hot-button issues. It can keep the door open to seeing opportunities as well as risks.

When it comes to inflation, one of the important positive aspects is that it is better for economic growth, innovation, and wealth-building than its opposite: deflation.

Deflation is the persistent tumbling in a broad range of prices that can squeeze corporate profits, send the real cost of debt soaring for businesses and households as asset values sink, and that could lead to economic stagnation.

Just before the pandemic, a dominant debate in the economics profession was determining how close the U.S. and Europe were to experiencing outright deflation. Economists focused on it because they worried that central banks had few, if any, tools for getting out of a deflationary period. A worry that was – and still is – most clearly evident in Japan’s unsuccessful two-decade fight against it.

The reigning worry two years ago was that the U.S. and Europe might be one economic crisis away from following in Japan’s footsteps. When Covid hit, some argued that it could be a deflation-triggering event.

  • Japanification, Secular Stagnation and Bad, Bad News: QuickTake (Bloomberg, March 13, 2020)
  • Terminal Deflation Is Coming (Foreign Policy, April 29, 2020)
  • Why the Prospect of Deflation Could Pose a Threat to the U.S. Economy (Associated Press, May 12, 2020)
  • Specter of Deflation Rises Again (Wall Street Journal, May 12, 2020)
  • Deflation Is the Real Killer of Prosperity (Financial Times, May 20, 2020)
  • Market Sees Inflation Well Below Fed Target Until at Least 2050 (Bloomberg, May 21, 2020)

What’s so good about inflation? We’re no longer staring into the scary deflation abyss.

Inflation’s Relatively Better Than Deflation
Deflation is scary because people are incentivized to put off shopping or investing in new business ideas, which chokes off economic growth. Why buy a product now when you can buy it cheaper in the future? For businesses, why take on debt or additional employees to create a new venture when deflation means there’s a risk that the real cost of the loans and employees will rise over time, reducing or erasing the venture’s profitability.

Japan is the modern example of how difficult it is to escape deflation once it’s ingrained in an economy. For the last two decades, the Bank of Japan has set interest rates at or below zero and bought trillions of yen in bonds. And yet economic growth is anemic and prices of goods and services have barely moved.

Newly elected Prime Minister Fumio Kishida is the latest Japanese leader to offer a stimulus plan to spur a turnaround in the country’s economy. Among his first targets is changing the widespread corporate mentality against giving pay raises. Companies are reluctant to hike salaries fearing the higher cost will force them to raise prices, which could drive away price-sensitive customers. Kishida is promising corporate tax breaks as a way of offsetting the cost of fatter paychecks.

The Prime Minister is also targeting consumer demand. He’s promising cash payments to families in hopes that they’ll spend the money rather than save it, creating a virtuous circle of demand-driven growth that supports bigger paychecks and higher rates of inflation.4 

The Great Depression and Deflation
America had its own battle with deflation. During the Great Depression, the rate of deflation exceeded 10% in 1932.5 Despite various ideas to break the Depression’s grip, it’s generally accepted by economists that the manufacturing and spending booms during and after World War II in the 1940s were important factors in breaking the country out of the deflation cycle.

To borrow a phrase from the late, former Secretary of U.S. Defense Donald Rumsfeld, inflation is a known known – we can measure it, and we know how to effectively fight it. Inflation can be defeated by a simple tool that every central banker knows how to use: higher interest rates.

Deflation, however, is a known unknown – we are aware of it but have no good ideas about how to arrest its corrosive effects. Will Japan’s newest stimulus effort be the magic bullet that solves the deflation riddle? Let us hope it is, but the probabilities are against it as the policies appear to be new versions of earlier failed ideas. Japan’s annual inflation rate in 2021 was projected to be -0.2%, according to forecasts compiled by Bloomberg.

Inflation Helped Stock Market Investors, Home Owners, Low-Wage Workers
Contrast Japan’s stock market, where the Nikkei 225 Index’s total return was 6.6% last year, with the experience of investors who owned U.S. assets in general.

Rising inflation potentially played an important role in boosting the value of stocks, broad financial assets, and real estate – something that could have helped an investor’s net worth keep pace with inflation’s gain.

The stock market, as measured by the S&P 500 Total Return Index, rose 28.7% last year, far outpacing the Consumer Price Index’s expected advance of 4.7%, according to forecasts compiled by Bloomberg. The gain for equities came as many companies reported higher profits as managers offset higher input costs and rising wages with a combination of changes, including operational efficiency gains, product substitutions, technology, and price hikes.

Investing in commodities, as reflected by the S&P GSCI Spot Index, produced a return of 37.1%.

However, using gold as an inflation-hedge turned out to be an unwise investment decision in 2021. The LBMA Gold Price Index slumped 7.1%, and surprisingly it underperformed core bonds which were typically the most inflation-sensitive investments historically.

The middle class and wealthy may also be benefiting from quickly rising home prices. They’re up an average of 19.1% nationwide, year-on-year as of October, according to the most recent S&P CoreLogic Case-Shiller U.S. National Home Price Index report.6

Those inflating home prices have, in turn, boosted home owner’s equity to the highest level since 1986. True, the run up in home prices is bad news for first-time buyers and anyone who’s moving. But they are only a slice of the real estate market. Most American home owners are staying put and seeing a boost to their net worth as higher home prices reduce their debt burdens.

Little Guy Can Benefit From Inflation, Too
People who don’t own financial assets or homes, generally those in low-income households, may welcome some inflation, at least in regards to their paychecks.

Those at the bottom of the wage scale – where there’s a shortage of workers – are seeing their pay rise by 5.1%, according to the Atlanta Federal Reserve Bank’s most recent monthly Wage Tracker report. That’s outpacing the 2.7% gain for those at the top of the pay scale.

If the prices of many everyday items go up more slowly or tumble this year, those bigger paychecks may feel good as buying power goes up. Some retailers, notably Wal-Mart and Target, have already promised to keep using low prices to attract shoppers, to the chagrin of their shareholders.7

2022: Another Unprecedented Year
In last quarter’s Focus, we looked at several ways this year could be “unprecedented.” (Read the Q3 Focus) It is certainly shaping up to be markedly different from recent years given the unknown outcomes for inflation, the pandemic, government spending, and consumer behavior, to name a few. But then again, every year is “unprecedented,” with its own unique twists and turns. 

We are, hopefully, never surprised by the fact that surprises happen.

Inflation will likely remain one of the thorniest questions facing investors this year given the wide range of possible outcomes, the Fed’s possible responses, and the financial markets’ potentially unpredictable reaction to events. 

But beside concern, there’s also the possibility of a fortunate stroke of serendipity. It can play a large role in the economic landscape when companies see an opportunity to capitalize on an opportunity. Today’s high prices are likely spurring many business managers to devise lower-cost solutions that benefit their companies through market share gains, and soften the blow of inflation’s punch to Americans’ pocketbooks.

We at Horizon Investments remain optimistic. Inflation may be quite different from the recent past, but we are not convinced a shift to permanently higher prices is a reasonable view. After all, little has changed with regard to the underlying strengths and flexibility of the U.S. and global economies, the massive investment in technology and labor saving inventions, and human ingenuity to profit from opportunity. At the dawn of 2022, we continue to believe that diversified financial market investing can be one of the best ways for gaining, protecting and spending wealth despite the inflation backdrop.

As always, we’re on guard for when conditions change. And we renew our commitment to advisors and their clients to rigorously examine the incoming data, to be disciplined in our investment process, and to be prepared to make appropriate adjustments to our goals-based portfolios as we navigate this “unprecedented” year. Q3

A Goals-Based Perspective

During an investor’s journey through the wealth curve inflation may pose challenges that vary between the Gain, Protect and Spend stages.

The Gain Stage

The accumulation stage is probably the most straightforward in regards to inflation. Put simply, with a time horizon of two, three or four decades until a Gain stage investor reaches their goal, inflation shouldn’t be of any major concern. The erosion in buying power from inflation should be offset by the growth of an equity portfolio and the positive effects of compounding. Bottom line: We think it’s a good idea for Gain stage investors to stick to their wealth-building plan and try to avoid the distraction of today’s focus on inflation.

The Protect Stage

Inflation can pose new questions for goals-based investors in the preservation stage. Today’s rising cost of goods may prompt a Protect stage investor to consider whether their financial goal needs to be raised to account for potentially higher prices. Additionally, rising inflation could negatively affect core bond returns within a portfolio, which may affect an investor’s probability of success. Protect stage investors may wish to consider replacing some or all of their bond exposure with defensive equity positions which may offer higher inflation-adjusted returns and a lower correlation to the fixed-income market. Separately, there may be multiple steps the investor can take to get back on track, including a larger contribution, or a shift in the portfolio towards higher yielding and growth assets.

The Spend Stage

Inflation may pose the biggest challenge to those in the Spend stage. Financial market returns in 2021 showed that inflation-adjusted core bond returns can be negative, which might affect a retiree’s standard of living. Horizon’s long-held view is that an over-reliance on core bonds may increase the risk of running out of money during retirement. For Spend stage investors worried about longevity risk, they may wish to consider replacing some or all of their bond market exposure with defensive equity positions which may offer higher inflation-adjusted returns and a lower correlation to the fixed-income market. 2021 also demonstrated that equities could be an effective inflation hedge if they generate sufficient returns to replenish a retiree’s spending reserve.

1 Cornerstone Macro, ‘’The Coast is Clearer, Solid Growth & 1% CPI Here We Come,’’ Nov. 21, 2021

2 Bloomberg, ‘’U.S. INSIGHT: Stealth Threat to Fed Target – Modeling Rent Surge,’’ Dec. 7, 2021

3, ‘’Consumer sentiment rebounds in December, but fears of an inflation ‘spiral’ loom, UMich survey finds,’’ Dec. 10, 2021

4 Reuters, ‘’Japan’s Kishida sends message to shareholders: raise wages’’, December 21, 2021

5 Federal Reserve Bank of San Francisco, ‘’The Risk of Deflation,’’ March 27, 2009

6 S&P Dow Jones Indices,

7, ‘’Walmart and Target Just Put Long-Term Customer Loyalty Over Short-Term Profits,’’ Dec. 1, 2021

The commentary in this report is not a complete analysis of every material fact in respect to any company, industry or security. The opinions expressed here are not investment recommendations, but rather opinions that reflect the judgment of Horizon as of the date of the report and are subject to change without notice. Opinions referenced are as of the date of publication and may not necessarily come to pass. Forward looking statements cannot be guaranteed. We do not intend and will not endeavor to provide notice if and when our opinions or actions change. Horizon Investments is not soliciting any action based on this document. This document does not constitute an offer to sell or a solicitation of an offer to buy any security or product and may not be relied upon in connection with the purchase or sale of any security or device. Information has been obtained from sources considered to be reliable, but the accuracy and completeness cannot be guaranteed. Horizon Investments, the Horizon H, and Gain Protect Spend are registered trademarks of Horizon Investments.

© 2022 Horizon Investments, LLC.


© 2022 Horizon Investments, LLC.
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