Inflation Explained… And The Future Opportunities It Foreshadows

Written by the William Allan team · Published 2023-08-16

For the past year or even a bit longer, the topic of inflation and anything related has led the evening news. In fact, it’s led the morning and daytime news, and if you still read them, it’s been on the front page of your local or national newspaper (or website). And every time it's mentioned, the question abounds: How high will it go, or when will it start declining? This got me thinking… Do we know what inflation is, and is it that bad?

Simply put, inflation is a broad rise in prices that reduces purchasing power. Constraints on supplies, higher labor costs, changes in demand, and other forces can contribute. The pandemic disrupted production and spending patterns, while policy support helped sustain demand. The contribution of each factor varied over time and across products.

As of August 2023, inflation had eased from its earlier surge. The July 2023 CPI release reported that consumer prices were still higher than a year earlier. Slower inflation means prices rise more slowly; it does not mean the overall price level has returned to its earlier level. The Fed’s longer-run inflation goal is 2%, measured by the personal consumption expenditures price index. Actual inflation varies and need not equal that target in any particular year.

Why do people experience inflation differently? Much depends on what they buy or sell. A broad consumer price index measures a basket; it is not the price change experienced by every household or business. Categories do not move in lockstep. Those differences may point toward business challenges and potential investment opportunities. Let’s examine…

One way to think about it is by comparing parts of the economy that consistently rise in price with those that tend to become cheaper over time.

Consider hospital services and televisions. They are very different products, and comparing their price trends requires consistent dates and measures. Television price indexes also account for changing product quality: a better screen or other improved features can affect the measured price even when the checkout price does not fall by the same amount. The BLS explains quality adjustments in its consumer price measures.

Technology has changed the television itself. Today’s sets can offer lighter designs, larger screens, and capabilities that older models lacked. Healthcare also uses increasingly sophisticated technology, but that does not imply that healthcare’s overall costs must fall.

Now take hospital services. Have you visited a doctor’s office or a hospital in the past two decades? How much has changed? On the most basic level, do you wonder why you are still filling out forms with a pen? While technology is everywhere in your care (i.e., surgeries done by robotic arms, monitors, etc.), it almost seems like it is forbidden when it comes to all the administrative tasks… which are a lot!

Better administrative tools may reduce some tasks and improve efficiency. Their effect on overall healthcare spending is a separate question. New technology can also introduce treatments, expand use, and add costs; the Congressional Budget Office has examined that relationship.

As investors, we can look for businesses trying to solve these problems. High margins may attract competitors seeking to serve customers at lower cost. Whether a new entrant can do so profitably is something to investigate, not assume.

Healthcare and education costs reflect several forces, including labor, market structure, payer incentives, regulation, and technology. Government funding or inefficient administration alone cannot explain their price paths. For example, a 2022 CBO report on healthcare prices examines providers’ market power and insurers’ and employers’ incentives.

Wearables offer one example of technology entering healthcare. The Apple Heart Study evaluated irregular-pulse notifications and subsequent clinical assessment. Such tools may help users identify a potential issue, but that study did not establish that Apple’s apps broadly reduce hospital use.

I sense that Apple and its tech cohorts are just scratching the surface of the healthcare and education industries. We’ve seen new ways to educate people online, but tech firms that dive into higher education will go way deeper. I mean, do we think parents will continue to send their high school graduates to an overpriced university for 4+ years for a piece of paper that they can receive in a much more efficient manner?

Inflation is real even when it receives less attention. Changing prices can create opportunities for some businesses and pressure for others. As investors, we need to understand both the potential benefit and the risks, including the price we pay for an investment.

Companies and securities mentioned are examples for discussion only, are not recommendations to buy or sell, and may or may not be held in client accounts. Any investment decision depends on the investor's objectives, risk tolerance, time horizon, tax situation, and other circumstances.

This commentary is for informational purposes only and is not investment, tax, or legal advice. All investing involves risk, including the possible loss of principal, and past performance does not guarantee future results.