THE SONG REMAINS THE SAME
- Inflation is currently the topic de jour for investors. The easing of COVID-19 lockdowns has pushed inflation (as measured by CPI) to levels not seen since 2008.
- While transitory effects such as supply bottlenecks and lockdowninduced year-over-year comparisons explain much of the recent increase in inflation, we believe the seeds have been planted for sustained longer-term inflationary pressures.
- As discussed in our 2016 Insight, inflation is particularly detrimental for not-for-profit (NFP) healthcare organizations, as they must contend with the impact of inflation on both operations and the investment portfolio. Post COVID-19, healthcare inflation and operational pressures are unlikely to recede and could possibly accelerate.
- Despite healthcare’s powerful inflationary forces, many NFP healthcare investors remain under-allocated to inflation-sensitive assets.
Today’s Environment
If there’s a topic currently dominating financial markets and news media, it’s inflation. It’s easy to see why, considering that inflation has been mostly contained for the past 40 years. However, recent signs point to much higher levels of inflation, particularly here in the United States. As the world emerges from COVID-19 lockdowns, bottlenecks in the global supply chain along with labor shortages are pushing prices higher. In June, the consumer price index (CPI) report showed inflation rising to 5.4% on an annual basis, its highest reading since 2008. Additionally, core CPI rose to 4.5% (annualized), a level not seen since 1991.
While it’s likely that these transitory forces pass by next year, cooling off levels of near-term inflation, we believe investors should be mindful of sustained inflationary pressures over the longer term. As we discussed in a recent Asset Allocation note titled “Heat Waves”, there are a number of reasons for this:
- Looser monetary policy could contribute to inflation. The Fed’s embrace of average inflation targeting, for instance, has shifted monetary policy in a more dovish direction.
- Relaxed fiscal policy could prove inflationary. Congress has passed a record >$5T in fiscal stimulus since the end of 2019, with more proposals currently being debated in Washington.
- Evolving consumer expectations could compound these fiscal and monetary pressures. While economists and market participants expect inflation will return to more normal <2.5% levels by 2022, American households are less sanguine. The May University of Michigan Survey of Consumers showed Americans’ intermediate-term inflation expectations are climbing. That could become a self-fulfilling prophecy if inflationary psychology makes it easier for businesses to pass along price hikes.
Already one of the most overlooked and unmonitored risks for investors, higher levels of inflation can erode an institution’s purchasing power more quickly. For example, with a 5% inflation rate, an investor’s purchase power is cut in half every 14 years. Dovish monetary policy, expansive fiscal policy, and climbing inflation expectations greatly increase the risk of higher longerterm inflation.
The Implications for Healthcare
For NFP healthcare organizations, inflation presents its own set of challenges. We discussed this in greater detail in a 2016 Insight titled “A Hospital’s Balancing Act: Operations, Investments, and Inflation.” In summary, while other institutional investors are generally focused solely on the investment portfolio and maintaining its purchasing power, healthcare organizations must contend with the impact of inflation on both its operations and investment portfolio. Additionally, as healthcare organizations are capital-intensive institutions, they must contend with inflation’s impact on capital expenditures. Healthcare entities also have a much higher hurdle, as medical inflation has historically outpaced the general overall level of inflation. As shown in Figure 1, since 1990, overall CPI has averaged 2.4%, while medical CPI has averaged 4.1%.