The document discusses inflation and its potential impacts given policy changes under the new US administration. It notes that inflation has eroded purchasing power over the long-term and that equities have historically outperformed bonds and cash in inflationary environments. However, unexpected high inflation in the short-term could negatively impact the economy and markets. The conclusion is that the potential for higher inflation exists, which increases the difficulty of holding cash, so flexibility and risk management are important.

1. Market Perspective – February 2017
Experience Insight Impact
biegelwaller.com
Overview: Since the election, undercurrents of inflation have reemerged. Considering the
possibility of meaningful policy shifts under the new administration, we find it important to
explore various aspects of inflation – how it impacts investors (and consumers) and what
expectations look like moving forward.
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2. Experience Insight Impact
What Is Inflation And Why Is It Important?
• Inflation is the rate at which the
general level of prices for goods
and services rises.
• The concept of inflation is
important to understand because
it erodes the purchasing power of
money.
• The Consumer Price Index (CPI)
measures the weighted price
average of a basket of consumer
goods and services (i.e.
transportation, food and medical
care).
• According to the CPI, due to
inflation, a weighted basket of
goods and services costs 5x more
today than it did prior to the
1970s.
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U.S. CPI Index
Source: Bloomberg

3. Experience Insight Impact
Long-Term Inflationary Impacts
The biggest impact of inflation is its erosion of purchasing power, which has profound negative implications to
holding cash.
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Ten Year Treasury Yield

4. Experience Insight Impact
The Historical Inflation Perspective on Stocks and Bonds
• Due to loss of purchasing
power from inflation, it is
important to focus on
investment returns in
excess of inflation (i.e. real
returns).
• Equities have delivered
returns comfortably in
excess of inflation while
fixed income’s returns
were barely above
inflation over a long
period of time.
• Equities offer superior
inflation protection over
traditional fixed income,
albeit with far greater
volatility.
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Ten Year Treasury Yield
10-Year Note Yield

5. Experience Insight Impact
What May Change Going Forward?
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Yield Difference:
U.S. 10 Year Note
– 10 Year TIPS
Source: Bloomberg
Going forward, there are a number of reasons
to believe inflation may accelerate from the
roughly 2% rate that we see today.
• A border tax would likely raise prices on
many foreign goods
• A falling unemployment rate with tight
labor market conditions
• Prospects for deregulation that would
stimulate economic activities
• Fiscal stimulus (e.g. infrastructure spending)
• The Fed’s pace of raising rates is slower
than the market expectations
In fact, inflation expectations have been
steadily rising.

6. Experience Insight Impact
How Could Higher Inflation Impact the Real Economy and the Financial Markets?
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Low, stable, expected inflation is not bad
for the economy. Deflation hurts the
economy as it encourages economic
participants to delay purchases in
expectations of prices going lower. As a
result, economic activities decline. The
best example is Japan, illustrated on the
left. Stagnant CPI has largely coincided
with growth-less GDP levels.
Unexpectedly, accelerating inflation
reduces households’ real income and in
general shrinks corporate profit margins.
However, as previously discussed, higher
inflation makes holding cash very
difficult as investors will face negative
real returns in a near-zero interest rate
environment.
Japan
Nominal
GDP
Japan CPI
Source: Bloomberg

7. Experience Insight Impact
How Could Higher Inflation Impact the Real Economy and the Financial Markets?
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S&P 500
CPI %∆YOY
Source: Bloomberg
Despite clear long-term outperformance of equities in excess of inflation, periods of
high accelerating inflation beyond expectations may result in a weak economy and
markets. This experience was demonstrated in the 1970s, due to unexpected higher
prices, which reduced real income and shrunk profit margins.

8. Experience Insight Impact
Investing During A Rising Rate Environment
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Over the long-term, equities (and other tangible assets) have served as effective inflation hedges.
Within the fixed income category, floating rate loans and shorter term bonds have outperformed during
inflation. These instruments have the ability to reset to the higher rates which accompany inflation.
S&P 500
CPI %∆YOY

9. Market Perspective – February 2017
Experience Insight Impact
biegelwaller.com
Conclusion: Given the current policy goals and objectives in Washington, the potential for higher
inflation exists. In the short run, this could make “holding cash” (which earns very little) more
difficult for investors. Flexibility and risk management remain essential to the investment process
in order to adapt to the rapidly changing landscape under the new administration.
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10. Experience Insight Impact
Disclaimer
Opinions expressed in this commentary may change as conditions warrant and is for informational
purposes only. Information contained herein is not intended to be personal investment advice for
any specific person for any particular purpose. We utilize information sources that we believe to
be reliable but cannot guarantee the accuracy of those sources. Past performance is no guarantee
of future performance; investing involves risk and may result in loss of capital. Consider seeking
advice from a professional before implementing any investing strategy.
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