Ally’s image shows article title, “The Inflation Situation” with faded stock charts in the background and “Weekly Viewpoint” in the top left corner.

What started as a whimper at the beginning of the year has become louder with each passing month.

Prices are rising all around us.

Copper prices have surged to record highs. The cost of lumber has more than doubled from January lows. Even crops such as corn and coffee have jumped more than 20% since the beginning of April. In fact, commodity prices en masse just logged one of their biggest monthly jumps in the past decade.

Chart titled A Pop in Prices depicts monthly changes in the Bloomberg Commodity Index since 2016. The chart highlights April 2021 at +8.3%. The largest drop, which was -12.9%, occurred in March 2020.

These are the first signs of an economic phenomenon called inflation, and they could eventually mean a lot for your wallet.

So what is inflation? And how can you deal with inflation as an investor and as a consumer?

The State of Inflation

First, it’s important to understand why we’re seeing inflation.

There are several economic factors that can help drive inflation. Two of these are big drivers right now.

The first is an increase in the money supply. Simply put, the U.S. is printing more money to help pay for the $5 trillion of stimulus efforts that have been enacted over the past year. That leads to more money in consumers’ and businesses’ wallets, and higher spending can lead to higher prices.

The second factor is a basic case of supply and demand. As different regions are gradually emerging from the COVID-19 pandemic, both consumers and businesses alike are flooding the market with pent-up demand for products.

Right now, inflation is mostly apparent in commodity charts, but it’s slowly creeping into real life. You’ve probably noticed an increase at the grocery store or in your gas or electric utility bill each month. According to AAA, the national average price of unleaded gasoline is up 30% since the beginning of the year.

Remember that rise in lumber? In late April, the National Association of Homebuilders estimated that the wood for a new house would cost $36,000 more than it did a year ago. And that was when lumber prices were 25% lower than now.

Inflation and the Growth Boom

Most investors view inflation with a negative slant. Yes, it’s true that rising prices mean your paycheck may not stretch as far in the future, and runaway inflation has led to economic downturns in the past.

But in small doses, it can be a positive sign that an economy is healthy and growing. And that can be a boost for the stock market.

The U.S. has experienced robust job growth of late – even though hiring slowed in April – and millions of Americans have also received stimulus payments from the government. Those factors helped drive 6.4% of annualized GDP growth last quarter.

The key question for coming quarters is: Can businesses pass along rising costs to their customers? That appears to be the case so far, according to company accounts and the 80% of S&P 500 companies that have exceeded earnings estimates this quarter.

From there, it’s a question of if consumers can pay those prices or if the price increases overwhelm the consumer. That depends on whether wage increases keep up with price increases.

The Data

So where do we stand on the inflation front? We’ll get some clues in the upcoming week’s reports.

The core reading of the consumer price index (CPI), which excludes food and energy prices, is expected to show 2.3% year-over-year growth in April, the highest since the pandemic began. Year-over-year readings are a bit misleading these days, but the CPI’s monthly increases have been noticeable as well.

Producer price index (PPI) data on business costs will come out May 13. That measure (excluding food, energy and trade) showed 3.1% core annual growth in March, which was its highest reading in years. Data points from the Institute for Supply Management show that all 18 manufacturing industries it tracks have seen commodity costs increase each month in 2021.

Chart titled Industries Across the Board Deal With Higher Costs tracks the percentage of industries reporting higher raw material prices since 2016. The largest drop occurred in late 2018 and early 2019 when it dropped from over 90% to nearly 30%. The percentage rose sharply in early 2020 from under 20% to over 90% again.

Again, the key item to watch is whether these costs can be passed along to customers. And right now, that seems to be a good bet.

Inflation and Your Portfolio

If inflation pressures prove temporary, as Fed Chair Jerome Powell, Treasury Secretary Janet Yellen and many other market watchers believe, then there may not be as much for investors to be concerned about. And there are signs that this recovery may be more uneven with hiring issues in the job market.

If the U.S. economy continues to grow at a strong pace, the environment could favor cyclical sectors. Think financial stocks and industrials, although the latter group is currently footing the bill for these higher commodity costs in order to meet customer demand.

Should higher prices become the “new normal” for longer than just a couple of months, it could favor investors that have exposure to commodity producers in energy and basic materials sectors.

Bond investors could also find inflation protections through TIPS (Treasury Inflation-Protected Securities) and non-traditional assets (including crypto), especially if stock prices are impacted by higher costs and interest rate expectations.

The Bottom Line

Signs of rising inflationary pressure are increasing, and there are two opposing camps forming on just what that means. We think this brewing inflation spike could be temporary, and we don’t expect it to weigh significantly on economic growth or the market.

But it’s a risk we’re watching, and one for which we think investors should be prepared.

Sign up to receive the Weekly Viewpoint and other top market insights delivered to your inbox.

Callie Cox, senior investment strategist, contributed to this article.

  Speech bubble icon next to text "Expert Take"

Headshot of Lule DemmissieAs president of Ally Invest, Lule leads Ally Invest Securities, Ally Invest Advisors and API business lines. She is responsible for the products and services delivered to Ally’s all-digital client base, the shaping of the end-to-end client experience, and the management of the P&L and growth strategy for the business. Lule has a passion for investor behavior and agile product development and an appreciation of design thinking in shaping user-centric experiences.

An advocate for financial and retirement solutions that rely on a mix of digital and human guidance, Lule believes in empowering individuals, especially women and minorities, to independently drive their own financial futures.

The opinions expressed here are not meant to be used as investing advice. For more information, visit our website.