What inflation is, why it matters, and how it’s measured
Hi everyone, and welcome to this new video.
Today we’re going to talk about a word we hear all the time, especially lately, but few people still truly understand what it actually means.
We’re talking about inflation. What does it really mean for us as citizens and for investors?
How is it measured in Europe and in the United States? And above all, how does it impact financial returns?
Let’s explore that together in this video.
Let’s start with something fundamental: where do we get the inflation data from?
In Europe there’s the Eurostat, which publishes the HICP, that stands for Harmonized Index of Consumer Prices.
In the United States, on the other hand, that job falls to the BLS, which publishes the well-known CPI every month, also called the Consumer Price Index.
All of these institutions gather thousands of data points on prices of goods, services, food, transportation, rent, energy, and so on, and from that they produce both monthly and annual figures.
But let’s take a concrete look at what this all really means.
Inflation data in Europe: Eurostat and HICP
First of all, I always recommend going directly to the source. Don’t rely on third-party websites, don’t look for summaries or “ready-made meals,” so to speak. Really go deep and look for data from authoritative sources.
As far as Europe is concerned, as we said, we can get the data from the Eurostat website. Once we’re inside, we can click on “Explore Data,” then “Database,” and from there we can retrieve the price index.
Now the process is really simple, and we can get just about everything we need here.
Inflation in the United States: BLS and CPI
To retrieve U.S. inflation data, I actually recommend using the official Federal Reserve website rather than BLS.gov.
Here it is. From here, we can search for whatever we want.
We can click on CPI, and all the inflation indexes will show up.
The one we’re interested in is the CPIAUCSL, that’s the seasonally adjusted Consumer Price Index.
What does “seasonally adjusted” mean? It simply means it takes into account the fact that some products might cost more or less depending on the season, like natural gas, which is used for heating homes in the winter, so it’s naturally going to cost more in winter than in summer when less people are using it.
The same logic applies to food products.
And here it is—this is public enemy number one for Americans.
On this website, we can download data all the way back to 1947. You’ll see that the adjustment was made in 1982–84, when the index was set to 100. So, anything before that is below 100, and anything after is above.
The index today stands at around 320. That means it has more than tripled since the 1980s. So now it takes over $320 to buy what $100 could buy back in the ’80s.
How investors can analyze inflation data
Now, after this quick overview on how to retrieve data, let’s take a look at how we can analyze them, and how they can be analyzed from an investor’s perspective.
I’ve downloaded the data and imported them into MultiCharts, which is a platform we use to study and analyze data, and here I’ve plotted a very simple chart of the S&P 500 with the CPI shown underneath.
Inflation and the markets: comparing the S&P 500 and CPI
After that, I simply normalized the U.S. stock index with the CPI to see what the real returns have been within the U.S. stock market.
It’s easy to think the US stock index has grown by an average of 8%, but in reality, we’re overlooking the effects of inflation.
For example, earnings that constantly seem to be rising… yes, that’s also tied to the fact that life simply costs more.
Today we pay €1,000 for an iPhone, whereas 15 years ago it cost €300 or €400. Sure, technology evolves and there are many other variables, but overall, tech products are more expensive, just like life in general.
Earnings may increase, but not necessarily because a company is growing bigger and stronger. It’s often simply because inflation rules everything, and like the tides, it lifts or lowers the prices of everything.
This is a very broad concept, of course. It’s just a first step to help us understand what the real returns on the US stock index might actually be.
There are many other factors we’d need to take into account. We don’t have time in this video, but if you’d like to dive deeper, we can definitely talk about it in another one.
What I wanted to highlight here is that, as tempting as stock market returns may look, if we compared the same index but adjusted for inflation, we’d see that instead of +300% or +400% gains in recent years, we’d be looking at a much smaller return.
That said, it’s not like we’re talking about something that loses value over time. On the whole, it does go up.
The darkest periods for the index in the last 30 or 40 years were during the DotCom bubble around 2000, and then again in 2008.
How inflation impacts investing
The recovery, when looking at prices not adjusted for inflation, happened in April 2013.
But if we want to see the real recovery when considering inflation-adjusted returns since 2000, we’re not talking 2013 anymore. We’d have to push it out to May or June of 2015.
From that point on, yes, returns have had some impact. We could also look at this chart using a logarithmic scale to smooth it out, but this non-logarithmic version gives us a much clearer view of the real impact and what we really need to consider when thinking in financial terms.
Key takeaways
So, to wrap things up: inflation isn’t just a number we hear on the news. It’s one of the most powerful forces that shape our everyday lives, both as consumers and as investors.
To protect yourself from inflation and invest with awareness, you need to track it constantly and compare it against the assets in your portfolio.
Make sure to always keep it in mind, because it’s a heavy-hitting enemy for anyone trying to preserve their purchasing power and protect their investments.
We’ll see each other again soon with new videos here on this channel. Bye for now, and until next time.
